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Low-consumption China needs serious reforms

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In Brief

Despite several years of solid growth in China’s domestic household consumption, as a share of GDP this sector has declined from around 55 per cent in the early 1980s to around 34 per cent in early 2011.

China’s 12th Five-Year Plan clearly indicates that increased domestic consumption is a major economic restructuring target, and key to achieving this goal will be reforms within the financial sector and policy on healthcare and the environment.

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China’s financial system is beset by problems that curtail domestic household consumption. Beijing has consistently made poor lending decisions for its state-supported projects over the past decade, a fact which has inevitably propagated non-performing loans (NPL). Beijing has thus established a number of state-run asset-management companies and injected large amounts of foreign currency reserves into the ‘Big Four’ banks, to ensure recapitalisation. But it is Chinese households that are ultimately left to clean up the mess of NPLs, and this through a number of means.

First, by transferring huge amounts of resources to pay for expected losses on NPLs, bank regulators have captured a significant portion of Chinese income that could have funded consumption. Second, regulators have mandated a wide spread between deposit and lending rates. The policy aims at keeping both lending and deposit rates low; the first to slow the growth rate of NPLs and the second to ensure bank profitability. Consequently, Chinese savers are forced to accept brutally low returns on their savings, which also serves to constrain household consumption. Third, bank authorities force down the lending and deposit rates in order to address NPLs and to spur investment; and considerably low deposit rates effectively provide incentives to Chinese households to save more and consume less.

Considering Chinese investment is fully financed through domestic savings, household consumption will likely increase with banking-system reform and by relinquishing control on interest rates.

Underdeveloped consumer finance is another issue currently repressing household consumption. Increasing access to and use of consumer credit would stimulate consumption, and if China can expand the use of mortgage credit, educational financing and other consumer finance, a surge in consumption would be possible.

Equally, there can be great difficulty and expense in accessing China’s healthcare system, and while total healthcare spending in China has risen to about 5 per cent of GDP, the government’s share of expenditure has fallen. Poor-quality healthcare provision often drives rural inhabitants to seek better services in urban regions. But the high cost of healthcare in large cities has resulted in a rising number of people being priced out of treatment. Concerns about the affordability of healthcare and the potential for future illness, combined with the lack of any effective social protection scheme, mean Chinese households plan well ahead for future expenses.

But if China can achieve the twin aims of significantly increasing overall government expenditure on healthcare while also limiting related household spending, it could reduce financial strain on Chinese citizens, thus decreasing precautionary savings and increasing consumption.

The government has also introduced initiatives to tackle environmental problems caused by China’s rapid industrialisation and urbanisation — but pollution, drought and flooding remain serious concerns for their impact on public health.

In Chinese mega-cities, air pollution has caused non-communicable diseases (NCDs) such as lung cancer and asthma. Importantly, the explosive increase in the number of people with at least one NCD has led to a reduced ratio of healthy workers and implies more urban dwellers using costly hospital care for longer periods of time. And low-income inhabitants are often lacking in or have limited access to quality healthcare if they develop an NCD. Consequently, these sectors of the population tend to accumulate precautionary ‘excessive’ savings for future healthcare spending.

Increasing public concern means these environmental issues (and others) have gradually received more attention in Chinese society. And with environmental reform, Chinese citizens will lead healthier lives in the medium and long run. True, environmental reform might have some negative impacts on consumption growth in the near term; the introduction of an environmental tax could impose extra financial burden on consumers, and consumption growth would likely decrease by 0.38–1.39 per cent.

China’s best bet is to implement bold reforms to encourage a new wave of consumers. Otherwise, there are still significant costs, which are borne one way or another by the country’s households. Keeping this system would only make it more difficult for China to achieve a consumption-driven economy.

Yuhan Zhang is an International Fellow at Columbia University and former Researcher at the Carnegie Endowment for International Peace.

Lin Shi is a Research Assistant at Columbia University and Consultant at the World Bank.

3 responses to “Low-consumption China needs serious reforms”

  1. This is an issue that always seems confusing. Its been fashionable for a while to explain China’s low consumption rate as a result of a combination of precautionary savings and the weak dividend system, plus a few other causes but I haven’t been able to find much evidence that these are really the main causes (of course I agree they are important issues, I’m just questioning whether these are really the main causes of the low consumption rate).

    Surely the reason Chinese consumption is low is that Chinese wages are low. If the Chinese government wants to increase consumption, shouldn’t it focus on increasing the wages of Chinese people? (which it is now doing)

    This was probably best put forward by Aziz and Cui in this IMF Working paper: http://www.imf.org/external/pubs/ft/wp/2007/wp07181.pdf
    I’d be interested to know the reasons you favour explanations like precautionary savings, rather than low wages, for explaining China’s low consumption rate.

    Two other points.
    The authors will have to explain to me are: how ‘brutally low’ deposit rates provide an incentive to save more; and are we really advocating consumer credit as an urgent reform for China after the mess the US got into with this? I think as China reforms its financial system, there are other things that can change first. Let this problem sleep for a little while.

    • Thank you for your comments.

      Lin and I actually argue precautionary savings are not a cause of low consumption. In this essay we deliver a message that after financial/healthcare/environmental reforms, China’s consumers could then be able to spend more.

      The fundamental cause of China’s low consumption as a share of GDP can be found in my piece at http://www.voxeu.org/index.php?q=node/7267

  2. Part of the issue with generalizing about the “Chinese” market is that there is no single statistic (at the macro level) that can really portrays effectively what is going on.

    When it comes to p/cap consumption, energy, or water footprints, it is really important to highlight the difference between the urban and rural footprint and the fact that the average urban footprint is at a par with (or has surpassed) many of the world’s urban populations.

    R

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