It needs a more balanced growth model that fosters more of a pro-consumption thrust to growth and development
By STEPHEN ROACH 10 December 2009
One thing is a constant in China - change. Over the past 30 years, a new and modern China has come alive, achieving unprecedented results on poverty reduction, economic development, and rising standards of living for the world’s largest population mass. But the export- and investment-led growth model that has delivered these spectacular results is nearing the end of its most dynamic phase.
The Next China promises to be very different - ushering in a more balanced growth model that derives increasing support from the Chinese consumer. This transition is now close at hand. I believe it will be a centrepiece of China’s upcoming five-year plan - the 12th Five-Year Plan of 2011-16. China is on the cusp of a dramatic new phase of its development journey, with profound and lasting impacts on the rest of Asia and the broader global economy.
China’s leadership has been foreshadowing this shift for nearly three years. The 11th Five-Year Plan that was enacted in early 2006 laid out the broad framework for the evolution into more of a consumer-led model. However, it was long on theory and short on execution.
Chinese Premier Wen Jiabao has voiced clear frustration over this failed transition - warning in his now celebrated words at the conclusion of the National People’s Congress in March 2007 of a Chinese economy that was increasingly ‘unstable, unbalanced, uncoordinated, and ultimately unsustainable’.
This disappointing transition was a result of two developments: First, the heavy lifting of structural rebalancing is never easy of any economy. It requires a fundamental rewiring of behavioural norms for businesspeople, consumers, and government. And for a developing economy such as China, it requires a new and hard-to-implement set of reforms and policy initiatives aimed at encouraging a shift away from the growth formula that has been extremely successful for 30 years.
Second, the global environment has been increasingly seductive in recent years by providing support for the old model. Surging global trade - hitting a record 32.4 per cent of world GDP last year - in conjunction with China’s accession to WTO in 2001 provided new and powerful support to the world’s most dynamic export machine. Chinese GDP growth averaged 12 per cent over the 2005-7 period and surged to 13 per cent in 2007 alone. It hardly seemed urgent to break with a model that was producing such spectacular results.
That was then. Courtesy of a wrenching global crisis and subsequent recession, there is now good reason to believe that the export-led growth model has lost one of its key underpinnings - sustained support from external demand. The global trade share of world GDP is projected to have plunged by nearly six percentage points to 26.7 per cent this year - the sharpest contraction in the modern post-World War II era. With the post-crisis climate ushering in the early stages of what is likely to be a multi-year retrenchment of the American consumer - long the main engine on the demand side of the world economy - export-led growth models, such as those in China, will be facing very stiff headwinds in the years ahead.
This crisis is China’s wake-up call. For a Chinese economy whose exports had surged from 20 per cent of GDP in 2001 to 36 per cent in 2007 - by far its most rapidly growing sector over this period - this came as an especially rude awakening. In the short span of seven months, China’s export dynamic went from boom to bust, as a +26 per cent year-over-year increase in July 2008 gave way to a -27 per cent contraction by February this year. In response, the Chinese economy came to a virtual standstill in the final quarter of late 2008 (as measured on a sequential quarterly basis) and the government moved aggressively to enact a large four trillion yuan (S$814 billion) fiscal stimulus that was quickly funded by a record surge of seven trillion yuan in bank lending in the first six months of this year.
While crisis and recession have now given way to healing, China cannot count on the classic cycle of a vigorous rebound in global growth that has proved so supportive to its export-led growth model in the past. If Beijing wants to avoid downside risks to economic growth and concomitant risks to unemployment and social instability that could arise from an anaemic global recovery, it now needs to move quickly in executing the long awaited transition to a new model. The recent ‘pro-active’ fiscal stimulus buys China time in implementing this strategy, but it does not forestall the endgame of a major strategic shift in its macro structure.
An assessment of China’s current strategy underscores the imperatives of this transition. A year ago, the World Bank published a detailed analysis of the progress achieved under China’s 11th Five Year Plan; with the assistance of the Beijing-based World Bank team, we have been able to update this assessment through 2008.
