- Recent policy signals indicate that “re-balancing” the Chinese economy away from investment and manufacturing towards consumption and services is no longer a priority.
- Policymakers now believe that high investment and manufacturing shares of GDP are necessary for achieving technological self-sufficiency and managing the impact of demographic aging.
- Pro-consumption and pro-services policies that encouraged investment in sectors like healthcare, education, and tourism may become less important in the coming years.
For the last decade, China’s economic policy has aimed to promote so-called “re-balancing” of the economy to address two related imbalances: first, an excess of savings and investment over consumption and second, an excess of manufacturing and construction over services. Though policymakers acted more slowly and cautiously than institutions like the IMF and World Bank would have preferred, Beijing accepted these institutions’ basic diagnosis of China’s economic challenges. This diagnosis held that excessively high savings rates led to wasteful, debt-fueled investment at home and tension-inducing trade surpluses abroad.
The resulting prescription was to reduce savings and investment as a share of GDP, while the boosting consumption share. Among various forms of consumption, consumer services like health care, entertainment, education, and tourism were viewed as especially promising growth areas. Now, however, evidence is mounting that Chinese policymakers no longer view re-balancing as a key policy objective. This shift has important implications for analyzing which sectors of the economy will receive policy support in the years ahead.
Re-balancing and similar policy concepts remain present in Chinese policy rhetoric. Last year the Politburo created a new phrase, “demand-side reform,” that appeared to signal a commitment to redistributive tax-and-transfer policies and expanded social welfare spending. Reducing income and wealth inequality would facilitate re-balancing towards consumption, since lower-income households save a lower share of income on average then richer households. An enhanced social safety net would reduce households’ incentive to save for future expenditures on healthcare, education, and pensions. Similarly, Premier Li Keqiang’s annual government work report in March promised to “boost consumer spending across the board,” while the 14th Five-Year Plan (2021-2025) includes a chapter on “creating a robust domestic market.” Yet another policy slogan that debuted last year, “dual circulation” also appeared to imply policies to reduce reliance on exports (“international circulation”) by boosting domestic demand (“domestic circulation”).
Yet policymakers have so far not fleshed out these broad slogans with concrete policies. Indeed, the pandemic highlighted China’s persistent unwillingness to embrace redistributive economic relief and stimulus policies. Whereas most economies relied on unemployment benefits and other direct cash assistance to households as the main tools to buffer the pandemic’s economic impact, Beijing stuck to its traditional playbook of supply-side stimulus targeted at companies, despite a surge in unemployment in early 2020. Further policies to promote income equality may yet arrive, as the government is currently preparing an action plan on “common prosperity,” but there is little sign that aggressive action is pending.
The benefits of high investment
Meanwhile, other recent policy statements suggest that Beijing favors continued high rates of investment. The most important of these is the push for technological self-sufficiency and indigenous innovation, an effort that will require large-scale investment in research and development and advanced factories. A second trend is the call for investment in “new infrastructure,” which includes 5G base stations, cloud computing centers, clean energy, and artificial intelligence add-ons to traditional transport infrastructure. The idea is to maintain the role of infrastructure investment as a key driver of overall economic growth, while diverting investment away from traditional infrastructure (transport, power, and water), where returns on investment have fallen.
A third policy trend is the desire to prevent de-industrialization and maintain a robust manufacturing sector. The 14th Five-Year Plan calls for holding the manufacturing share of GDP, which was 27% in 2019 (compared to 9% in the UK, 10% in France, 11% in the US, UK, and France and 21% in Japan) “basically stable.” By contrast, the 13th Five-Year Plan pledged to raise the services share of GDP to 56% by 2020 (the actual share was 54.5% last year), a target that is absent from the 14th.
The manufacturing-to-GDP target reflects the Chinese leadership’s desire that China avoid the fate of some developing countries that have suffered “premature industrialization,” i.e., de-industrialization that occurs before countries achieve high- or even middle-income levels. Even for rich countries, the coronavirus pandemic arguably exposed significant weaknesses related to the loss of manufacturing capacity. The ability of China’s factory sector to quickly scale up production of medical equipment supported the notion that given various positive spillovers, manufacturing contributes more to a country’s overall national strength and prosperity than the same unit of value-added from services.
All three of these policy trends suggest an interpretation of “dual circulation” according to which the goal is to increase reliance on domestic demand but not necessarily domestic consumption. On this view, maintaining high levels of investment demand, while re-directing this demand towards “new infrastructure” and high-tech manufacturing, can reduce reliance on foreign markets without resorting to consumption-driven growth.
“Consumption is never a source of growth”
The People’s Bank of China (PBoC) published a working paper in late March that makes a similar argument. It analyzes the economic challenge arising from China’s demographic aging and concludes that as the working-age population declines, the correct response is to pursue capital investments designed to substitute machines for workers. Japan is cited as a positive model. The paper states:
“We must recognize that consumption is never a source of growth. We must understand that it is easy go from frugality to extravagance, but difficult to go from extravagance to frugality. The high consumption rate of developed economies has historical reasons; once you switch, there’s no going back, so we should not take them as an example to learn from.”
The paper received heavy attention online and reads more like an op-ed than the highly technical analyses typical of PBoC working papers. Though not an official statement of government policy, the paper appears consistent with the trends noted above.
Despite these trends, however, both the consumption and services shares of GDP – which have risen slowly over the last decade – are likely to continue rising. Demographic aging tends to reduce national savings, as retirees stop working and draw down savings. Similarly, the services share of total household consumption tends to rise along with per-capita income, as households shift towards nonessential items. Nevertheless, the trends above broadly suggest that re-balancing is no longer a top priority. This conclusion implies that sectors like healthcare, education, and tourism – which were popular investment targets over the last decade – may enjoy less policy support in the years ahead.