Can China Change Its Growth Model?


Charles Wilson, PhD

The transition to consumption-led from investment-driven growth, and the shift away from the one-child policy will help.

Along with many major economies, China’s economic growth following the 2009 rebound from the global financial crisis has continued to disappoint relative to expectations. As we wrote previously (This Time is Different: A Look at the State of Emerging Market Debt and Dissecting China's Debt Load), China’s debt has increased rapidly over the last decade, particularly over the last five years. It was driven largely by corporate debt to fuel a massive investment binge. The Chinese government has rightly recognized that the investment-led growth model is not sustainable over the long term and is in the process of guiding the economy toward a more consumption-driven model. Considering that China represents about 13% of global gross domestic product (GDP), and nearly a third of incremental GDP growth, execution of the transition is of critical importance to global growth. With that in mind, it’s clear why there has been so much hand wringing in relation to the Chinese growth outlook over the last two to three years. We thought it was worth exploring the likelihood of success in the transition and some of the likely implications.

According to the National Bureau of Statistics of China, Chinese real economic growth reached a recent peak in 2007 at 14.2% (figure 1). The rate of growth in 2007 was just slightly less than other recent high points reached in 1992 at 14.3% growth and in 1984 at 15.2% growth. Over the last three decades, Chinese economic growth has been remarkably consistent. Since 1980, real Chinese GDP growth has averaged just under 10%, with an average of 9.7% between 2000 and 2014 and an average of 9.8% between 1980 and 2000. The consistent growth has come despite the economy growing from $190 billion in 1980 to over $10 trillion today – an increase of over 50x since 1980 (figure 2). How has China been able to sustain this economic growth miracle?

Figure 1: China’s Real GDP Growth

Source: National Bureau of Statistics of China


Figure 2: China’s GDP, USD

Source: National Bureau of Statistics of China


The drivers behind this miracle are probably a lot different than you might expect. Looking at the long-term contribution to GDP growth, household consumption was actually the largest portion of the economy until investment took the lead about 10 years ago (figure 3). This is contrary to the long-held view that the Chinese economy is based on bridges to nowhere and low-cost labor driving low-value exports. The heavier reliance on investment to drive growth is actually a fairly new reality. As you can see in figure 4, consumption growth never really recovered to pre-crisis levels following the 1997/1998 Asian financial crisis. It’s likely the government was looking for a way to extend China’s economic golden age of growth and as a result pressed a bit more on the investment pedal to offset a natural slowdown in consumption growth as the economy became larger.

Figure 3: Expenditure Contribution to GDP

Source: National Bureau of Statistics of China


Figure 4: Annual Growth in Consumption and Investments

Source: National Bureau of Statistics of China


Perhaps the more interesting question is not why the government accelerated investment spending, but why didn’t consumption growth recover following the Asian financial crisis. The answer may actually lie in a policy put in place twenty years earlier – the famous one-child policy. The one-child policy, implemented in 1979, as you might expect, had a dramatic impact on the fertility rate, which fell from 2.8 in 1979 to a low of 1.51 in 2000, according to the World Bank (figure 5). As we noted previously (Dissecting China's Debt Load), China has a very high savings rate – the highest of any major economy in the world. As shown in figure 6, the savings rate increased substantially in the decade after 2000, going from 35% to over 50%, during the time you would have expected consumption growth to rebound. It also corresponds with the point in time when the first wave of children born under the one-child policy would be entering university. Recent research under review to be published in the American Economic Review, suggests that the savings rate increased due to a variety of impacts related to the one-child policy. The social safety net in China has long been primarily family, in particular children supporting aging parents. To insure the ability of the children to provide support when necessary, Chinese parents invested heavily in preparing children for their career through education. When the number of children per family fell, the parents had to make investments in their child’s future that would make them twice as successful or they would be left with less support during their retirement years. Most recognized they could not reliably double the economic output of their children and instead reduced their overall spending as the number of children per household declined. Out of concern for their own post-retirement financial security, they saved the money normally intended to educate their second or third child instead of consuming through other channels. The end result is a much higher savings rate, lower consumption growth, less children to support their elders, and a young population with a higher level of education. As a side note, the rapid rise of the savings rate in China probably played an important role in driving the more capital intensive investment-led growth model not only through direct funding but also by distorting the cost of money in the economy.

Figure 5: China’s Fertility Rate

Source: World Bank


Figure 6: China’s Savings Rate, % of GDP

Source: World Bank


It sounds simple – drive down the savings rate and consumption will grow. Well, it isn’t that easy, considering the demographic corner into which they have painted themselves. But China is currently implementing several policies that should help over the medium term. First, the government ended the one-child policy, which should start driving consumption for pediatric-related goods and services soon. Next, they have started to encourage savings outside of the traditional “family as the social safety net model,” with several recent changes to the domestic insurance industry that should accelerate demand for savings- and health care-related products. China is also doing quite a bit to drive down the cost of health care by centralizing purchasing, driving out corruption, and inviting privatization of certain sectors like hospitals. Lastly, China has also begun moving up the value chain in several sectors, including technology, health care, clean energy, and retail services. Figure 7 shows that just recently, services contribution to GDP overtook the contribution from industry, which is a good way to employ the large class of highly educated people that were a byproduct of the one-child policy.

Figure 7: Contribution to GDP by Sector

Source: World Bank


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