To Jim O’Neill, China’s economic future comes down to a US$4 trillion question.
That’s how much additional gross domestic product (GDP) the former Goldman Sachs bigwig and economic guru who coined the acronym “BRICs” reckons China would contribute globally by raising its share of consumption-to-GDP to 50%. Today, it’s less than 40%.
This is less about what China can do for humankind than the Covid-19 reality dawning on President Xi Jinping. China’s export engine isn’t what it used to be in a pandemic-wracked world. Though the US is stabilizing, the Delta variant is sending fresh storm clouds its way as Europe and Japan underperform.
China thus must expedite moves to get its consumption engine going. Of course, Xi’s government has been pledging to do just that since 2012. That direction was underscored in last year’s announcement of the “dual circulation” policy, which at its core aims to stimulate more domestic demand.
But with the globe enjoying a synchronized growth expansion – a rare occurrence – exports were doing the job, reducing the urgency for China to recalibrate growth drivers.
“It is therefore in everyone’s interest that Chinese consumption demand continue to increase,” says O’Neill. “While it is unlikely that China’s consumption spending will ever reach 70% of GDP, an increase to 50% is a perfectly reasonable and desirable target for both China and the world.”
Trouble is, he adds, “the goal of boosting domestic consumption poses a dilemma for the Chinese development model.” O’Neill notes that investment spending and exports are what have fueled the Chinese juggernaut for most of the past three decades – and especially the early years.
“China’s modest consumption-to-GDP ratio stands in stark contrast to that of the United States, which, at around 70%, is probably excessive,” O’Neill says. “The upshot, in terms of the global economy, is that Chinese consumer spending is technically only about one-third that of US consumer spending.”
Xi’s policies over the last year are working at cross purposes with these goals. Abroad, Beijing’s actions in Hong Kong, its stance on Taiwan and its provocative maneuvers in the South China Sea have alarmed the global community.
At home, his battle against technology companies and their founders is causing stock market turmoil at a moment when Xi needs to re-energize his capital markets. His clampdowns on a growing number of industries at home risks deadening the spirit China needs to develop a more innovative and productive model.
“At the end of the day, China will need the rest of the world if it is to increase both domestic consumption and productivity,” O’Neill says.
“The best way that China can improve its international standing is through soft diplomacy that respects other countries’ preferences and aspirations, rather than treating them as sources of confrontation. Without such a change in attitude, China will not reach its goal of doubling incomes within 15 years, leaving its people – and the rest of us – worse off as a result.”
Granted, it takes two governments to generate the level of enmity currently clouding the global outlook. The US-led trade war since 2017 has pushed China to turn prickly. Donald Trump may be gone, but US President Joe Biden has been slow to unwind taxes on mainland goods and other non-tariff barriers.
But Xi has had a breather. Since January, Biden has spent far more time tending to domestic economic challenges than trying to pull jobs away from China. Biden, it appears, is set on raising US productivity and supporting entrepreneurship.
In other words, he’s more focused on building economic muscle at home than US-China trade dynamics.
China needs to accelerate its own great rebalancing in order to raise GDP rates. The slow pace of change has become particularly apparent in the Covid-19 era. And this belies the popular narrative that China is ready to lead the global economy.
Saving not spending
“The weak recovery in Chinese household spending is certainly holding back the momentum of global growth,” says economist Shaun Roache at S&P Global Ratings. “If anything, China’s growth is being supported by the rest of the world, as reflected in a rising current account surplus” over the last year.
This is not to say that progress has not been made on Xi’s watch. The role of exports in boosting GDP was about 36% in 2016. At the end of 2020, it was roughly 18%. Yet, as Oxford Economics calculates, household consumption ended the year with a 39% GDP share. That compares with a roughly 55% average for other large industrialized nations.
Bottom line, China is still a long way off from scrapping the export and investment growth model that is starting to fall short in 2021. This time around, says Luis Kuijs at Oxford Economics, “the tried-and-true way to stimulate the economy” via boosting investment is no longer working.
Yet, inadvertently or not, Xi’s government is standing in the way of the most direct routes to a domestic demand-led growth model. Xi’s team could turn things around by increasing productivity, re-energizing the stock market, closing urban-rural wealth gaps and letting tech disruptors shake up Asia’s biggest economy.
O’Neill admits he didn’t foresee the extent to which Beijing’s interactions with the rest of the globe would warp the economy’s development. And who, really, could’ve foreseen how Covid-19 would accelerate the devolution of China’s relations with the Group of Seven nations?
Industrial contradiction
First and foremost, O’Neill says, Beijing must resolve what he terms a “major contradiction” in its industrial strategy.
“Typically, an economy’s most productive sectors are in manufacturing, not services; and it is in manufacturing that additional productivity gains are easiest to achieve,” he says. “But China must simultaneously boost the role of personal consumption, which generally implies higher demand for services.”
