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This is a guest article by Michael Pettis, professor of finance at Peking University and senior researcher at the Carnegie-Tsinghua Center.
Since May, when President Xi Jinping first introduced the concept of a “dual circulation” economic model, analysts who follow the Chinese economy have struggled to understand exactly what the Chinese leadership is committed to. . From the many subsequent formal references that followed, it appears that Beijing’s new economic strategy calls on the country to continue to develop domestic production for exports (“international circulation”) while shifting the economy towards greater relative importance of production for domestic consumption (“internal circulation”).
In principle, this makes sense. Once it bridged the underlying gap between desired investment and actual investment – which it probably did in the early 2000s – China had to base its growth on domestic demand driven by rising wages, rather than depending on exports or increasingly unproductive investments. Because China has relied so heavily on it, its debt burden has become one of the highest in the world.
But if “dual circulation” is presented as a new strategy, it really is not. Beijing has been proposing something similar since at least 2007, when a speech by then-prime minister Wen Jiabao pledged that Beijing would make rebalancing domestic demand toward consumption a priority.
This does not happen. The share of consumption in China’s GDP remains extraordinarily low, barely two percentage points higher in 2019 than it was in 2007. Meanwhile, and it is no coincidence, during this period. period, China’s debt-to-GDP ratio has doubled.
It will get worse this year. With the sharp decline in consumption relative to GDP – partly due to Covid-19 and partly due to Beijing’s production-oriented response to the pandemic – the share of consumption in GDP will decline in 2020 for erase most of the gains it has made since its low point a decade ago. Meanwhile, China’s debt-to-GDP ratio, which increased by six percentage points in 2019, will increase by 16 to 20 percentage points in 2020. Not much has changed since 2007, in other words , with the exception of the country’s debt burden: demand in the Chinese economy is also more unbalanced than ever.
Double circulation by name, rebalancing by nature
This is clearly unsustainable and this is why it is so urgent for China to stimulate sustainable domestic demand. However, Beijing faces two major problems with dual circulation. The first problem is that the reorientation of the economy towards domestic demand, whether you call it ‘rebalancing’ or ‘dual circulation’, requires an economic, social, and political transformation that will likely be far greater than Beijing – and most. Chinese and foreign economists, for that matter – seem to realize.
China’s low domestic consumption rates – among the lowest in history – are mainly the result of households maintaining one of the lowest GDP shares of any country in history. Rebalancing demand towards consumption means nothing less than a major rebalancing of income towards ordinary households. For Chinese consumption to be broadly in line with that of other developing countries, ordinary households must recover at least 10 to 15 percentage points of GDP at the expense of businesses, the rich or the government. This means that rebalancing involves a massive transfer of wealth – and with it, political power – to ordinary people. This will not be easy.
The second major problem is the internal contradiction at the heart of the new Chinese “dual circulation” model. China’s export “competitiveness”, as former Alphaville writer Matt Klein and I explain in our recent book, Trade wars are class wars, depends on ensuring that workers receive, whether through wages or the social safety net, a very small share of what they produce. The strength of China’s exports, in other words, depends, at least in part, on how little workers keep of what they produce.
Here is the problem. China can only rely on domestic consumption to generate a much larger share of growth if workers start to receive a much higher share of what they produce, so the very process of rebalancing must undermine competitiveness. of China’s exports.
This means that for “internal circulation” to be successful, “international circulation” must be undermined. One cannot stimulate the other, as Beijing proposes: the change itself will require a difficult period of adjustment.
Although the vocabulary has changed, the sustainable growth desired by Chinese policymakers still requires a major transformation in the way income is distributed among different sectors. Not only is the policy challenge still as great as ever, but because past Chinese growth has depended so much on current distortions in income distribution, the transformation to a new model will almost certainly require a very difficult adjustment period. For dual circulation to work, internal circulation can only come at the expense of international circulation, and in doing so, wealth – and with it power – must be transferred from today’s elites to ordinary Chinese households. .