This ‘mid-term report card’ underscores China’s stunning success in achieving its top-down targets. Increases in per capita GDP are running far ahead of plan - in 2008 standing at a level that is already 65 per cent above the 2010 target. Good progress has been made on urbanisation and on the number of citizens covered by old-age insurance - although on that latter count, as noted below, there is a major shortfall in the amount of coverage available.
At the same time, this mid-term report card on the 11th Five-Year Plan reveals some notable deficiencies in the quality dimension of its growth experience - especially in boosting the services sector, R&D spending, and in reducing carbon-based emissions. These shortcomings are very much in line with Mr. Wen’s more generic concerns about China’s increasingly unbalanced macro structure. By staying the course of the old model, with its reliance on exports and fixed investment, China risks compounding its already formidable imbalances. That shows up most clearly in the investment share of GDP, which is now moving above 45 per cent - a record for China and, for that matter, for any major economy.
In a weak external demand climate, the failure to embrace the pro-consumption model means that China will only compound its already formidable investment imbalances - and concomitant risks to bank loan quality - as it seeks to sustain its growth and social stability imperatives. This is not a sustainable answer for anyone - including China.
All this sets the stage for what I believe is going to be a critical but, ultimately, very exciting transition for China. Focused on sustained economic development and the reforms required to spur such change, China has always operated from a very pragmatic point of view. It will do whatever it takes to stay this course. But there is a big difference as Beijing now looks to the future: China sees the handwriting on the wall in terms of looming sustainability constraints with respect to external demand and mounting macro imbalances.
As such, there is a new urgency to the long-talked-about transition - an urgency that I believe will be addressed head-on in the 12th Five-Year Plan of 2011-16.
Specifically, I look for initiatives in three major areas in the new plan that will seal the fate of a pro-consumption transition in the Chinese economy.
In my view, China will need to address the social safety net imperatives that have kept households biased towards excessive levels of precautionary saving. The household saving rate went from 27.5 per cent in 2000 to 37.5 per cent last year, according to estimates by Cornell University Professor Eswar Prasad. In the absence of the long-standing cradle-to-grave support of the ‘iron rice bowl’ and with state-owned enterprise reforms leading to elevated labour turnover, fears of income and retirement insecurity have intensified, and saving strategies have turned increasingly defensive.
Such uncertainties can be effectively countered by major initiatives in social security, private pensions, medical care, and unemployment insurance. China has taken only tiny steps in those directions in recent years and needs to do a good deal more. For example, the National Social Security Fund currently has only about US$82 billion assets under management - the equivalent of US$90 per worker of lifetime retirement benefits; at the same time, the enactment of a 850 billion yuan national healthcare plan in early 2009 translates into only about US$30 per capita over the next three years. To reduce excessive levels of precautionary saving, those efforts need to be sharply expanded in the 12th Five-Year Plan.
I expect the new plan to address the deficiencies on the supply side of the domestic consumption equation in China. In particular, I look for the 12th Five-Year Plan to contain blueprints for the development of large-scale consumer products and service industries - both of which are notably lacking today in China. With services comprising only about 40 per cent of Chinese GDP - well below norms elsewhere in the world - there is nothing but upside in this key area. Accelerated growth in labour-intensive services - especially retail and wholesale distribution, transportation, logistics, and a wide variety of professional services - will be an enormous plus for China’s labour absorption and social stability imperatives. Emphasis on the IT-enabled ‘services cluster’ model - centred on institutions of educational excellence - is likely to be an increasingly important element of this strategy as it pushes into central and western China.
Most believe that such pro-consumption structural changes are likely to be glacial, at best. The argument is that Asians, in general, and the Chinese, in particular, have an innate predisposition towards saving that is extremely difficult to dislodge. I reject this line of reasoning. Saving in China is more by necessity than DNA - especially the rational and understandable excesses of fear-driven precautionary saving.
If the 12th Five-Year Plan delivers in the three areas outlined above, I suspect there will be a surprisingly quick shift in the mix of Chinese GDP. The consumption share could rise from its rock-bottom reading of 35 per cent towards the 50 per cent threshold by the end of the 12th Five Year Plan. Similarly, the services piece of China’s GDP could rise from its similarly depressed 40 per cent range to nearly 50 per cent by 2016.
