China has had some initial success in shifting its economic structure to services from manufacturing. However, it has made far less progress in boosting private consumption. Investors have to be realistic when assessing the investment themes stemming from China’s consumption growth.
China’s tertiary sector out-grew the secondary sector in 2013. The gains in services, as reflected by the tertiary sector, have been particularly strong in wholesale and retail trade, finance and real estate.
The shift towards services will continue, broadening out to healthcare, education, IT services, domestic tourism and leisure and transportation. China’s tertiary sector is expected to grow towards 60% of GDP from about 50% now in the next decade.
However, it is unclear if this expenditure-switching process will deepen, as China’s consumers have remained unwilling to spend. While the GDP share of the tertiary sector has risen by almost 6 percentage points since 2010, the share of consumption has only risen by 2 percentage points. This gap represents a yawning household savings rate.
China’s urban savings rate has been rising on the back of strong per-capita income growth in recent years. This reflects a preference for precautionary saving over discretionary spending, and is a rational response by the majority of Chinese households to their uncertain future, which is not supported by a reliable social safety net. Given China’s demographic structure, under-developed financial market and weak welfare state, high precautionary saving is likely to persist in the medium-term.
In the past, the Confucian tradition of filial piety meant that children were proxy savings vehicles, as they were expected to support their ageing parents. However, after more than three decades of one-child policy, retirees now cannot expect much support from their children, many of whom subscribe less assiduously to the Confucian tradition. Meanwhile, the country lacks a strong pension system to pick up the slack.
One crucial macroeconomic factor hurting consumption may be the fall in the share of GDP represented by labour income from over 50% in the early 1990s to about 43% in 2014. This has eroded private consumption power, and is likely the result of China’s lopsided growth model and financial repression.
More than 35 years of distorted industrial policy has favoured investment over labour income growth and relied on wage suppression to subsidise output and exports. Financial repression has boosted investment and output growth at the expense of Chinese household savings by suppressing its real rate of return to almost zero.
Thus, the structural imbalance that China must address is really between the income share of labour and that of other factors of production in the economy. Macroeconomic policies cannot resolve this structural woe to boost consumption effectively. This is already seen in the lack of improvement in growth, inflation expectations and consumption since 2014, despite rounds of monetary and fiscal policy stimulus.
Monetary easing may even backfire on consumption, as households may save more to preserve their purchasing power in the face of declining returns on their savings. This may help explain why China’s CPI and PPI inflation rates have kept falling, despite monetary easing, which has boosted asset bubbles instead of consumption.
However, this is not to say that China’s effort to switch from investment-led to consumption-led growth will fail. The young generation today is keenly aware of their quality of life and more inclined to consume than their parents were. When they reach the prime-spending middle-age, their consumption should be a much stronger driver of GDP growth.
Beijing could pursue a different set of consumption-boosting policies to make that transition happen. One possible measure is to relax the household budget constraint. China’s consumption potential has been constrained by its cash-based transaction and excessive saving behaviour.
The household sector is a net creditor in the economy, with net assets amounting to more than 8% of GDP. The gross household debt-to-GDP ratio was only about 7% of GDP, compared to a massive 95% in the US and 66% in Japan in 2015.
The personal loan industry in China is under-developed. In 2015, consumer loans accounted for less than 19% of total bank loans. The bulk of personal loans were in the form of mortgages, which accounted for only 14% of all loans (while it was more than 100% in the US). Only 5% of people over the age of 15 in China had mortgage debt, and 8.2% had credit cards, compared to more than 33% and 61%, respectively, in the US.
It is clear that Chinese households have plenty of room for borrowing to boost consumption. By developing the personal loan business through financial liberalisation, Beijing can effectively relax the household budget constraint by enabling intertemporal choice by individuals to boost consumption.
China’s consumption landscape will be totally different in the future, with the country becoming a global buyer rather than the global seller it is today. But this will take years. To facilitate the transition to consumption-led growth, China needs more banking and structural reforms and needs to raise labour income’s share of the economy.
It should also empower the middle class and accelerate urbanisation. Consumer staples, services, telecommunications, healthcare, education and software are some of the main economic sectors that will be shaping China’s future consumption. They are also medium-term investment themes for participating in China’s new growth story.
（Cover Photo: Eyepressphoto）
