China's Domestic Rebalancing

As worries about economic overheating in China escalate, Chinese policy makers are focusing on domestic rebalancing. China’s new five year plan—recently debated by the National People’s Congress—prioritizes increasing domestic consumption and promotes urbanization, demonstrating Beijing’s commitment to rebalancing.

Steven Barnett, division chief of the Asia and Pacific department at the IMF and Carnegie’s Pieter Bottelier and Michael Pettis assessed the need for rebalancing, its progress, and what can be expected in the future. Carnegie’s Douglas Paal moderated.

Why is Rebalancing Needed?

• Low Consumption and High Savings: Private household consumption in China has fallen to around 35 percent of GDP—among the lowest in the world. As a corollary to its low consumption, savings rates in China are exceptionally high. Barnett argued that a large proportion of savings is likely precautionary, as many Chinese have to save to pay for pensions, health care, and education.
   
• High Investment: At 50 percent of GDP, investment levels in China are also among the world’s highest. Bottelier and Barnett said the high rate has been driven in part by a dramatic expansion of credit following the financial crisis, though investment was already very high by international standards before the crisis.
   
• Current Account Surpluses: China’s current account surplus has fallen from almost 11 percent of GDP in 2007 to close to 5 percent in 2010, but Barnett predicted it will grow again in the coming years.

With much of the world still struggling to recover from the Great Recession, China’s low-consumption, high-investment, export-oriented economy will likely be unsustainable, participants agreed, making rebalancing toward domestic demand necessary.

Correcting the Problem

Rebalancing will require household consumption to rise as a share of GDP—meaning that savings and investment as a share of GDP will fall—and the narrowing of current account surpluses.  Numerous policy changes will be needed to support rebalancing, and the transition may be bumpy.

Bottelier argued that some rebalancing is already occurring and will continue in the coming years.

• Service Growth: Employment in the service sector, which is primarily oriented toward the domestic economy, is rising much faster than employment in manufacturing. Aging among the population will also require a vast expansion of healthcare service employment.
   
• Less Need for Savings: Consumer finance—and therefore access to credit—is improving and government spending on health care is rising, limiting the need for precautionary savings.
   
• Exchange Rate Appreciation: Since June 2011, the RMB/USD exchange rate has been rising at the relatively high rate of at least 10 percent in real terms. If this appreciation is maintained, China’s real exchange rate will no longer be undervalued in a few years, and China’s trade balance will narrow.
   
• Political Changes: Policy makers are well aware of the domestic imbalances and have made addressing them a priority. They plan to use monetary tightening, a lower growth target of 7 percent, and reform of the personal income tax system to help with rebalancing.

However, rebalancing in China is unlikely to be easy. Pettis argued that increasing consumption growth will be difficult, since consumption has already been expanding very rapidly. The only way to viably increase consumption is to transfer wealth from the public sector to households, which many of the current reforms fail to do. Bottelier noted that the privatization of urban housing around the turn of the century was an example of such a transfer (on an enormous scale), but more should be done.

Participants also highlighted the potential problems caused by debt. Rapid investment has led to a rise in debt, and though official and household debt levels are still low, Pettis noted that the China Banking Regulatory Commission has said local government financing vehicles are barely solvent. Financing these debts requires low interest rates, but low rates depress household income and therefore consumption.

Policy Changes

Participants offered several policy recommendations to help ease the transition in China.

• Reduce Investment: Bottelier said that since consumption cannot be expected grow any faster than in recent years, rebalancing will require lower investment. This will slow GDP growth, an outcome Chinese leaders appear prepared to accept, as demonstrated by the lower growth targets.
   
• Financial Sector Reform: Barnett commented that opening the financial sector would lead to higher consumption and lower investment, while bank lending should be based on market forces. Pettis argued that many of the reforms during the past decade, however, have done little to fundamentally change how the financial sector operates.
   
• Greater Social Spending: Participants agreed that greater government spending on health care and pensions would help increase consumption and lower savings, but Pettis noted that this must transfer wealth to the household sector to be successful. Bottelier pointed out that rapidly rising real wages and a shift in employment from manufacturing to service sectors suggest that the low share of household disposable income has probably bottomed out already.
   
• Exchange Rate Adjustment: Barnett said that a continued rise in the exchange rate would help increase household purchasing power and investment in the non-tradable sector, but noted that appreciation is only part of a broader package of reforms.

International Impact

Panelists also addressed questions about how Chinese rebalancing would affect the United States and the rest of the world.

• No Export Boom: Since rebalancing in China should come from slower investment rather than higher consumption growth, Bottelier said that it was unlikely that U.S. exports to China would rise significantly.
   
• No Slowdown: Just as Japan’s economic slowdown in the 1990s did not lead to a slower global expansion, Pettis argued that a slowdown in China will have a minor impact on world economic growth. If China succeeds in narrowing its current account surplus, the impact on the global economy could be positive.

Barnett concluded that, like all major economies, China has a part to play in global rebalancing. Though challenging, this rebalancing is not only in the best interest of China, but also of the world economy.