If these shifts do, in fact, come to pass, China would reap enormous benefits. As noted above, a broadening of the macro base would be key in addressing the mounting income disparities that pose a major problem for the aspirations of a harmonious society. Similarly, I underscore the point above that a shift to labour-intensive services has the potential to usher in new sources of employment growth that could be extremely helpful in addressing China’s daunting labour absorption problem. In addition, a shift to consumption would reduce China’s surplus saving - tempering its current account and trade surpluses and having the potential to diminish mounting trade frictions with the rest of the world. Moreover, the shift to more of a services-intensive GDP would push China away from the smokestack-intensive industrial production model that is biased towards excess resource consumption, environmental degradation, and pollution. Under the new model, there is much greater hope for China to achieve a lighter, cleaner, and greener GDP.
Better macro balance
Most importantly, the Next China is a more sustainable China. Better macro balance - moving away from over-reliance on exports and investment towards internal private consumption - puts China’s long spectacular development story on much firmer footing in looking to the future. Opening up the world’s largest consumer market would also be an enormous plus for the rest of Asia, especially for less-populated export-led economies in the region that have no choice but to uncover new sources of external demand growth. Similarly, a China that turns increasingly to resource efficient clean technologies would be especially beneficial to suppliers of such products in Asia’s most advanced economies - namely, Japan, South Korea, Taiwan, and Singapore.
While there is much to celebrate as China looks back on the stunning accomplishments of the past 30 years, the Next China must embrace the imperatives of a major strategic shift in its growth model. I am confident that an ever-pragmatic Chinese leadership will take its cue from a protracted post-crisis weakening in external demand. I suspect the upcoming 12th Five-Year Plan will mark a pivotal turning point for China in fostering more of a pro-consumption thrust to growth and development. The time for talk is over. China now needs to move into the execution phase of this exciting development. The outcome could well be the defining mega-trend of the 21st century.
The writer is chairman of Morgan Stanley Asia and author of ‘The Next Asia’, published by Wiley and CITIC Press
4 comments:
Time for shift in China’s growth strategy
It needs a more balanced growth model that fosters more of a pro-consumption thrust to growth and development
By STEPHEN ROACH
10 December 2009
One thing is a constant in China - change. Over the past 30 years, a new and modern China has come alive, achieving unprecedented results on poverty reduction, economic development, and rising standards of living for the world’s largest population mass. But the export- and investment-led growth model that has delivered these spectacular results is nearing the end of its most dynamic phase.
The Next China promises to be very different - ushering in a more balanced growth model that derives increasing support from the Chinese consumer. This transition is now close at hand. I believe it will be a centrepiece of China’s upcoming five-year plan - the 12th Five-Year Plan of 2011-16. China is on the cusp of a dramatic new phase of its development journey, with profound and lasting impacts on the rest of Asia and the broader global economy.
China’s leadership has been foreshadowing this shift for nearly three years. The 11th Five-Year Plan that was enacted in early 2006 laid out the broad framework for the evolution into more of a consumer-led model. However, it was long on theory and short on execution.
Chinese Premier Wen Jiabao has voiced clear frustration over this failed transition - warning in his now celebrated words at the conclusion of the National People’s Congress in March 2007 of a Chinese economy that was increasingly ‘unstable, unbalanced, uncoordinated, and ultimately unsustainable’.
This disappointing transition was a result of two developments: First, the heavy lifting of structural rebalancing is never easy of any economy. It requires a fundamental rewiring of behavioural norms for businesspeople, consumers, and government. And for a developing economy such as China, it requires a new and hard-to-implement set of reforms and policy initiatives aimed at encouraging a shift away from the growth formula that has been extremely successful for 30 years.
Second, the global environment has been increasingly seductive in recent years by providing support for the old model. Surging global trade - hitting a record 32.4 per cent of world GDP last year - in conjunction with China’s accession to WTO in 2001 provided new and powerful support to the world’s most dynamic export machine. Chinese GDP growth averaged 12 per cent over the 2005-7 period and surged to 13 per cent in 2007 alone. It hardly seemed urgent to break with a model that was producing such spectacular results.
