China’s Consumption Conundrum

In the three months since the Chinese government abruptly lifted its far-reaching “zero COVID” policy, the Chinese economy has roared back. For nearly three years, the policy wreaked havoc on Chinese businesses and supply chains, pushing growth down to its lowest level in decades. The chaotic reopening then led to a viral wave that infected an estimated 80 percent of the population but rapidly petered out. With the worst now over and the biggest constraint on the economy lifted, the Chinese government announced a growth target of five percent for 2023.

Although China’s faster-than-expected rebound brought cheers from global markets, despite growing fears of a global recession, that optimism should be tempered. China’s growth is unlikely to rescue the global economy the way it did after the 2008 financial crisis. Indeed, a five percent growth target is hardly ambitious. Instead, it reveals the Chinese government’s concerns about its economy’s many underlying vulnerabilities. These range from local government finances, which are increasingly starved of revenue, to the ailing property sector. A particular vulnerability is exports. The pandemic hardly dented China’s export sector—it now exports 15 percent of the world’s goods, its highest level ever—yet that bright spot will turn from an asset to a liability during a global recession that will reduce external demand for Chinese goods.  

But the larger problem is not external demand; it is the lack of domestic demand. With a central government unwilling to stimulate the economy, local governments tightening their belts, and an export sector facing headwinds, the only growth driver left is consumption. Yet boosting consumption among China’s 1.4 billion citizens is difficult. It is well known that Chinese households are big savers—generally putting away about one-third of their income, a rate that is more than three times as high as their American counterparts. Unleashing those savings has not been easy: the Chinese government has attempted the so-called rebalancing from investment to consumption for the better part of 15 years. That agenda, however, often gets derailed or becomes subordinated to other priorities. When the Chinese economy falters, the government has typically resorted to driving investment and exports because that gets immediate results. Those results can be seen in the vast sums poured into new housing and bullet trains, as well as world-class highways and airports—all of which support Chinese manufacturing and exports.

China also faces other problems, including demographic decline, which can hamper consumption. China’s population growth is now slowing faster than anticipated, and it shrank for the first time in 2022. Although it has been seven years since Beijing abandoned its one-child policy in the hope of boosting the birthrate, there has been no baby boom. There are no good solutions to reverse that trend, and the Chinese government seems to be out of ideas. With these challenges, shifting course will be difficult. But there are some important steps that Beijing can take to get behind a genuine “pro-consumption” agenda. Whether it succeeds will not only determine how fast China grows in the years to come; it will also have significant implications for the global economy.

SPEND MORE, SAVE LESS

For any government, boosting consumption is difficult. For China, the challenge is especially daunting because of its scale. It would be prohibitively expensive to perpetually subsidize the consumption of 1.4 billion people, 600 million of whom still live on roughly $5 per day. To boost consumption sustainably generally requires two things: organizing the economy to optimize it for growth and raising household income and confidence. Chinese President Xi Jinping, having secured his third term, appears much less interested in organizing the economy for growth than his predecessors did. Instead, he is optimizing it for security and resilience. Strikingly, in the Five-Year Plan released in 2021, Xi made the decision to abandon China’s long-standing policy of setting a hard growth target. For decades, such a target served as the organizing principle for the Chinese political economy, establishing a signal that incentivized all provinces to compete with one another to achieve higher growth. As such, the five percent target for 2023 should be understood within this context—it now serves only as guidance, not an order.

Instead of focusing on growth, the new Chinese leadership is reorganizing the economy so that provinces pull together to develop leading technologies and to protect supply chains. In short, Xi and his team want to conduct industrial policy more efficiently and more cost effectively. This priority is clearly driven by both China’s intensifying technological competition with the United States and by frustration over not achieving as much progress at home as desired. Although China has one of the world’s most formidable and efficient manufacturing ecosystems, chasing frontier technologies nonetheless requires hefty spending, with no assurance of returns. Indeed, even after decades of government subsidies, China’s semiconductor industry is still at least a decade behind its leading international competitors. Although redoubling on industrial policy is by no means guaranteed to succeed, it appears that the target that matters most to Xi is not GDP growth but the nanometers of a chip.

If growth is no longer the overwhelming priority, then a pro-consumption agenda can still focus on raising household income and building consumer confidence. China’s leaders know that its citizens are not optimistic about their economic future. The household savings rate, an indicator of household confidence, rose to 38 percent of disposable income during the pandemic, its highest level since 2014. The preference of Chinese households for saving instead of spending will not change until the clear and present risks to growth—including deleveraging, flatlining productivity, and the flagging property sector—are dealt with, especially at a time when youth unemployment is 17 percent. To give households confidence in the future will require more than just announcements and public messaging. It will require concrete actions.

