President Chi Fulin, fellow panelists, ladies and gentlemen
It is truly a great pleasure and honor to be invited to address this International Forum on China Reform, and to celebrate with you the 30th anniversary of the China Institute for Reform and Development. The Institute has played an important role in the process of reform and opening up and we in the World Bank cherish the partnership we have enjoyed throughout this time.
I have been asked to speak about Chinese consumption and its impact on the world economy. Actually, the organizers gave me the choice to pick another topic, but I found this one important and interesting so I will follow the instructions I received.
To summarize the main point I wish to convey upfront: if China succeeds in shifting the balance of domestic demand towards consumption, while sustaining rates of growth in the range of 4-5 percent over the coming decade, Chinese consumers could indeed become the locomotive of the world economy, taking over the baton from US consumers, who have played this role for the past two decades if not longer. However, this outcome depends on a number of policy choices. An alternative scenario in which China’s savings rates remain at recent record levels would aggravate domestic debt risks and may in fact slow growth or cause growing tensions related to Chinese trade surpluses and capital exports or a combination of both. China’s households, businesses and trading partners thus must hope that the shift is successful.
Let me briefly elaborate this point.
China is the world’s largest trading nation, a position it gained more than a decade ago. The reforms that led to China’s WTO accession exactly 20 years ago initially brought access to foreign capital and technology, which rapidly translated into growing export competitiveness, which in turn increased the demand for commodities and intermediate inputs, making China today the largest trading partner for the majority of the WTO’s 164 member countries.
So clearly China’s market is a crucial one for many countries, including many developing countries. This became apparent in the aftermath of the global financial crisis, when China’s large domestic stimulus triggered a boom in commodities that helped the developing world emerge from the crisis far quicker than the advanced economies.
Today the world economy faces another crisis. Yet, China’s role this time around is different. With fiscal space, particularly at the local government level, more limited and with corporate leverage at record highs, the authorities have enacted a much more modest stimulus, roughly half the size in percentage points of GDP than during the global financial crisis, and much below the efforts in Europe, Japan and North America.
As a result, this time around, it is China that is benefiting from a boom in global demand for manufactures – helped by the fact that COVID related restrictions to supply were lifted much earlier in China than elsewhere. After declining from around 10 percent of GDP in the years preceding the global financial crisis to just 0.2 percent of GDP in 2018, the current account moved back to a surplus of close to 2 percent of GDP in 2020 and 2021. It seems China is benefiting from revival of global consumption demand rather than the other way around.
One of the reasons for these developments is that while the authorities are rightly cautious about fueling another debt-financed investment cycle, they have not succeeded so far in replacing investment as an engine of growth with domestic consumption. Standing at around 38% of GDP in 2020, private consumption is only marginally higher than in 2010 and almost 10 percentage points below what it was in two decades ago. These are unusually low levels by any international comparison, and they reflect a combination of high household savings and a low share of disposable household income in GDP.
What measures could lower the propensity of households to save and increase household disposable income? Aggregate household savings are determined by host of factors, including demography, inequality, and the strength of a country’s social security system. The rapidly aging population will tend to bring household savings down over the coming decades. Measures to reduce inequality of opportunity – particularly by widening access to quality education for all – and to further enhance coverage and benefit levels for China’s social security system would help reduce the need for precautionary savings. Household disposable incomes would rise with increasing government transfers and with a growing wage share in value added, as labor markets tighten thanks to the demographic transition and with measures to strengthen workers’ rights.
Some of this is envisaged under the banner of “common prosperity”. Key targets under Zhejiang’s pilot program, for instance, cover the ratio of urban to rural incomes, the share of wages in GDP, average years of schooling and the share of out-of-pocket health expenditures in total health spending. The government has also tried to reign in house price inflation and increase public investment in social housing, thereby reducing the savings motive associated with the growing difficulty for labor force entrants to get onto the housing ladder.
Will this be sufficient to raise consumption as a share of GDP? Some analysts believe it might. According to Robin Xing of Morgan Stanley, for example, private consumption as a share of GDP could rise to 48 percent by 2030, creating a domestic market of US$12-13 trillion, more than double the value of private consumption today and just shy of current levels in the US. If the share stays at 38 percent, the market would grow to just around US$9 billion.
The impact of these trend on China’s trading partners is enormous, not only because of market size but also because of the likely shift in the composition of import demand. Today, more than a third of Chinese imports are commodities, up from 20% two decades ago. The share of low and medium technology content manufactures meanwhile has declined from over half in the mid-1990s to less than 30% today. A shift in the composition of China’s demand towards consumption would likely reduce the weight of commodities in imports and boost market opportunities for labor intensive, low technology goods. This would present a major opportunity to China’s trading partners in the developing world, just as the growth in US consumption helped first European and then Asian exporters catch-up.
Since previous speakers have addressed climate change, let me just add that such a shift in domestic demand towards consumption would likely also trigger a shift in the structure of production away from heavy industry and construction towards services and high value consumption goods. Such a structure of production would come with much lower levels of emissions per unit of output. The rebalancing of demand would therefore make an important contribution to China’s climate objectives as well. Policies to put a price on emissions and recycle the revenues generated to lower labor taxes or increase government transfers could accelerate the shift.
But let me close on a cautionary note. After several decades of record investment, returns are declining and in public infrastructure and real estate, it is not too difficult to find cases of excess. Tightening regulations and de-risking on the one hand and slowing aggregate growth prospects on the other may bring investment rates down. Should they decline more rapidly than domestic savings, the result would be rising current account surpluses along the lines of what we have seen in the past two years. China’s experience over the past decade or so reveals how difficult it is to invest these surpluses productively abroad. Indeed, China’s trading partners and its households and businesses must hope the shift to consumption is successful.
Thank you very much and wishing the Forum the greatest success.