That was then. Courtesy of a wrenching global crisis and subsequent recession, there is now good reason to believe that the export-led growth model has lost one of its key underpinnings - sustained support from external demand. The global trade share of world GDP is projected to have plunged by nearly six percentage points to 26.7 per cent this year - the sharpest contraction in the modern post-World War II era. With the post-crisis climate ushering in the early stages of what is likely to be a multi-year retrenchment of the American consumer - long the main engine on the demand side of the world economy - export-led growth models, such as those in China, will be facing very stiff headwinds in the years ahead.
Wake-up call
This crisis is China’s wake-up call. For a Chinese economy whose exports had surged from 20 per cent of GDP in 2001 to 36 per cent in 2007 - by far its most rapidly growing sector over this period - this came as an especially rude awakening. In the short span of seven months, China’s export dynamic went from boom to bust, as a +26 per cent year-over-year increase in July 2008 gave way to a -27 per cent contraction by February this year. In response, the Chinese economy came to a virtual standstill in the final quarter of late 2008 (as measured on a sequential quarterly basis) and the government moved aggressively to enact a large four trillion yuan (S$814 billion) fiscal stimulus that was quickly funded by a record surge of seven trillion yuan in bank lending in the first six months of this year.
While crisis and recession have now given way to healing, China cannot count on the classic cycle of a vigorous rebound in global growth that has proved so supportive to its export-led growth model in the past. If Beijing wants to avoid downside risks to economic growth and concomitant risks to unemployment and social instability that could arise from an anaemic global recovery, it now needs to move quickly in executing the long awaited transition to a new model. The recent ‘pro-active’ fiscal stimulus buys China time in implementing this strategy, but it does not forestall the endgame of a major strategic shift in its macro structure.
An assessment of China’s current strategy underscores the imperatives of this transition. A year ago, the World Bank published a detailed analysis of the progress achieved under China’s 11th Five Year Plan; with the assistance of the Beijing-based World Bank team, we have been able to update this assessment through 2008.
This ‘mid-term report card’ underscores China’s stunning success in achieving its top-down targets. Increases in per capita GDP are running far ahead of plan - in 2008 standing at a level that is already 65 per cent above the 2010 target. Good progress has been made on urbanisation and on the number of citizens covered by old-age insurance - although on that latter count, as noted below, there is a major shortfall in the amount of coverage available.
At the same time, this mid-term report card on the 11th Five-Year Plan reveals some notable deficiencies in the quality dimension of its growth experience - especially in boosting the services sector, R&D spending, and in reducing carbon-based emissions. These shortcomings are very much in line with Mr. Wen’s more generic concerns about China’s increasingly unbalanced macro structure. By staying the course of the old model, with its reliance on exports and fixed investment, China risks compounding its already formidable imbalances. That shows up most clearly in the investment share of GDP, which is now moving above 45 per cent - a record for China and, for that matter, for any major economy.
In a weak external demand climate, the failure to embrace the pro-consumption model means that China will only compound its already formidable investment imbalances - and concomitant risks to bank loan quality - as it seeks to sustain its growth and social stability imperatives. This is not a sustainable answer for anyone - including China.
All this sets the stage for what I believe is going to be a critical but, ultimately, very exciting transition for China. Focused on sustained economic development and the reforms required to spur such change, China has always operated from a very pragmatic point of view. It will do whatever it takes to stay this course. But there is a big difference as Beijing now looks to the future: China sees the handwriting on the wall in terms of looming sustainability constraints with respect to external demand and mounting macro imbalances.
As such, there is a new urgency to the long-talked-about transition - an urgency that I believe will be addressed head-on in the 12th Five-Year Plan of 2011-16.
Specifically, I look for initiatives in three major areas in the new plan that will seal the fate of a pro-consumption transition in the Chinese economy.
In my view, China will need to address the social safety net imperatives that have kept households biased towards excessive levels of precautionary saving. The household saving rate went from 27.5 per cent in 2000 to 37.5 per cent last year, according to estimates by Cornell University Professor Eswar Prasad. In the absence of the long-standing cradle-to-grave support of the ‘iron rice bowl’ and with state-owned enterprise reforms leading to elevated labour turnover, fears of income and retirement insecurity have intensified, and saving strategies have turned increasingly defensive.
