China's unwilling consumers: a dramatic expansion in household demand is a long way off.

Author:Jin, Keyu

For several years, Chinese leaders have been pursuing economic "rebalancing." The country's longstanding growth model, based on investment and exports, is to be replaced by one based on services and domestic consumption. It's a necessary transition for China. Unfortunately, consumption-led growth remains a distant prospect.

Yes, the contribution of domestic consumption to GDP has risen slightly over the last few years. But that mainly reflects weak investment demand, not strong consumption growth. In fact, wealth accumulation remains the primary objective of Chinese households. And, given China's economic structure, underdeveloped financial market, and weak welfare state, high levels of precautionary saving will persist for the foreseeable future.

Indeed, one key factor impeding consumption is the imperative faced by China's older workers to save for retirement. In the past, the Confucian tradition of filial piety meant that children supported their parents in their dotage. But, after more than three decades of the one-child policy, retirees cannot reasonably expect nearly as much support, and China lacks a strong pension system to pick up the slack.

As it stands, urban retirees derive about half of their income, on average, from family support. But middle-aged workers know to expect less when they retire. Even the elderly are increasing their savings, owing partly to longer life expectancy and a surge in medical costs. This contrasts sharply with rapidly declining savings rates among the elderly in the United States.

Another reason Chinese households are unlikely to increase their spending is that their income's share of GDP has been falling--from about 70 percent in 1990 to about 60 percent 2010. (It remains at a constant level of 80 percent in the developed economies.)

The problem here is twofold. First, China's growth model is distorted, as it emphasizes investment over employment growth and depends partly on wage suppression to subsidize production and exports. Second, financial repression has capped Chinese households' savings at about a zero real rate of return.

Cheap capital and low labor costs might be good for output growth, but household demand is being throttled. In this sense, the main imbalance that China must address is not between consumption and investment, but between households on one hand and the government and corporations on the other.

That's why typical stimulus policies haven't worked--and not for lack of effort. In...

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