Chart 1: China GDP Expenditure Approach Breakdown (RMB bn)

Chart 2: 2009 China Government Spending Plan (RMB bn)

China’s impressive economic growth trajectory of the last 30 years has to a large extent relied on investment from, and exports to, the developed world. While household consumption accounted for around half of China’s GDP in the 1970s, economic reform since then has been accompanied by a decline in the contribution of household consumption to GDP, reaching 35 per cent in 2006 (compared to about 70 per cent in the United States), and an increase in household saving rates to 25 per cent in 2007 from 15 per cent in 1995 (compared to less than 5 per cent in Japan and Korea). Rapid growth has transformed China in the last thee decades, yet the global financial crisis has driven a temporary wedge in China’s economic relationship with the rest of the world, and, in mitigating the impact of the crisis, China’s government has one place to turn - inwards.

The slowdown has seriously impacted China’s export sector and caused a large number of job losses, yet it has also provided a massive incentive to wean China’s economy further off its traditional growth engines of exports and investment towards exports, and to focus more on spurring consumption in the domestic market. In fact, by means of its 586 billion US dollar stimulus package, China is not only attempting to keep its economy growing by offsetting the slack global demand for Chinese manufactured goods, but also to reconfigure the set of structural economic factors that has underpinned the Chinese success story of the last 30 years. 

Looking for the bottom

China’s exports in February were a full 26 per cent down from a year earlier, and declined for a fifth consecutive month in March, yet at a slower rate of 17.1 per cent. These marginally improved trade figures for March have inspired talk of China’s economy ‘bottoming-out,’ complemented by a rebound in March of industrial output growth by 8.3 per cent (from a record low of 3.8 per cent in the first two months of 2009), and by the CFLP (China Federation of Logistics & Purchasing) measure of the Purchasing Managers’ Index (PMI) rising for three months to break through the 50-level mark (indicating expansion) in March.

Yet exports and GDP growth may not be the government’s main concern. Commerce Minister Chen Deming said earlier this year China’s biggest challenge was unemployment. Various media reports indicated that more than 20 million migrant workers may have lost their jobs due to the crisis. Chinese household savings amounted to 24.7 per cent of their disposable income in 2006 (compared to only 0.7 per cent in the US), and the absence of a substantial social security net, combined with increasing joblessness and falling rural incomes, have continued to inspire high precautionary saving rates among households in China.

Bricks, people and confidence

The largest share (RMB 1.5 trillion, or 38 per cent) of the stimulus spending is devoted to ‘bricks’: public infrastructure, with projects lined up including railways, irrigation, roads, and airport construction. RMB 1 trillion is to be spent on funding reconstruction work in the quake-affected Sichuan province. RMB 400 billion has been earmarked for civil works, including low-income housing and renovation, while RMB 370 billion will be spent on rural infrastructure, including improvements to the power grid, roads and substandard housing. In the revised outline of the stimulus spending announced in March this year, RMB 370 billion was devoted to technology initiatives, and RMB 210 billion to energy-saving projects, while RMB 150 billion was allocated to educational, cultural and family planning purposes. Following the release of China’s GDP data for Q1 2009, eight additional measures to spur the economy were announced, laying out a range of broad objectives including the boosting of fixed-asset investment, consumption and exports.

Intended both to create employment and expand China’s social security net, the stimulus package endeavours to address the structural reasons why Chinese private and household savings are high and the consumption share of GDP is relatively low. The share of household income in GDP is very low in China (about 40 per cent) yet the share of corporate savings in GDP is relatively high as most of the corporate sector’s profits in China are held by firms in the form of retained earnings and not distributed to shareholders as dividends. In a world where the US consumer can no longer be the consumer of first and last resort, government spending and investment in China must over time be compensated by private consumption.

Side effects

Revitalisation plans have also been announced for ten manufacturing industries: textiles; light industry; electronics and information; logistics; automobiles; shipbuilding; machinery; steel; nonferrous metals; and petrochemicals. Yet these ten stimulus plans may not adequately address the concerns about excess capacity, instead creating even more inventory and an illusion of increased demand. 

The government has been encouraging banks since November to extend more credit, and in March Chinese banks accordingly lent a record amount of RMB 1.9 trillion, an increase of more than sixfold compared to a year earlier and the third straight month that bank lending exceeded RMB 1 trillion. This lending surge has raised fears of the emergence of a new credit bubble. Growth in M2, the broadest measure of money supply, hit a record 25.5 per cent in March, 8.5 percentage points higher than the government’s targeted annual rate.

In April, the French insurance firm Coface reported a rapid deterioration in the ability of Chinese companies to honour payments to their suppliers, which, it concluded, has significantly increased the risk of doing business in China. The change in the risk environment, moreover, seems to be more acute for China’s SMEs (particularly in the export-oriented sectors) who have been faced with a liquidity crisis as China’s banks are traditionally more accustomed to extend credit to larger state-owned enterprises.

Riding out the storm

China has embarked on a massive stimulus package to get its economy back on track. As such, the spending-led intervention is not a significant break with trusted growth models. Yet inherent in the vigorous response is a more long-term initiative aimed at rebalancing China’s path of development. China’s future depends on the development of its citizens as consumers and contributors to the economy, and if China’s population can be given incentives to play greater role in China’s economy, the financial crisis may yet go from being a temporary jolt to a stepping stone.