China's Rebalancing Act

Stephen Roach has access to some of China's top economic policymakers. They are aware that the phenomenal export-driven growth, is ultimately unsustainable. I loved his account of a conversation he had, in China, with Senator Schumer. (In case you haven't heard, Senators Schumer, Graham, and Coburn are in China hoping to pressure the Chinese to revalue their currency.) The one thing that never changes is that "all politics is local" -- so expect changes in economic policy in both China and the U.S. to be SLOW.

Hat tip to Brad Setser:

... Instead, China will focus increasingly on boosting its support from domestic demand -- especially private consumption. This was music to my ears. If China can successfully execute this important shift in the mix of its GDP, it will go a long way down the road of its own rebalancing. The Chinese leadership is, in effect, conceding a very critical point on the sustainability of its all-powerful growth machine -- that it has pushed the export- and investment-led growth paradigm to the limit. It fully recognizes the potentially destabilizing consequences of staying with this formula for too long -- trade frictions and protectionism from open-ended export growth and excess capacity and deflation from open-ended investment spending. Without the solid underpinnings of internal consumer demand, China’s supply-side growth model poses mounting sustainability risks of its own. A major rebalancing is the only answer -- and one that China’s senior leadership now endorses wholeheartedly.

... At the China Development Forum, I challenged Chairman Ma on the execution of this strategy, asking him point blank how China expects to spark a dynamic consumer culture in the face of a daunting sense of job and income insecurity that appear to be unavoidable outgrowths of ongoing reforms. My question: “Don’t the massive headcount reductions brought on by the continuing dismantling of a state-owned system make it very difficult for China to count on a pro-consumption growth dynamic?” Chairman Ma’s response was both candid and very wise. He stressed four keys to success for China’s shift to an increasingly consumer-led growth dynamic: (1) Income support -- always the main driver of consumption -- will be directed at the lower end of the pay distribution, especially in rural and agricultural China. (2) The safety net will be emphasized as the means to cope with consumer insecurity and the related excesses of precautionary saving; this implies heightened emphasis on social security, educational, and healthcare reforms. (3) Emphasis will be placed on improving the retail distribution network; this is a physical infrastructure issue (i.e., roads and rail) but also a commitment to expanding China’s retail and wholesale trade establishments -- part of a broader set of services-based growth initiatives. (4) Improving the quality of the Chinese consumption experience is also a major focus; this includes initiatives on land-price reform, enforcement of hazardous product regulations, and tilting export growth away from the low-labor-cost production model.

Chairman Ma’s response hit the nail on the head, in my view. It was a great exposition of the macro and micro considerations of spurring the shift to a consumer-led growth dynamic. He left us with one critical point: The emergence of a Chinese consumer culture will take time -- and possibly a good deal of it. This is a key point on the coming rebalancing of the Chinese economy. For 50 years, the state provided the people everything from cradle to grave -- from jobs and income to shelter, medical care, education, and retirement stipends. As the state-owned enterprise system gets dismantled, so, too, does that umbrella of all-inclusive support. This is as profound a shock as any nation has to face -- unleashing a powerful surge of precautionary saving to compensate for the Chinese life-style that has been turned inside out. It may well take a new generation of Chinese consumers to overcome that shock.