Lack of Domestic Demand — A Potential Threat to Economic Growth
Since the beginning of this year, the national economy has stabilized at an average quarterly economic growth rate of 9.5 percent, with a 23 to 24 percent monthly growth rate of fixed asset investment. Export growth is above 30 percent, and the trade surplus has continued to enlarge, with the growth of the residential consumer price index (CPI) down to 2.4 percent. All of these are signs of both high growth and low inflation.
However, there is a huge structural imbalance hidden behind the surface stability, and the situation is getting worse. The imbalance is reflected in the fact that, since 1990, there has been a continuous slide of the ratio of residential final consumption to GDP. In 2004, the ratio was at a record low, even substantially lower than the period from 1960 to 1962, the worst time of the planned economy. A conclusion can be drawn that since the late 1980s, income distribution has undergone a gradual change, resulting in a drop in residential consumption demand. The situation has deteriorated despite the year 2004’s overheating of the economy. A few observations can be offered.
Observation 1: Although the economy overheated in 2004 (the January/February growth rate of fixed asset investment was as high as 53 percent), the monthly produce product index (PPI) growth was never higher than 9 percent, and the monthly CPI growth was never higher than 5 percent. Starting from July 2004, the CPI has been declining month by month, with the CPI growth in January 2005 down to 1.8 percent. The retail price index (RPI) growth rate was down to 0.6 percent, with prices of many consumer goods actually dropping. At present, the positive growth rate has been sustained by the prices of housing, recreation and education, and food. High-income households drove the rise in price of the former two items, while the prices of most consumer goods have been falling. The price of food has been affected by fluctuations in the supply and demand of agriculture products.
Observation 2: High savings ratio. At the end of 2004, the residential savings deposited in financial institutions amounted to 120 trillion yuan (US$15 trillion), the equivalent of one year’s GDP. This was double the number at the end of 1999. However the nominal GDP only grew 66.8 percent from 1999 to 2004, while residential savings doubled. There is over saving in comparison with GDP. With the rapid rise of deposits, the ratio of total loans of financial institutions to total deposits was 74 percent in 2004, lower than the 86 percent in 1999, a troubling phenomenon indicating that the utilization of capital was less efficient. At present, the growth in savings deposits is gaining momentum. By the end of May 2005, the total amount of residential saving deposits in all financial institutions was over 130 trillion yuan (US$16.2 trillion), and it will certainly surpass 140 trillion by the end of the year.
Observation 3: A lack of domestic demand puts pressure on exports. Since 2004, the monthly growth rate of total exports has never been lower than 33 percent. By contrast, from January to May 2005, the import growth rate dropped to 13.7 percent. The trade surplus for the first five months of 2005 was as high as US$30 billion, equaling the annual total for all of 2004. At the end of the first quarter, the foreign reserves amounted to a record high of US$659 billion, about US$50 billion more than the 2004 year-end figure. In the second quarter, that number was still climbing. The rapid growth of foreign reserves is posing a serious challenge to the effective use of resources.
Exports have been one of the pillars of economic growth. However, unrestricted export growth will lead to friction between China and other developed and developing countries, and intensified international pressure for appreciation of the Chinese currency RMB. Finally, exports have to slow down in the face of restrictions from the world market, and they have.
Observation 4: Because of the lack of consumer demand, economic growth is more and more dependent on investment. From January of 2000 to May of 2005, the annual growth rate of fixed asset investment (in constant price) is 9.1, 12.5, 16.7, 25, 19.1, and 24.2 percent, respectively. The expanded capacity induced by rapid investment has been assimilated by the low consumer demand. The conflict between drastic expansion of production capacity and slow growth of personal consumption will lead to periodic depression.
Currently, the key elements of high investment are real estate development, public debts and local metropolitan construction projects, and energy and raw material industrial investment. The above are important driving forces for economic growth in the long run. However, without a corresponding growth in personal consumption, those investment projects are not sustainable.
Reasons for the Drop in Personal Consumption
Major reasons for the drop in personal consumption are as follows:
Ever since the late 1980s, with structural change in income distribution, the gap between the incomes of urban and rural residents has been widening. In 1984 the Gini coefficient for residential income was 25.7. That figure climbed to 35.5 in 1990, and was up to 44.7 in 2001. In the 2005 World Development Report published by the World Bank, ranked by the Gini coefficient from lowest to highest, China is 85th out of the 120 countries and regions so ranked. That is, China’s inequality is the 35th lowest (32 of the lowest are Latin American and African countries) of the socially polarized countries.
With such a large income inequality, the consumption level of middle and lower income families is restricted. High-income families have already reached a high level of consumption and are less likely to put more of their income into consumption. The Chinese people have a tradition of high savings. Savings will only increase as the income gap widens.
The high risks during the economic transition have also put a brake on personal consumption. For many years, the rapid increase in the cost of health care, education, and housing expenditures has far surpassed the affordability of many rural and urban residents. Urban employees who face an immediate threat of unemployment, and farmers who have lost their normal income source when they lost their land have no choice but to save more and consume less.
The urban system of lowest living standard security and unemployment insurance, to some extent, has alleviated the burdens of the people mentioned above. However, the other parts of the social security system may not help as they should. Investigations have revealed that the portion of health expenditures that are covered by health insurance for middle and high-income families is higher than for low-income families, who still need to pay for the majority of their own health care costs. The pension system should cover poor and low-income families. However, the current social security system is not hedging against income uncertainty for low-income families, and even widens the gap to a certain extent. Most rural families are not even covered by the social security system.
Unemployment or under employment is still a major reason for the depressed personal consumption of low-income families. Historically, most nonagricultural job opportunities are provided by small enterprises. Because of the poor economic environment, they are creating fewer and fewer jobs. Firstly, the current system of "big banks" is not geared to enable small enterprises to obtain loans; secondly, the policy implementation is usually in favor of middle-size enterprises instead of the small ones; thirdly, the unhealthy legal and institutional environment, causes small enterprises to be faced with trivial, unnecessary, and nontransparent administration; finally, there are few services to provide management, technology, and legal and financial training for small enterprises. The current statistical system does not cover the enterprises that are under a certain size. Thus the government finds no reason to care about the development of small enterprises.
The ongoing gradual consumption drop is leading to an internal balance of the economy, which will not only lead to serious economic slides, but will threaten the sustainability of economic growth. It’s vital to correct the income inequality and increase the percentage of personal consumption in GDP.
Possible strategies can include the following:
• Further reform the taxation system and strengthen the taxation on the high income class
• Advance governmental reform so as to establish a systematic, standardized, and transparent administration
• Improve the operation environment of small enterprises so as to facilitate job creation
• Strengthen the social security system and provide a basic guarantee for low income people
• Introduce a competition mechanism into important sectors such as health care, education and housing, and strengthen the supervision of the public service sector to protect the public’s interests
Wang Xiaolu is the Vice Director of National Economic Research Institute, China Reform Foundation.
Translation by CHINASCOPE from Internal Reference for Reform, Issue 22 , 2005