China decrees consumption!

It’s official. China’s 12 Five Year Plan confirms that China has a two speed economy that makes Australia’s two speed economy look thoroughly normal. On one side of the two speed economy is the private sector, which is well documented in an overview by The Economist. Ninety per cent of China’s 43 million companies are private, and the return on equity of unlisted private firms is 14%, compared with  higher than the modest 4% achieved by wholly or partly state-owned enterprises. On the other side of the two speed economy is the SOEs and heavy industries, which were initially promoted in the 1st Five Year Plan (1951-1956). They still enjoy tremendous privileges and have almost tripled in size between 2003 and 2008, according to the European Chamber of Commerce. They are capital-intensive and create few jobs, which is one reason why wages have not kept pace with GDP.

The dominance of the SOE/heavy industry side of the economy is one reason why China’s economy is skewed towards investment. The strategy was to identify about 200 SOEs in key sectors, i.e. telecoms, oil, defence contractors, chemicals, banking, steel, coal, etc.  They were professionalised and subjected to much tougher corporate governance standards.  Many were listed or merged, about 140 remain. It was designed to provide capital for the CCP. The SOEs paid little or no tax, or provided dividends, to the government.  The plan was to make them big enough to provide a social safety net and fund education and health.

The GFC changed that. Realising that there was a lack of consumption in the economy the CCP has instigated a massive fiscal stimulus over the last two years. But the problem has not been solved. Boosting consumption in China has been an official goal of the CCP since 2004, but since then it has actually fallen as a percentage of GDP. Wen Jiabo was comparatively open about the problems in the 12th Five Year Plan, referring to a lack of high quality educational and medical resources, and problems of income distribution. In the previous 5 Year Plan such references by Zhu Rongji were extremely perfunctory. Wen’s comments reflect an intense debate within the CCP about whether to pursue Western style reform or pursue a “Beijing consensus” state centred capitalism. The speech followed up his comments in 2008 about the paradox of the Four Uns – strong economic growth concealing a system that is unstable, unbalanced, unco-ordinated and ultimately unsustainable.

The shift was flagged by Stephen Roach, of Morgan Stanley:

Instead, under the new plan, China will adopt a more labor-intensive services model. It will, one hopes, provide a detailed blueprint for the development of large-scale transactions-intensive industries such as the wholesale and retail trade, domestic transport and supply-chain logistics, healthcare, and leisure and hospitality.  Such a transition will enable China to create far more jobs.  With the employment content of a unit of Chinese output more than 35 percent higher in services than in manufacturing and construction, China could actually hit its employment target with slower GDP growth. Moreover, services are far less resource-intensive than manufacturing, offering China the added benefits of lighter, cleaner, and greener growth.

The new plan’s second pro-consumption initiative will seek to boost wages.  The main focus will be the lagging wages of rural workers, whose per capita incomes are currently only 30 percent of those in urban areas.  Among the reforms will be tax policies aimed at boosting rural purchasing power, measures to broaden rural land ownership, and technology-led programs to raise agricultural productivity.

But the greatest leverage will undoubtedly come from policies that foster ongoing and rapid migration from the countryside to the cities.  Since 2000, annual rural-to-urban migration has been running consistently at 15-20 million people.  For migration to continue at this pace, China will have to relax the long-entrenched strictures of its hukou, or household registration system, which limits labor-market flexibility by tethering workers and their benefits to their birthplace.

Boosting employment via services, and lifting wages through enhanced support for rural workers, will go a long way toward raising Chinese personal income, now running at just 42 percent of GDP, half that of the United States.  Major efforts to shift from saving toward spending are also required to boost Chinese private consumption.

That issue frames the third major component of the new plan’s pro-consumption agenda – the need to build a social safety net in order to reduce fear-driven precautionary saving.  That means social security, private pensions, and medical and unemployment insurance – plans that exist on paper but are woefully underfunded.  For example, in 2009 China’s retirement system assets – national social security, loal government retirement benefit plans and private-sector pensions – totalled just 2.4 trillion yuan ($364 billion).  That boils down to only about $470 of lifetime retirement benefits for the average Chinese worker.  Little wonder that families save out of fear of the future.  China’s new Plan must rectify this shortfall immediately.

The emphasis on the Chinese consumer is likely to be the new Plan’s defining feature – sufficient, in my opinion, to boost private consumption as a share of Chinese GDP from its current rock-bottom reading of around 36 percent to somewhere in the 42 to 45 percent range by 2015.  While still low by international standards, such an increase would nonetheless represent a critical step for China on the road to rebalancing.

It would also be a huge boost for China’s major trading partners – not just those in East Asia, but also growth-constrained European and US economies. Indeed, the 12th Five Year Plan is likely to spark the greatest consumption story in modern history. Today’s post-crisis world could hardly ask for more.

This is very much the tenor of the Plan. The era of China’s being the world’s factory is coming to an end, for a number of reasons. It has long been obvious that China cannot pursue a mercantilist, trade-based approach like Japan or Korea. It has to be a continental economy. And that means boosting internal demand.

China’s comparative advantages are also fading. There are already strong signs of wages growth. Excess labour is drying up and the population is beginning to age. Wage growth is projected to be 20% over the next few years. China’s wage differential in the global economy is beginning to fade, and there are few signs that it can keep pace with developed economy’s innovation, despite its aggressive approach to absorbing (or stealing)  Western intellectual property.

The shift away from SOEs, heavy industry and state capitalism was implied by Wen Jibao when he admitted that China’s service industries, which last year accounted for 43% of GDP and 35% of employment, had not met targets.   At China’s current stage of development the service sector should be about approaching 60% of GDP, mostly from private sector labor.

Which is where the other, private side of China’s two speed economy comes in. The “Bamboo Capitalism” to which The Economist refers. Much of this business activity is going on, if not outside the law, then certainly outside the state controlled sector. It is likely to get stronger and shift China to a more conventional mid-industrial style of economic development.

This private, more consumption driven, sphere lurks underneath the latest Five Year Plan. It spells the end of the very concept of the Five Year Plan and state controlled economic growth. What will probably happen is that the state-centred side of China will start to fade and the private sector will continue to burgeon. But whether that leads to stability, balance, co-ordination and sustainability is a moot point. Because its political implications are not congenial to a communist central government.

Comments

  1. Pettis argues that China can’t rebalance consumption and investment without slowing GDP. He says the Chinese authorities will attempt to slow credit growth and investment, but when it begins to hurt the GDP numbers they’ll panic and jump on the accelerator again.

    Roach keeps banging on about the rural-to-urban migration (like most China boosters) but neglects to point out China has 65 million empty apartments … And BTW, that’s where the lion’s share of China’s post-GFC investment binge went –> empty apartments.