China’s Rebalancing Act Sees Limited Progress

While China has made advances in rebalancing its investment-driven economy to one that is consumption-driven, that progress is limited and risks are increasing, according to credit insurer Atradius.

Investments and exports have driven the Chinese economy for decades. As the second-largest economy in the world, China had maintained GDP growth of 10% per year for nearly 30 years. The country’s growth policy was supported by large numbers of workers moving from rural areas to the cities, with only modest increases in wages. Its export policy was supported by the undervalued renminbi. China’s economy remains highly reliant on investments, which have become increasingly credit-driven.

Future growth is not sustainable under this model. The Chinese leadership has sought a transition whereby consumption becomes the driver for growth. In 2013, the Third Plenum meeting of the Central Committee proposed reforms that included an increased role of the market in the allocation of resources, as well as plans to liberalize exchange and interest rates.

In China, about 45% of GDP is devoted to fixed capital investment, a level well above neighboring East Asian countries. Overinvestment and excess capacity in the construction sector and industries such as steel and cement have contributed to a leveling off of China’s productivity. Investment-driven growth has also impeded the growth of personal consumption. The share of household consumption in GDP reached 35.5% in 2010, a low that has increased only slightly since then. (In the U.S., the consumption share is 68.8%.) Chinese authorities believe that if they can grow private consumption, it will foster employment growth and reverse income inequality.

Progress has been made. The size of the industry sector has declined over the past few years, while the services sector has grown, favoring a consumption-driven economy. China’s trade balance has declined, and steps have been taken in opening up the capital account and lifting the peg of the renminbi. Consumption rates are kept down, however, by high savings rates. Chinese families are forced to save large amounts of disposable income due to the lack of developed health care and a pension system. They must self-insure.

After the financial crisis of 2008, consumption and investments were equal partners in GDP growth, with consumption pulling forward in 2011. But the share of total investments in GDP remains high at 45%. While consumption increasingly drives growth, its share in GDP has not risen extensively since its low in 2010.

Further steps toward rebalancing are necessary, according to Atradius. The risk lies in China’s high growth rate, rather than its total debt. The debt problem can be alleviated if the savings rate goes down, if social welfare is extended in order to reduce the necessity of households to save as a precautionary measure. Overcapacity issues in the coal and steel industries have been addressed, but a more comprehensive and centrally led approach is needed, the credit insurer said.

– Adam Fusco, editorial associate

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