As most analysts expected, the Chinese Communist Party’s Third Plenum communiqué, released July 18, was much vaguer on demand-side measures designed to boost the role of consumption in driving the Chinese economy than it was on supply-side measures. This was the case even though over the past five to ten years a near unanimous consensus has developed among both Chinese and foreign economists that consumption’s very weak role in driving the economy is the main constraint to sustainable growth in China.
Globally, according to the World Bank, consumption accounts for roughly 75 percent of gross domestic product (GDP), with the remaining 25 percent driven by investment. In China, however, consumption accounts for 53–54 percent of GDP, while investment accounts for an astonishing 42–43 percent of GDP. (The rest is accounted for by China’s trade surplus.)
Despite this consensus, Beijing has been unable to shift the economy away from its overreliance on investment—and, more recently, on its trade surplus—to maintain high growth rates. In early June, American economist Paul Krugman publicly worried in a Bloomberg interview that China’s leaders were “bizarrely unwilling” to use more government spending to support consumer demand instead of production.
But Beijing’s reluctance to support consumer demand might not be as bizarre as it seems. Other countries in similar positions—most famously Japan in the 1980s—also said they wanted to boost the consumption shares of their economies but struggled to do so. Raising the consumption share of the economy is much more difficult than it may at first seem.
This is probably because a low consumption share is not a feature of the economy that is separate from its overall functioning. It is fundamental to the way the economy works, and resolving it requires structural, supply-side changes that are very difficult to manage.
In China’s case, since the early 1990s, growth has been underpinned by a series of transfers. These transfers have subsidized investment in manufacturing, infrastructure, and the property sector—in part by ensuring high and rising savings rates but almost always at the expense of Chinese households. These transfers included the following:
- A strictly managed credit system that ensured Chinese savings, which by the early 2000s had reached the highest share of GDP ever recorded, were mostly directed by government-controlled banks into investments in sectors targeted by Beijing, including transportation and logistical infrastructure, a very efficient communications system, manufacturing plants and equipment, and technology research.
- Repressed interest rates (with highly negative real rates for much of the 2000s) and repressed risk-adjusted credit spreads. These represented a transfer of resources from net savers to net borrowers. Because the household sector was always among the largest net savers and local governments, state-owned enterprises, and large businesses were the largest net borrowers, repressed interest rates forced household savers to subsidize manufacturers and property and infrastructure investors.
- China’s hukou system for household registration, which limited the ability of workers to obtain social benefits and limited their legal rights in disputes with employers. More generally, the limited right of workers to organize kept wages and household income from growing as fast as they might have otherwise. This benefited local governments, state-owned enterprises, and businesses employers at the expense of workers.
- Eminent domain and environmental degradation, which pushed a portion of development costs onto the household sector.
- Inefficient investment that effectively transferred resources from households to businesses. China’s massive investment in transportation and logistical infrastructure was positive for the overall economy in the decades when the Chinese economy was severely underinvested relative to investment it could productively absorb. Beginning in the late 2000s and early 2010s, however, it became evident that an increasing share of this investment was generating negative value creation for the economy. This is when local government debt began to soar relative to GDP, even though most of this debt was directed into investment. (It is worth noting that if investment is productive overall, total debt cannot rise more quickly than GDP except in a limited number of cases over short periods of time.) The problem was that the net costs of inefficient investment were distributed widely throughout the economy (mainly, at first, in the form of a rising local government debt burden), while the benefits tended to be highly concentrated toward businesses, which benefited from an extremely low-cost transportation and logistical network.
These transfers (sometimes amounting to as much as 4–5 percentage points of GDP per year in the 2000s) meant that for decades household income could not keep pace with GDP growth. However, when GDP surged at annual rates of 10–11 percent in the period through the early 2010s, Chinese households barely noticed the impact because their income was also surging. Although this occurred at a much lower rate thanks to the transfers, it was still extremely high (7–8 percent annually). Pressure to close the gap between GDP growth and household income growth only rose more recently as GDP growth rates (especially nominal GDP growth rate) sharply dropped.
These and other direct and implicit transfers meant that China’s global competitiveness in manufacturing was the other side of the coin of China’s very weak consumption. Thanks to these direct and implicit transfers, in other words, China’s extremely competitive manufacturing—and the world’s best transportation and logistical infrastructure—should not be thought of as separate from the country’s extraordinary low domestic consumption. The former exists because of the latter, and one requires the other.
That is why it is so difficult to boost the role consumption plays in the economy. There are basically two ways China can do so.
One way is in the form of a fiscal stimulus directed at the demand side of the economy. Beijing can borrow anywhere between 1 trillion and 3 trillion renminbi, as Chinese economists have suggested, and directly and indirectly distribute the proceeds to households in ways that boost consumption. Besides the fact that many in Zhongnanhai find this to be ideologically problematic, the problem is that this would be a one-off boost and could only be achieved with increased debt. As Beijing wants to rein in an extraordinary surge in debt that has left China with among the most indebted balance sheets in the world, this is not a sustainable solution.
The other way—the sustainable way—is to gradually reverse the transfers so that household income begins to grow substantially faster than overall GDP. Here, the problem is that an increase in the household share implies a reduction in the share of some other sectors: the business sector, local governments, or Beijing.
It is the transfers to these sectors that create the constraint. After three decades when Chinese manufacturers’ global competitiveness was effectively built on transfers in one direction, what would happen to their manufacturing prowess if these transfers were reversed? Their prowess would almost certainly decline, as they would struggle to manage in a significantly less friendly supply-side environment.
One likely result could be a short-term contraction, as Chinese manufacturers learn to live without the implicit supply-side support and essentially return the various subsidies. Because one of the consequences of these transfers has been a disproportionately large manufacturing share of the economy (27–28 percent of China’s GDP, compared to 15–16 percent of global GDP, as I explained in this June 2024 piece), anything that undermines China’s manufacturing competitiveness in the short term is likely to be especially painful for the economy.
This is why Beijing’s unwillingness to boost the consumption share of GDP is not as bizarre as it seems. Raising the consumption share in a sustainable way, as was the case in Japan in the 1990s, implicitly means reversing what has made Chinese manufacturing so globally competitive. The long-term benefits of rebalancing the economy could be overwhelmed by the adverse, short-term consequences to China’s large manufacturing share and its important infrastructure investment.
It is one thing to say—as most analysts inside and outside China now agree—that households should gain additional resources. It is quite another thing to decide how the cost of their gain is to be allocated. If the goal is to avoid any short-term pain, the process is likely to be extremely slow, as was the case with Japan.
