The Arithmatic of Chinese Consumption

This post draws heavily on M. Pettis.

First - Chinese consumption is not depressed by the "investment model" - which is an effect - it is depressed by trade policies, monetary policies, distorted credit allocation, and rigid financial system. Second, Chinese consumption in the 35% area in 2008 compares to 55%-65% in Europe, Latam 65%-70% and above 70% in the U.S. Other Asian consumption figures are mid 50% - India is an example at 57%.

The flip side is the savings rate in China. From 12-15% in early 1990s, the savings rate rose steadily to 25% in 1998 and only rose to 26% recently. The increase in national savings in the 2000s occurred at the corporate level - though this is due to transfer from households to producers.

China's last trade deficit was in 1996. After that trade surpluses grew to around 5% of GDP in 2003 and then surged to a high of 10% in 2007. Investment grew as a share of GDP, from 23% in 1990, jumped to 31% in 1992-94 where it stabilized, then grew at steadily to 40% by 2008.

The Asian growth model forces households to subsidize investment and production, which generates employment and growth which at the expense of household income and consumption.

In 1992 household income peaked at 72% of GDP, then erratically declined to 66% in 2002, and subsequently plunged to 55%.

Rebalancing is not just a rise in consumption, it is a expansion in Chinese net demand so that China can adjust to dropping net demand in the US in a way that doesn't harm trade partners and escalate trade tensions. Rebalancing is not consumption growing (which is the critical mistake analysts make everywhere), it is consumption growing relative to GDP. In fact, this can occur by GDP dropping below current consumption rates, which would be the worst outcome. The best outcome is for GDP to grow and for consumption to grow more quickly.

If consumption continues to grow more slowly than GDP imbalances get worse, while the trade numbers can be temporarily disguised by surging investment. This only makes rebalancing more difficult and increases the cost if capital is missallocated.

The arithmetic is very difficult. If China grows at 8%, consumption must grow at 11% to raise consumption as a share of GDP from 35% to 36% in a year. To return consumption to 40% of GDP in the next five years (40% is still well below any global consumption rate), at 8% GDP rate, consumption has to grow at 11%; at 7% GDP, consumption growth is 10%. To bring consumption to 50% of GDP in twenty years (the low end of other Asian high savings economies) if GDP grows at 7%, consumption must grow at 9%.

So, if Chinese GDP slows from 14% over the past decade, consumption none the less must surge in excess of 8-9% growth rates of recent years for any rebalancing to take place.