Why consumption stimulus is still China’s best option to revive its economy

What ails China’s economy is a deficiency of demand, making fiscal transfers to boost domestic spending the right cure
A consumption-led recovery is not only consistent with Beijing’s goal of rebalancing the economy, but will also help address China’s trade imbalance with the US and strengthen relations with its regional partners

Aidan Yao

Published: 3:30pm, 27 Sep 2023

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The latest economic data for August shows some tentative signs of stabilisation in the Chinese economy. Virtually all activity indicators surprised on the upside, with some even pointing to sequential growth acceleration. Notably, retail sales growth almost doubled to 4.6 per cent, while export growth contraction eased by almost half to minus 8.8 per cent.

Industrial production growth quickened by 0.8 percentage points to 4.5 per cent. The faster recovery in demand than supply points to a more balanced economy, helping to pull the consumer price index out of deflation and narrowing the decline in the producer price index for the second consecutive month.

The piecemeal policy easing is starting to add up. Credit growth accelerated last month for the first time in five months, helping to bolster manufacturing investment and big-ticket consumption. Faster local government bond issuance also supported infrastructure investment despite still flagging land sales.

Even the property market saw some signs of life, with year-on-year contraction of house sales, starts and investment all easing after Beijing loosened purchase and lending restrictions.

In all, it’s hard to fault the broad-based improvement shown in the August data. However, one data point does not make a trend. Given how downbeat sentiment is, it would likely take more than one month of data – and more forceful policy easing – to convince sceptics that the worst is over. The mixed, and somewhat muted, reaction to the data surprise suggests scepticism still abounds.

Therefore, what is needed to decidedly turn around the economy remains a hot debate. Some have advocated blanket support to circuit-break the property market decline, given the importance of the sector for economic and financial stability.

Others think it’s more realistic to increase fiscal spending on infrastructure as the central government can readily substitute for cash-strapped local governments in carrying out the task.

The call for consumption support, however, has dwindled somewhat as people question whether an American-style fiscal transfer would really work here.

I have been a firm supporter of consumption stimulus and believe it may be the only viable way to revive short-term growth without compromising the economy’s long-term health. A consumption-led recovery will have several benefits.

But first, any prescription for stimulus has to rest on the recognition that the fundamental problem facing the Chinese economy is a deficiency of demand, not supply. This is why China is teetering on the edge of deflation and the level of capacity utilisation is at a multi-year low.

Recognising this helps to narrow the stimulus options. For example, any policies that aim at boosting supply – whether it’s building more houses, roads and bridges, or manufacturing capacity – will not solve the issue and may in fact aggravate overcapacity and deflation.

Instead, the focus should be on boosting demand, which has two parts to it. Externally, demand for China’s exports is outside Beijing’s control, but its influence on domestic spending – whether by governments or households – is much greater. Hence, stimulating consumption – the only genuine domestic final demand – is really the only option left to get the economy out of its recessionary and deflationary spiral.

A worker checks a rotor core used for wind turbines at a factory in Nantong, Jiangsu province, on September 20. China, with its low level of capacity utilisation, suffers from a deficiency of demand, not supply. Any prescription for stimulus must be based on this recognition. Photo: AFP

Beyond the immediate future, a consumption-led recovery is also consistent with Beijing’s medium-term goal of rebalancing the economy. Although Beijing pledged to do so almost two decades ago and even coined the concept “internal circulation” (part of the “dual circulation” strategy), progress towards rebalancing remains limited. Consumption’s share of gross domestic product rose gently after the global financial crisis but has fallen back since the pandemic.

The lack of policies to structurally reallocate income from the government and companies to consumers is a fundamental reason consumption has struggled to make a breakthrough. In that regard, an American-style fiscal transfer could be one way to kick-start the income rebalancing needed to raise the consumption share of the economy.

The corresponding decline in investment’s share could also contribute to less debt accumulation as fewer resources will be wasted in funding unproductive projects.

Further, a successful economic rebalancing may yield geopolitical benefits. One of the sticking points of China-US tensions is trade imbalance – featuring a large and persistent surplus on China’s side.

Part of this reflects the relative export competitiveness of the two economies, but part of it also has to do with the lopsided nature of the Chinese economy. A decided shift towards consumption (and imports) could help to rebalance this relationship and cross one important item off the list of bilateral disagreements.

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A consumption-led economy may also help China strengthen ties with other developing countries. Many of them – especially those with a lower income per capita – look to China as a source of demand, not supply, to further their economic advancement. Conversely, as China moves up the value chain, it would increasingly need markets for its high-end electric vehicles and electronics.

Therefore, a more sustainable relationship is for China to be the buyer of imports from others, which will again require its economy to transform from factory of the world to consumer of the world. A strong economic bond between China and the Global South would be the foundation for more cooperation on other issues.

Finally, it is widely believed that the supplier of a global reserve currency needs to run trade deficits to ensure a constant provision of its currency to the rest of the world.

This is the case for the US today, as it was for the United Kingdom in the 19th century. If China were to succeed in internationalising the renminbi, a change in its trade position – from surplus to deficit – would require Beijing to prioritise consumption (and imports) over production (and exports). A successful economic rebalancing could therefore have profound financial implications too.

Aidan Yao is a macroeconomist with more than 15 years of experience in both public- and private-sector organisations