The decrease of the current account surplus, from 10.1 per cent in 2007 to less than 3 per cent in 2011, is a remarkable change. But despite progress on the external front, China remains internally unbalanced, with consumption occupying a critically low level of GDP. Moreover, the fundamental drivers of China’s economic imbalance are still in place and thus external imbalances may re-emerge in the near future.
Those who believe that China is rebalancing point to several trends. One frequently cited factor is rising wages. The argument is that increasing labour scarcity is leading to rapidly rising wages, thereby increasing the wage share of national income and the consumption share of GDP. Anecdotally, this view seems to be supported by the highly publicised labour strikes in southeast China in 2009 that led to large wage increases. Yet there is little systematic evidence that real wages for urban workers are increasing any faster than they have for the last decade: real wages seem to have been growing on average at an impressive 10 per cent per year during this time. Chinese manufacturers have shown a remarkable ability to offset more than a decade of wage increases with rising worker productivity. Unless worker productivity slows dramatically, wage increases, even if they have accelerated slightly over the past year, will not be enough to expeditiously rebalance the economy.
Others argue that while consumption is low, increasing the amount of consumer credit will quickly bring it back to normal levels. The problem with this argument is that the share of bank loans going to households has risen from next to nothing in the late 1990s to 36 per cent of all loans in 2010. Moreover, according to the IMF’s measure of consumer credit — which includes mortgages, credit cards, auto loans and consumer durable financing — credit availability in China is significantly higher than in countries at a comparable stage of economic development, such as the Philippines and Indonesia. That these countries maintain higher levels of consumption despite lower availability of consumer credit should cause us to be sceptical of claims that growing levels of consumer credit will rebalance China’s economy.
Finally, some economists have recently argued that official Chinese statistics significantly understate current levels of consumption. Implicitly this argument suggests there is no pressing need for policies aimed at rebalancing. The proponents of this viewpoint rely on two alternative measures of consumption to make their argument.
The first is retail sales of consumer goods, which have grown more rapidly than consumption for several years. If this statistic accurately represents consumer activity, then it would mean that the official consumption statistic is missing something. But when you take a closer look at what is included in the retail sales of China’s consumer goods statistic, it becomes clear that relying on this as a proxy for consumer activity is problematic. The statistic combines the sales of both retailers and wholesalers. Moreover, sales are recorded by the point of sale, not the type of buyer. Thus purchases of consumer goods by government agencies, social organisations, military units, schools, as well as by individuals from retail outlets will be included in this statistic. These are significant problems for data accuracy given that private enterprises and self-employed individuals have doubled over the past decade to 30 per cent of urban employment. A growing share of individual purchases of consumer goods in retail outlets is likely to be on behalf of small private businesses and self-employed workers. The employment share of state-owned enterprises, which are much larger and thus more likely to purchase directly through wholesale networks, has fallen from 42 per cent of urban employment to 19 per cent. Given such limitations, this statistic is an imperfect substitute for consumer activity.[1]
The second alternative measure of consumption used is a study by Wang Xiaolu of the China Reform Foundation. The Wang study asserts that the National Bureau of Statistics household survey is flawed because many of China’s wealthiest citizens are reluctant to report their full incomes, resulting in underestimates of household income by 66 per cent and household consumption by 20 per cent. To overcome this flaw, the Wang study has survey staff interview friends and family members. Additionally, unlike the official household survey, which requires participants to document in real time their consumption activities over a set period of time, the Wang survey gathers its information through participant memory.
The bottom line is that any estimate relying on a non-random sample composed of self-recollected income should be viewed with suspicion, as the margin of error is likely to be quite high. There may be problems with the official data on consumption, but this study is not sufficiently rigorous to act as a replacement.
The argument that China’s economy is rebalancing internally seems quite weak. Moreover, the current declines in China’s external surpluses are in large part the result of a weak global economy and a modest appreciation of the renminbi, not fundamental rebalancing. The underlying drivers of the surpluses that emerged during the boom years — negative real interest rates on deposits, cheap credit for business, and subsidised land and input prices — are all still in place. China remains unbalanced internally and its large external surpluses may return once the global economy recovers.
Nicholas Lardy is Anthony M. Solomon Senior Fellow at the Peterson Institute for International Economics. He is the author of Sustaining Economic Growth in China after the Global Financial Crisis.
[1] The inclusion of wholesale trade in reported data on retail sales of consumer goods is confirmed here, in footnote 2. Huang Yiping attempts to correct for this distortion by subtracting from reported data on retail sales of consumer goods sales of building materials and petroleum — items that are not likely to be major direct components of household consumption. However, even this adjusted retail sales of consumer goods concept is likely to overstate the level and growth of private consumption expenditure since private firms and individual businesses likely have purchased a growing share of some other product categories included in official data on retail sales of consumer goods.
If anything, the study and estimation of unreported household income (9.2 trillion Yuan in 2008) by Wang Xiaolu has only hit the tip of the ice-berg.
Across a wide range of industries and services both state and private, most salaries are supplemented with periodic bonus payments of which only one fifth is required to be declared for taxation purposes on the Mainland and one twelfth for declaration in Hong Kong.
Apart from Taxation requirements, the reality on the ground is that all Chinese income earners are reluctant to report actual income and not only the wealthiest of Chinese as stated.
The large amount of undeclared household income goes a long way in explaining the high savings rate and extremely low personal debt of Chinese households not to mention that few Chinese home owners outside of the first-tiered cites have mortgages.
Suppose high income households are hiding their income. It doesn’t follow that their consumption is sufficiently more than middle and lower income ones such that it would lift all consumption outpace GDP growth and the investment component of GDP (thus allowing the consumption component of GDP to increase relative to these; remember the pie is growing so consumption has to to outgrow it to increase relatively).
Indeed, high income individuals are most likely to have globally diversified investments, though surely with heavy weighting in domestic and regional assets (not to mention the largest asset class available to households in China, property).