16 September 2019
Stimulating domestic consumption is the only way to achieve long-term growth. Photo: CNSA
Stimulating domestic consumption is the only way to achieve long-term growth. Photo: CNSA

How to fix China’s economic dilemma

China’s GDP growth rate eased to 6.9 percent in the third quarter, the lowest level in recent years. The nation’s economy faces mounting downward pressure and has seemingly run out of steam.

The Producer Price Index dropped 5.9 percent in September from a year before, extending the decline to 43 straight months. The Consumer Price Index rose 1.6 percent in September from a year before, and inflation edged up by only 1.4 percent in the first nine months of the year.

China saw double-digit annual growth for decades because of massive investment. However, such a growth model is unsustainable.

The Incremental Capital-Output Ratio has surged to 6 from 3.5 in 2008, compared with global average level of 3. That means it takes six units of capital investment to get each unit of output, reflecting declining margin capital output.

Investment-driven economic growth can’t sustain in the long run. China has to rely on technology development, innovation and human capital to drive long-term growth.

Meanwhile, consumption generates over 60 percent of GDP in developed economies, and over 70 percent in the United States.

By comparison, the ratio of consumption in China’s GDP is 10 to 20 percentage points lower than that of developed economies.

China’s investment still accounts for 45 percent, which mainly stems from private savings. High savings rate has suppressed consumption.

Economic restructuring is a long journey. Private consumption is unlikely to change overnight and can’t offset the negative drag from reduced investment amid the shift to a new growth model.

The massive stimulus package launched in the 2008 financial crisis has stimulated growth through infrastructure investment. However, that also led to overcapacity and excessive housing supply.

Local governments are grappling with heavy debt burden. There is limited room for local governments to further increase their debt levels.

Investment already generates 45 percent of China’s GDP. In this case, government has limited room to further leverage on fiscal measures to boost growth.

Also, China needs to reduce its dependence on net exports, which are subject to external demand.

Stimulating domestic consumption is the only solution to achieve long-term growth.

But it takes time to change consumption habits. Authorities should improve the welfare system to encourage consumption.

However, the government has to reply on monetary measures to stabilize economic growth in the near term, including interest rate cuts, reserve requirement ratio reductions and its own version of quantitative easing.

The People’s Bank of China announced a double-barreled easing on Oct. 23. It’s the sixth rate cut and fifth RRR reduction since November 2014.

It has also expanded the re-lending program into nine provinces and cities. The move is considered China’s version of QE.

However, the capital has been sourced from private savings, which may in turn suppress consumption. That goes against the long-term goal of switching to a consumption-driven economy.

Nevertheless, it remains unclear whether the easing measures could stimulate loan demand of companies amid the gloomy economic outlook.

The Chinese QE is expected to channel financial resources to a targeted group of small and medium-sized companies as well as farmers, which have been neglected by traditional banks.

The new policy may unleash robust loan demand from the targeted group, which would fix the imbalance in the credit market.

This article appeared in the Hong Kong Economic Journal on Nov. 3.

Translation by Julie Zhu

[Chinese version中文版]

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Professor, Department of Economics, HKUST Business School; former senior research economist and advisor, Federal Reserve Bank of Dallas