“But your picture on my wall, it reminds me that it’s not so bad. It’s not so bad.”
– Yves V & Ilkay Secan
The jury is in on what ails China’s economy. It was only a matter of time. And the obvious solution – we are told – will be politically treacherous. The verdict is unanimous. China’s investment and export-led model has finally run its course.
Not only that but the model had been taken to such extremes that the rebalancing must be brutal. Proof is everywhere. The property sector is on its knees. Infrastructure debt has paralyzed local governments. Exports have peaked and are declining.
If only China could stop squeezing its long-suffering households, consumption could become an engine of if not growth then at least stability. But that would require empowering households.
And we all know inefficient SOEs and venal local governments will fight tooth and nail against the interest of households whose consumption was a paltry 38% of GDP in 2021. While profligate Americans consuming 68% of GDP may not be a proper comparison, frugal Japanese and Korean households consumed 54% and 48% of GDP, respectively, substantially more than their put upon Chinese neighbors.
Given the immense size of China’s economy, its imbalances have global implications, they say. Analysts have recently pointed out that while China’s economy is 18% of global GDP, it accounts for only 13% global consumption and a massive 32% of global investment. Through trade and capital flows, China is surely offshoring its extreme domestic imbalances to the world.
One perpetual bright spot is China’s insatiable appetite for luxury goods. According to Bloomberg, “Chinese consumers are expected to contribute 22-24% or worldwide luxury spending this year” far above China’s 13% contribution to overall global consumption. This is of course explained by a combination of China’s extreme inequality and odious taste.
Or is it? China also accounts for over 30% of cars sold globally, over 20% of mobile phones, over 40% of televisions and 25% of furniture. Drill down in just about any consumer category, excluding firearms, and China will likely be consuming well over 20% of the global total.
China reported retail sales of RMB44 trillion, or US$6.9 trillion, in 2021, ahead of the US at $6.5 trillion. Household consumption in the US – which includes non-retail sales expenditures like rent, healthcare, tuition and insurance – was expectedly much higher at $15.9 trillion.
Strangely, household consumption in China came in at $6.8 trillion, below retail sales. Chinese households apparently go on shopping sprees and neglect to pay for housing, healthcare, tuition and insurance.
Granted, China’s definition of retail sales includes some “social purchases” by government and corporate entities and is not an apples-to-apples comparison to US retail sales. But the ratio versus household consumption is revealing.
Household consumption in the US is 245% of retail sales while a mere 98% in China. Realistically, how many cars, mobile phones and Louis Vuitton handbags could possibly be from “social purchasers.” And given China’s tradition of in-kind and non-financial compensation, much of social purchases will ultimately be enjoyed by households.
What we are dealing with is a legacy of China having never properly transitioned from its Soviet-era Material Product System (MPS) system of national accounts to the United Nations’ System of National Accounts (SNA) standard. MPS accounting is only concerned with material production. Services are considered costs of production and excluded by design.
In China’s first attempt at converting MPS to SNA in 1985, it tacked on a ludicrously low 13% to the MPS number and called it China’s services GDP. Over the years, the World Bank has twisted the arm of China’s National Bureau of Statistics for modest increases to China’s services GDP with limited success. The NBS fought tooth and nail to minimize these adjustments in order to maintain developing economy status for as long as possible.
What we conclude from all this is that on an apples-to-apples UN SNA basis, Chinese households are consuming much more than 38% of GDP. And investments are much less than 42% of GDP.
Most controversially, perhaps, we also conclude that China’s GDP is under-reported by an amount largely equal to household consumption outside of retail sales. If we had to ballpark it, we would say China’s household consumption is 50-55% of GDP, investment is 30-34% of GDP and total GDP needs to be grossed up by 25-40%.
This has many implications. One is that China’s economy is not nearly as unbalanced as conventional wisdom believes – it is merely a peer of its Asian neighbors Japan and Korea. It explains why the government only seems to give lip service to increasing demand while all policies somehow favor supply. It explains how China has avoided the dire consequences of running such an unbalanced economy for so long – mostly because it hasn’t been.
If the above is true, the medium-term policy implications suddenly become less clear. Stimulating household consumption shifts from a no-brainer to a judgment call. The imperative of reigning in investment suddenly becomes less absolute. China’s domestic imbalances may not be so severe and, as such, its effect on global imbalances more limited.
To be sure, investing 30-34% of GDP is on the high side and can easily get an economy in trouble and consuming 50-55% of GDP is on the low side and a little stimulus may be helpful. But compared to the historically lopsided economy that China has been officially reporting, policy prescriptions are far from obvious.
Han Feizi is a Beijing-based financial industry veteran.