China’s recent economic problems come courtesy of declining American demand for Chinese exports, and have sparked renewed talk of how Beijing needs to shift from export-dependent growth to a greater focus on domestic consumption. If only saying it could make it so. In reality, history has shown that such transitions are wrenching, and China will be no exception.
Beijing certainly is under the gun right now. China’s economic growth and its financial system, like its American counterparts, depended crucially on an infinite capacity for leverage-fueled consumption by U.S. households. Since 2008, however, it is clear that as Americans save more to rebuild their shattered balance sheets, the U.S. trade deficit will contract rapidly from today’s levels of around 6-7% of GDP to levels more consistent with the historical average of around 1% of GDP. As a result, China’s GDP growth rate stalled in the fourth quarter, and both official data and anecdotal evidence suggest the drop-off in exports is exacting a heavy toll on employment. These trends come despite the fact that Chinese policy makers have claimed to be pursuing actively an increasing reliance on domestic demand during the past five years. Instead China, like the U.S. and Japan during their own export-heavy phases, did little to make that shift and instead developed a heady construction boom reliant on export-led growth to justify continually rising real-estate prices. If China had truly been shifting to greater domestic consumption, export industries would have shuttered, more robust finance and service sectors catering to locals would have developed, and capital and labor would have been reallocated throughout the economy accordingly.
Now China is attempting much more quickly, even desperately, to raise domestic consumption to counteract the expected decline in foreign demand for its goods. Beijing announced a $586 billion fiscal stimulus package in November and forced banks to massively expand credit to anyone who needs it.
But instead of reducing China’s export dependence, the opposite is happening. China’s trade surplus has risen, from an already-high monthly trade surplus of just under $17 billion in the first half of 2008 to nearly $33 billion in the second half, with January figures this year clocking in at just over $39 billion. The stimulus isn’t working because the money isn’t going where it needs to go — to household consumers and service industries, whose rising demand could absorb a greater share of Chinese production.
The service sector is almost nonexistent and it is proving fiendishly hard to boost consumption directly. So in Beijing’s effort to support domestic demand, most stimulus spending goes to investment and to the manufacturing sector, especially to the large state-owned enterprises that dominate the economy. Consider just a few of the elements of the fiscal stimulus plan that have been announced so far: promoting company restructuring and offering subsidized loans to support technical innovations within the nonferrous metals sector; giving tax rebates for electronics and information product exports; and increasing export rebates for textile producers.
The effects of these measures in terms of boosting “excess” production — in other words, production beyond China’s ability to consume domestically — far outweigh Beijing’s direct attempts to stimulate household spending via measures like subsidies on appliance purchases and cutting purchase taxes on cars. The result is to maintain employment and boost consumption. But this is done indirectly, by boosting manufacturing capacity (and the consumption of workers employed in factories), rather than by boosting demand directly.
As a consequence, although exports are declining, Chinese production capacity is declining at a slower pace than Chinese consumption. Since China’s trade surplus is by definition the excess of its production over its consumption, China’s trade surplus is actually growing. No matter how hard China pushes, its dependence has only increased.
China can and will eventually make the transition away from export-led growth, but no one should expect it to be quick or easy. China’s development model was based on expanding investment rapidly and boosting savings while constraining consumption, and for this reason it never developed a significant service industry or a financial system capable of channeling funding into consumption through developed-world-style consumer finance. These flaws are embedded deeply into the economy. As much as Beijing would like to change its model, it cannot do so quickly except by tolerating a massive collapse in manufacturing output.
Obviously China does not want to do this, and it would certainly be harmful for the world over the medium- and long term if it did. The world will benefit from Chinese stability and its committed adherence to the global trading system, after all. But while it is clear that China must make the transition as quickly as possible, it will be very difficult to show results over the short term. The transition from one development model to another is a long and painful process.
Originally published at the Wall Street Journal and reproduced here with the author’s permission.