China Confronts Demand Dilemma as Exports Slump, Investment Levels Remain Unsustainable: Teng Tai

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Chinese economist Teng Tai (滕泰) has highlighted the need for further measures to drive consumption growth via increases in household incomes, in order to deal with the challenge of ailing economic demand brought about by weakening export and investment levels.

In an opinion piece published on Sina, Teng, Dean of the Wanda Institute of New Economic Research and part-time professor at Fudan University, Renmin University of China, and Central University of Finance and Economics, points out that demand in the Chinese economy is likely to face heavy headwinds soon across a range of fronts.

These include weakening export levels, unsustainable investment growth, and consumption levels failing to stage a full recovery from the impacts of Covid.

“Considering the situation of exports, investment, and consumer demand, the Chinese economy is facing a long-term growth dilemma of insufficient aggregate demand,” Teng writes.

“If this is not resolved in a timely manner, not only will the economy rapidly enter a phase of low-speed growth next year, but it will also bring challenges such as employment.”

China’s export levels on track to weaken

China’s exports have already experienced negative growth for four consecutive months, while it is expected that the full-year growth rate in 2023 will be around -2%.

Teng argues that “given the international economic and political situation, the long-term downward trend in export growth rate will be difficult to reverse”

“From a regional perspective, exports to the European Union fell by 5%; exports to the United States fell by 15.2%; and although exports to Japan increased, imports from Japan fell by 16.8%.

“The decline in exports or imports to developed countries is due to both the contraction in demand caused by interest rate hikes in Europe and the United States, as well as international political factors.”

China has sought to pick up the slack by focusing in trade with emerging economies. Chinese exports to ASEAN countries and countries along the Belt and Road maintained high double-digit growth in the first two months of 2023, with both final product exports and intermediate product exports to Southeast Asian countries increasing due to the transfer of China’s processing and trading industry to these countries.

Further investment growth unsustainable

Teng points out that it will be difficult for the Chinese economy to use investment growth to compensate for further declines in export demand from developed economies, given that already accounts for an abnormally high share of national GDP.

“In the short term, high growth in fixed asset investment will be difficult to sustain due to the downward cycles in real estate, infrastructure investment, and manufacturing profits,” Teng wrote. “Over the next decade, overall investment is expected to see negative growth.

“In 2022, China’s total fixed asset investment is expected to have reached 57 trillion yuan, accounting for around 47% of GDP, which is the highest figure internationally.

“By comparison, the share of fixed asset investment to GDP in Europe, the US, and Japan is between 20% to 25%, and in India it is only 27%. Assuming that a 20% to 25% investment rate is normal for each country, China’s fixed asset investment of 30 to 40 trillion yuan per year would be sufficient. Is the excess of 20 trillion yuan a result of low efficiency, ineffective, or surplus investment?”

This high rate of investment is generating diminishing benefits for China’s regional economies in the form of multiplier effects. Data from the State Council Development Center indicates the multiplier effect of fiscal investment in China is 1.06, and at least half of China’s provinces have a fiscal investment multiplier of less than 1.

“Based on data published by various provinces, from 2014 to 2017, 14 provinces in China had a total fixed asset investment exceeding their respective GDP’s,” Teng observes. “Since 2017, the total fixed asset investment for each province is no longer publicly available, but in reality, the multiplier effect and economic benefits of local investments have declined rapidly in recent years.”

Consumption levels still weak

Teng notes that Chinese consumption has fallen as a share of national GDP since the turn of the century, as well as failed to stage a full recovery from the impacts of the Covid pandemic.

“In the past twenty years, consumption as a share of China’s GDP has decreased. In 2000, it was 63.57%, while in 2021, it was 54.29%, a fall of nearly ten percentage points.

“Consumer growth is currently in the stage of post-pandemic rebound, but the recovery momentum is lower than expected, and in the long term, it will be affected by the lagging growth of disposable income of residents.”

Increasing household incomes the key to boosting demand

Despite the enormous growth of the Chinese economy over the past several decades, levels of disposable income have lagged considerably behind gains in GDP. For this reason, Teng considers it vital to raise household income levels.

“According to data from the National Bureau of Statistics, the per capita disposable income of Chinese residents in 2022 is 36,883 yuan. Multiplying this by a population of 1.41 billion, the total disposable income of residents is about 52 trillion yuan, which is 43% of China’s GDP.

“This proportion is among the lowest in the world, highlighting the importance of increasing the share of household income in GDP to promote core consumption. The key is to promote reform of the national income and expenditure structure.

“Currently, consumption accounts for 54% of China’s GDP, but after excluding 17% of government consumption, the proportion of household consumption in GDP is only 37%, which is clearly unlikely to exceed the proportion of household disposable income in GDP, which is 43%.

“If we gradually increase the proportion of household disposable income from 43% to 53% or 63%, household consumption will also increase accordingly.

“Only when household disposable income increases can household consumption expenditure respondingly increase. However, the specific implementation path still requires further discussion.”

If China can successfully increase household consumption in lieu of boosting investment levels, Teng forecasts major benefits for the economy given its far stronger multiplier effects.

“Let’s assume the investment rate of 47% per year can be gradually reduced to 20% – 25% – or in other words, total fixed asset investment of 5-6 trillion yuan per year falls to the normal level of 3-4 trillion yuan, and this leads to the conversion of inefficient and ineffective investment of 2 trillion yuan per year into household consumption.

“According to a consumption multiplier of over 3-fold, the scale of domestic demand in China will rapidly expand, and internal circulation will accelerate.”

For this reason, Teng considers it imperative for China to expedite a transition from an investment and export-led growth model to an economy centred more upon household consumption.

“The Central Economic Work Conference called for the prioritisation of stabilizing and expanding domestic demand this year….in terms of actual decision-making, it is urgent to for us to discuss and solve issues such as whether to reduce ineffective and inefficient investment, how to transform the 2 trillion yuan of inefficient and ineffective investment into household consumption every year, how to reform central and local authorities from promoting investment to promoting consumption, and how various regions can shift away from the traditional growth model that is centred around investment.”