O’Neill adds that “achieving both objectives simultaneously is easier said than done. I suspect that Chinese policymakers have not yet thought enough about this dilemma or about how it might affect China’s other international challenges.”
Like any other country, O’Neill notes, “China’s economic growth will be driven over the medium term by the rate of productivity growth and the size and composition of its labor force. Because the labor force has stopped growing, additional economic growth will have to come from increased productivity.”
Here, a key priority must be making good on Xi’s stated plan for disposable income to grow at least as fast as GDP, as stated in the Communist Party’s recent 14th Five-Year-Plan.
As Torsten Weller, a policy analyst at the China-Britain Business Council, observes, this effort is key to Beijing’s “dual circulation strategy” that seeks to morph a giant consumer market into “an irresistible magnet” for foreign investment and businesses.
“Yet achieving this goal will require significant reforms,” Weller says.
Weller argues that retail sales have lost ground, dropping back to 2012 levels last year. To reverse things, he says, Xi’s team needs to tackle three deep-rooted problems: the rural-urban divide, low education levels and rising household debt.
The first challenge may be the thorniest.
In 2020, Weller notes, average disposable income of rural households was 61% lower than urban dwellers. This means that roughly 40% of China’s 1.4 billion people in rural areas drive just 22% of overall household consumption. “At this rate, it would take over 120 years for rural households to catch up with their urban peers,” Weller asserts.
The quickest fix: letting more rural Chinese migrate to cities. This would require bold reforms to the hukou household registration system limiting the access of rural Chinese to urban jobs, welfare, education and real estate. China plans to ease these restrictions, but not quickly enough.
Nor has Xi’s government expressed a willingness to let rural Chinese move to the top-tier mega-cities – Beijing, Shanghai, Shenzhen, Guangzhou, Chongqing or Tianjin.
In recent interviews, Chinese Commerce Minister Wang Wentao’s team has been highlighting a so-called “cross-cyclical” approach to recalibrating the economy. This means taking smaller steps sooner to influence policy directions.
It’s a departure from the more forceful “counter-cyclical” policy steps like big interest rate shifts, fiscal jolts or giant infrastructure initiatives.
It’s not clear, though, where efforts over the last nine months to police tech giants fall on the cross-cyclical/counter-cyclical continuum. Sudden moves starting last November to bring Jack Ma and other billionaire tech giant founders to heel are undermining trust in the stock market.
Most recently, Xi’s men tried to spin the scrapping of Ma’s giant Ant Group initial public offering, regulators scrutinizing Didi Global post-IPO in the US, and moves against private tutoring firms as part of a campaign to narrow wealth gaps.
In recent months, Xi’s own talk of “common prosperity” has increased sharply. A Bloomberg News analysis this week found the phrase popped up at least 65 times in Xi’s speeches and meetings so far in 2021 versus 30 in all of 2020.
Markets also are trying to assess a series of calls for the “reasonable adjustment of excessive incomes and encouraging high-income groups and businesses to return more to society.”
Analysts at Morgan Stanley note it’s clear Xi wants to “increase the middle-income group’s share of the economy.” China, they write, has “affirmed its effort to rebalance the economy toward labor, tackling social inequality with redistribution, social welfare, taxes and inclusive education.”
Reattracting the foreigners
Even so, it must be careful not to repel the foreign investment needed to support both China’s $18 trillion government bond market and bourses. After expressing reservations about Xi’s tech crackdown, Cathie Wood, one of Wall Street’s most-watched investors, is reportedly returning to the Chinese market.
On Monday, Wood’s thematic tech-focused Ark Investment Management bought American depository receipts of JD.com. The stocks of JD.com, Alibaba Group and Tencent Holdings have experienced a bounce of late amid investor bargain hunting.
In New York, the Nasdaq Golden Dragon China Index also is having quite a run. On Tuesday alone, it rallied 8%, sparking hope the worst of China’s tech rout is ending.
Yet Beijing’s effort to create a consumer-led economy requires more than the restraint of financial regulators. It requires a bold assortment of clear and methodical policy shifts, says World Bank economist Luan Zhao.
“Policymakers should redouble their efforts toward promoting growth-enhancing structural reforms and steering the economy on to a greener, more resilient, and inclusive development path,” Zhao says.
Getting there means generating higher-quality growth via “mutually reinforcing reforms,” Zhao says. Priorities include more progressive taxation and broader social safety nets to curb income inequality.
And opening up domestic markets. Further reducing the negative list for private and foreign investment coupled with policies to mitigate markets would also help. This, Zhao says, means the financial system should be tweaked to “ensure all firms, regardless of ownership, compete on an equal footing.”
These steps, together with a “strong effort in this direction” of the party’s latest five-year plan, Zhao says, “will raise productivity and incomes and lead to more balanced, consumption-driven, and environmentally sustainable growth.”
Those moves would get China closer to answering O’Neill’s $4 trillion question – and the vibrant consumer-led Chinese economy the world needs.