Date: Friday, August 30, 2024
Source: Wall Street Journal
China’s economy is unusual. Whereas consumers contribute 50% to 75% of gross domestic product in other major economies, in China they account for 40%. Investment, such as in property, infrastructure and factories, and exports provide most of the rest.
Lately, that low consumption has become a headwind to China’s growth because property investment, once a major component of demand, has collapsed.
This isn’t just a problem for China; it’s a problem for the whole world. What Chinese companies can’t sell to Chinese consumers, they export. The result: an annual trade surplus in goods now of almost $900 billion, or 0.8% of global gross domestic product. That surplus effectively requires other countries to run trade deficits.
China’s surplus, long a sore spot in the U.S., increasingly is one elsewhere, too. While China’s 12-month trade balance with the U.S. has risen by $49 billion since 2019, it’s up $72 billion with the European Union, $74 billion with Japan and Asia’s newly industrialized economies, and about $240 billion with the rest of the world, according to data compiled by Brad Setser of the Council on Foreign Relations.
Logan Wright, head of China research at Rhodium Group, a U.S. research firm, said China accounts for just 13% of the world’s consumption but 28% of its investment. That investment only makes sense if China takes market share away from other countries, rendering their own manufacturing investment unviable, he said.
“China’s growth model is dependent at this point on a more confrontational approach with the rest of the world,” he said.
While many developing countries relied on investment and exports to fuel early growth, China is an outlier for how low its consumption is, and its sheer size. In a report, Rhodium estimates that if China’s consumption share equaled that of the European Union or Japan, its annual household spending would be $9 trillion instead of $6.7 trillion. That $2.3 trillion difference—roughly the GDP of Italy—is equal to a 2% hole in global demand.
The sources of this underconsumption are deeply embedded in both China’s fiscal systems and its policy choices.
Chinese incomes are highly unequal, and because the rich spend less of their income than the poor, this automatically depresses consumption. Rhodium cites data that says the top 10% of households had 69% of total savings, while a third had negative saving rates.
Other countries address such disparities by taxing the rich more heavily and boosting the spending power of lower and middle classes through cash transfers, and public health and education. China does much less of this. Just 8% of its tax revenue comes from personal income taxes, compared with 38% from value-added taxes, similar to sales taxes, which fall much more heavily on lower-income families, Rhodium estimates.
China also spends less on health and education than major market economies, forcing poor and middle-income families to spend more of their disposable income on both.
Meanwhile, suppressed wages and interest rates depress household income and spending while boosting the profits of state-owned enterprises. The limited taxing authority of local governments forces them to raise revenue by selling property for manufacturing and infrastructure, which further inflates investment.
A decade ago top Chinese policymakers shared Western economists’ perspective that, at the macro level, China needed to rebalance away from investment to consumption. In 2013, the ruling Communist Party said growth would henceforth rely on market forces and consumers.
President Xi Jinping ended up going in the opposite direction; consumption stayed weak while state control over the economy grew. He has replaced reformers with loyalists more preoccupied with sector-specific targets than overall growth.
The bedrock principle behind trade is comparative advantage: countries specialize in what they do best and then export it in exchange for imports. Xi rejects this principle. In pursuit of “independence and self-reliance,” he wants China to make as much and import as little as possible.
Officials in China boast that it is the “only country to produce in every single one of the United Nations’ industrial product categories,” notes Andrew Batson of Gavekal Dragonomics.
Even as China targets advanced products such as electric vehicles and semiconductors, it refuses to surrender market share in lower-value products: “Establish the new before breaking the old,” Xi has instructed his bureaucrats, my colleagues have reported.
As a result, Rhodium argues, “China provides fewer opportunities as an export market for emerging countries while competing head-on with them in the low-tech and mid-tech space.”
Countries that once saw China as a customer now see a competitor. “Many Chinese businesses are manufacturing intermediate goods, which we mainly export,” Rhee Chang-yong, the governor of the Bank of Korea, said last year. “The decadelong support from the Chinese economic boom has disappeared.”
Mexican Finance Minister Rogelio Ramírez de la O complained last month, “China sells to us but doesn’t buy from us and that’s not reciprocal trade.”
Ironically, foreign officials have tended to see the U.S. as the biggest threat to the world trade system, ever since President Donald Trump in 2018 imposed steep tariffs on China and narrower tariffs on other trading partners. He has promised to expand those tariffs if elected this fall.
And yet Trump’s tariffs should be seen as a reaction to China’s beggar-thy-neighbor economic model, one that has proved impervious to existing trade rules.
Still, no single country can fix the problem. Like a dike deflecting floodwaters, U.S. tariffs have diverted Chinese exports to other markets.
Those other countries are now taking action. Mexico, Chile, Indonesia and Turkey have all announced or said they are considering tariffs on China this year. This week Canada announced steep new tariffs on Chinese electric vehicles, steel and aluminum, aligning with those already announced by the U.S.
Yet the world thus far lacks a unified solution to Chinese underconsumption, because China refuses to accept that it’s a problem.
Xi has rejected fiscal support for households as “welfarism” that breeds laziness. In April, Treasury Secretary Janet Yellen complained that China’s “weak household consumption and business overinvestment” were threatening jobs in the U.S. The state news agency Xinhua called it a pretext for protectionism. Earlier this month the International Monetary Fund advised Beijing to spend 5.5% of GDP over four years buying up uncompleted homes. Beijing politely declined.
With China dug in, more friction is sure to follow, and an already fragile world trading system will be stressed to its breaking point.
