China's Donkey Of Consumption Drags Its Hooves
The Age
Friday May 30, 2008
The Chinese economy is dangerously unbalanced towards investment, writes John Lee.
CHINESE leaders and economists have been saying for a decade that the country's economy is pulled by two strong horses and one weak donkey. China is too reliant on unsustainably high levels of (inefficient) investment and exports to produce its world-record rates of growth. Consumption has always been the stubborn, old donkey dragging its feet. China's leaders are justifiably worried that the two strong horses will soon run out of puff and the donkey will remain too slow and weak to step up. The economy is dangerously unbalanced, which is worrying for the Chinese but a continued boon - in the short term - for Australia.The problem is that domestic capital is getting less bang for its buck. Ten years ago it took only $2 to produce $1 worth of output. Now it takes six. The Government has constantly reiterated the need to restructure the economy away from an investment-led one. Yet, in the first four months of this year, China's investment spending increased by about 28%. From 2000-07, it increased 20%-40% year on year. In contrast, consumption this year is increasing by only about 15%, despite the rise in average income outpacing economic growth. China's worsening inflation problem - the rate is almost 9% - will further hinder domestic consumption. The consumption donkey is, in historical terms, much weaker today than it has ever been. From 1978 (when reforms began) to 2002, domestic consumption was about 60% of gross domestic product. It is now about 35%. Most respectable economies have levels of about 70%. China's consumption figure is the lowest of any major economy. What impact will the devastating earthquake in Sichuan province have on the Chinese economy? The province accounts for about 4% of Chinese GDP. According to its official media, the earthquake is expected to bring down GDP growth by 0.2% this year while consumption growth will decline sharply in the province and surrounding areas for the next few months. Thankfully, the earthquake largely missed major industrial centres but it did hit the major pig-producing areas hard, bringing an immediate shortage of the staple meat and a rise in prices. But the earthquake-affected regions will undoubtedly now get big injections of state capital as part of urgent reconstruction efforts, leading to a minor spike in investment and further demand for commodities for rebuilding. Official plans for reconstruction are ambitious and some believe that newly built areas will experience rises in consumption once completed. This seems unlikely to be significant. The flow-on economic benefits - especially a rise in consumption - following large injections of money into building projects will eventually cease and consumption is most likely to return to pre-earthquake levels. Even if there was an upsurge in consumption, these were not big industrial and population areas. Hence, in the longer term, the earthquake will have little effect on the trajectory of Chinese consumption. While consumption growth remains modest, Chinese leaders are forced to rely on the same old, inefficient investment strategy to produce the bottom-line growth on which their political legitimacy so much depends. Inefficient, to be sure, but this does provide a silver lining for Australia, if only in the short to medium term.China has been largely responsible for driving up the price of almost all hard commodities, which has been a boon for the Australian economy. Since 1983, China has been responsible for 64% of the increase in global demand for copper, 54% for steel, 70% for aluminium and 82% for zinc. This translates to once-in-a-generation good news for BHP Billiton and Rio Tinto. About four-fifths of Chinese demand for hard commodities is driven by investment in "heavy" projects such as the construction of factories and other buildings, roads and ports. Now running at about 25% in terms of year-on-year growth, Chinese officials have suggested that 10%-12% would be more appropriate. But as Stephen Roach from Morgan Stanley correctly states, such a reduction would produce a "major global commodity downturn".This less reliance on a fixed-investment strategy will only be allowed to occur if domestic demand can pick up the slack - which I have argued is not happening quickly enough. Meanwhile, Australia will continue to rake in the dollars.Dr John Lee is a visiting fellow at the Centre for Independent Studies, which this week released his paper, Democracy on Hold in China.
© 2008 The Age