Because the Chinese state is the ultimate owner of many firms, it can use the firms’ profits to fund other priorities.

To jump-start consumption immediately, the Chinese government could offer consumption coupons to households. These are government-issued vouchers that can be used for the purchase of goods or services. A pilot program in 2020 proved successful in driving three yuan of consumption for every one yuan distributed through coupons. In addition, Beijing could reverse its recent crackdown on education services and Big Tech. If the government were to end the restrictions on these sectors that it imposed in 2021, it would immediately generate jobs for recent college graduates. More important than taking these immediate steps, however, is the need for China’s leaders to demonstrate their commitment to prioritizing consumption over the long term. One way to do so would be for Beijing to announce its intention to raise household income as a share of GDP from the current 62 percent to at least 70 percent by 2030 (that ratio is 80 percent in the United States). Targeting income would serve a similar political purpose as the GDP target: it would require the Chinese government at every level to support that goal. Moreover, it would marry a concrete target to the vague notion described by the Chinese Communist Party (CCP) of achieving a “moderately prosperous Chinese society.”  

This will require a reset of the state’s relationship with the private sector, which is responsible for 60 percent of GDP and 80 percent of jobs, and is consequently indispensable to any pro-consumption agenda. One way to show its support for the private sector is for Beijing to declare that rather than levying higher taxes on private businesses and entrepreneurs, it will target redistribution from the state to households as a key means of raising household income. Because the Chinese state is the ultimate owner of these firms, it can use the firms’ profits to fund other priorities. For example, rather than investing their profits, state firms could be mandated to use them to finance public services for low-income households or to support households’ looming pension and health-care liabilities. In the countryside, Chinese farmers could be empowered to sell their land to the local government at a fair market price rather than simply transferring it for free. That would enable farmers to start their own businesses or move to the cities, where they can earn higher wages. These reforms would give households more confidence in their future prospects and reassure the private sector that the “common prosperity” agenda—which many suspect is predicated on a massive wealth redistribution from the private sector—is not intended to stifle its growth and dynamism.  

CONSUMERS, NOT RIVALS

If the Chinese government can develop and sustain a pro-consumption agenda, it will transform the country’s international reputation. Since it abandoned its obsession with GDP growth, China has been searching for ways to counter growing international skepticism about its economy. A genuine shift toward greater consumption would go a long way toward overcoming investor skepticism and reassuring global markets. That is not all. Unleashing domestic consumption is also the surest path for China to achieve its goal of becoming the world’s largest economy, anchored by the world’s largest middle class, by 2035. Such a shift brings climate benefits too: more consumption means less investment in those industrial sectors that have produced most of China’s carbon emissions over the last several decades. A successful pivot toward consumption, then, will also facilitate China’s challenging transition to net zero, which Beijing has pledged to achieve by 2060.

A systematic effort by Beijing to boost domestic consumption can also help stabilize the U.S.-Chinese economic relationship. By focusing on improving household income, the Chinese government would do much to recalibrate the equilibrium between the world’s largest saver and the world’s largest consumer. By becoming a more significant importer and consumer of foreign-made goods, China could help mitigate the long-standing sources of conflict with the United States over currency, trade, and jobs. At present, for example, China blames the United States for launching a trade war, and the United States blames China for using government subsidies and currency manipulation to undercut U.S. industries and dump its goods in U.S. markets. By focusing on domestic consumption, Beijing could moderate the tendency of each side to blame the other for its economic woes.

None of these steps, however, are guaranteed to bring results. Even if Beijing commits to a pro-consumption agenda, it will have difficulty executing the plan in the face of domestic political constraints, such as confronting vested interests in the state sector. For instance, economic policies that benefit Chinese households will necessarily come at the expense of a powerful constituency and fiscal tool of the CCP: state firms, which will be reluctant to distribute their profits to households. Without enlisting state-owned enterprises in redistribution, Beijing will have to either tolerate unfunded mandates or cut social security benefits to avoid draining its fiscal coffers. And this latter choice would be politically unpopular and likely to trigger social instability, as demonstrated by recent protests by retirees against government cuts to their medical benefits. Moreover, sustaining domestic consumption will require a thriving private sector, so that companies and businesses remain an engine of job creation and income growth. But such an approach will necessitate a reversal of Beijing’s centralization trend of the last decade in which companies were reined in. Giving more power to the private sector will severely test the Xi administration’s disposition toward greater control.

For China, boosting consumption has been as elusive as health-care reform in the United States: there has long been a consensus on the need for change but little to show for it. The main difference, however, is that China is still far below U.S. levels of GDP per capita, and relying on consumption is Beijing’s best bet to draw level. Whether it likes it or not, China faces a stark choice. It can either choose a pro-consumption path or risk forfeiting its goal of becoming the world’s largest economy over the next decade.