China’s economy is about to enter a period that many economists have long predicted to come one day. The times when China could afford to save at the expense of its own people seems to be slowly fading away. Beijing has for long cherished exports and investment-fuelled growth as the ultimate economic policy, but it had also simultaneously transferred resources from the private sector and thus subsidized the growth rate.
According to Michael Pettis, Professor of Economics at Beijing University, China has currently one of the lowest consumption shares among big economies – 34% compared to the 72% in the U.S. and 58% in the EU. Attempts to ‘rebalance’ its economy towards consumption, let’s say to 50%, would require consumption growth rate to overtake GDP growth by 4 percent. If we took the current predictions that China would slow down to grow at about 6-7 percent GDP annually, then consumption would have to grow at about 10-11 percent in order to ‘rebalance’ its economy in any meaningful way.
Such a shift towards a more consumption-driven economy might be difficult to achieve in the society whose innate characteristic feature is to economize … and to save. Moreover, higher consumption rates imply higher wages. Without increasing household incomes, it can be very hard to make households willing to spend more especially given staggering Chinese and global economic conditions. Needless to say that China seems to have missed the chance to stimulate domestic demand when the Chinese economy was hitting 10 percent GDP growth rates and the government chose to tightly ration goods and services at home in order to succeed worldwide.
Yet, as Beijing has already saturated global markets, neither United States nor Europe are keen to perpetuate the policy of borrowing from China to further support the ‘Made in China’ trademark. Investment, on the other hand, is still jeopardized by economic uncertainty that currently rules global markets. Therefore, the time has come to think again and reverse the tide. Earlier, the courage to do so was lacking among the Chinese establishment, but the recently enthroned President Xi Jinping appears that he is ready to take up that challenge. The assignment is not easy – to turn China’s rising middle class into the main engine of economic growth.
But if the giant, whom China turned into during the last decade, is to rebalance now, who is going to pay for it then? Earlier in February, the Central European Bank published a special report on China’s rapid economic growth that “has produced domestic and external imbalances which are associated with economic inefficiencies, financial stability risks, social unrest and tensions with major trading partners”. Importantly, the European Union is among those major trading partners.
The Rhodium Group, a U.S. consultancy, stated in its February report that in 2011 bilateral trade flows between the EU and China totaled €430 billion, four times higher than just ten years ago. In addition to growing exports, European firms have expanded and often maintain their physical presence in the mainland. The stock of foreign direct investment (FDI) by EU firms in China amounted to more than €100 billion in 2011. More important is, however, that Beijing has continuously transformed from a bare receiver to an active investor in Europe. Chinese companies have considerably increased their portfolio investments as well as holdings of EU securities, sovereign debt and equity shares in an effort to diversify China’s reserve holdings away from the U.S. Above all, however, China’s involvement in Europe has been lately crowned by a marked outward increase of FDI in the EU, while only in 2004, such investment was almost non-existent. In other words, what was once a one-way flow has been slowly becoming two-way torrent of investment, notes the consultancy.
Now, amidst China’s ‘glut’, fears loom that the Asian powerhouse will be forced to give up on some of its trading activities, and that the trade relations with the EU will have to be neglected for the sake of China’s own domestic consumption. To what extent, and in what resorts, is still unknown but is likely to be revealed fairly soon.