Such uncertainties can be effectively countered by major initiatives in social security, private pensions, medical care, and unemployment insurance. China has taken only tiny steps in those directions in recent years and needs to do a good deal more. For example, the National Social Security Fund currently has only about US$82 billion assets under management - the equivalent of US$90 per worker of lifetime retirement benefits; at the same time, the enactment of a 850 billion yuan national healthcare plan in early 2009 translates into only about US$30 per capita over the next three years. To reduce excessive levels of precautionary saving, those efforts need to be sharply expanded in the 12th Five-Year Plan.
I expect the new plan to address the deficiencies on the supply side of the domestic consumption equation in China. In particular, I look for the 12th Five-Year Plan to contain blueprints for the development of large-scale consumer products and service industries - both of which are notably lacking today in China. With services comprising only about 40 per cent of Chinese GDP - well below norms elsewhere in the world - there is nothing but upside in this key area. Accelerated growth in labour-intensive services - especially retail and wholesale distribution, transportation, logistics, and a wide variety of professional services - will be an enormous plus for China’s labour absorption and social stability imperatives. Emphasis on the IT-enabled ‘services cluster’ model - centred on institutions of educational excellence - is likely to be an increasingly important element of this strategy as it pushes into central and western China.
Most believe that such pro-consumption structural changes are likely to be glacial, at best. The argument is that Asians, in general, and the Chinese, in particular, have an innate predisposition towards saving that is extremely difficult to dislodge. I reject this line of reasoning. Saving in China is more by necessity than DNA - especially the rational and understandable excesses of fear-driven precautionary saving.
If the 12th Five-Year Plan delivers in the three areas outlined above, I suspect there will be a surprisingly quick shift in the mix of Chinese GDP. The consumption share could rise from its rock-bottom reading of 35 per cent towards the 50 per cent threshold by the end of the 12th Five Year Plan. Similarly, the services piece of China’s GDP could rise from its similarly depressed 40 per cent range to nearly 50 per cent by 2016.
If these shifts do, in fact, come to pass, China would reap enormous benefits. As noted above, a broadening of the macro base would be key in addressing the mounting income disparities that pose a major problem for the aspirations of a harmonious society. Similarly, I underscore the point above that a shift to labour-intensive services has the potential to usher in new sources of employment growth that could be extremely helpful in addressing China’s daunting labour absorption problem. In addition, a shift to consumption would reduce China’s surplus saving - tempering its current account and trade surpluses and having the potential to diminish mounting trade frictions with the rest of the world. Moreover, the shift to more of a services-intensive GDP would push China away from the smokestack-intensive industrial production model that is biased towards excess resource consumption, environmental degradation, and pollution. Under the new model, there is much greater hope for China to achieve a lighter, cleaner, and greener GDP.
Better macro balance
Most importantly, the Next China is a more sustainable China. Better macro balance - moving away from over-reliance on exports and investment towards internal private consumption - puts China’s long spectacular development story on much firmer footing in looking to the future. Opening up the world’s largest consumer market would also be an enormous plus for the rest of Asia, especially for less-populated export-led economies in the region that have no choice but to uncover new sources of external demand growth. Similarly, a China that turns increasingly to resource efficient clean technologies would be especially beneficial to suppliers of such products in Asia’s most advanced economies - namely, Japan, South Korea, Taiwan, and Singapore.
While there is much to celebrate as China looks back on the stunning accomplishments of the past 30 years, the Next China must embrace the imperatives of a major strategic shift in its growth model. I am confident that an ever-pragmatic Chinese leadership will take its cue from a protracted post-crisis weakening in external demand. I suspect the upcoming 12th Five-Year Plan will mark a pivotal turning point for China in fostering more of a pro-consumption thrust to growth and development. The time for talk is over. China now needs to move into the execution phase of this exciting development. The outcome could well be the defining mega-trend of the 21st century.
The writer is chairman of Morgan Stanley Asia and author of ‘The Next Asia’, published by Wiley and CITIC Press
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