Social security crucial to higher consumption

The unfolding global recession has already had a great impact on China, causing an economic downturn in recent months. What China's economy faces now is not just short-term difficulties but a fundamental challenge to its development model that originated from East Asia's economic success.

Indeed, from the Japan-led "East Asian miracle" to Asia's rise driven by China's and India's rapid growth, virtually the whole of Asia (except the oil producers) has followed the same export-led development model in the last several decades, a model that has open and prosperous external markets on the one hand and steady inflows of foreign investments on the other as preconditions.

China's fast economic growth has in a large part been achieved amidst swift economic globalization. But the financial tsunami has brought globalization to a standstill, as the unprecedented crisis has not only reversed the global financial expansion, but also derailed internationalization of manufacturing and services. It appears as if this export-led growth model has run out of fuel, causing a dramatic economic downturn all over Asia.

But China's effort to rescue this economic downturn has further exposed another problem: the structural imbalance of the Chinese economy, demonstrated by not only the heavy reliance on export-oriented manufacturing and processing industries, but also the excessive expansion of industrial capacity at the expense of consumption. Such a structural imbalance has made China's difficulties in the global recession more painful.

Obviously, the Chinese leadership has keenly realized these challenges and is making a remarkable effort to overcome them. The stimulus plan to invest over $586 billion in the next few years is timely and decisive. But there is a risk that this plan could exacerbate, rather than improve, the situation.

First of all, China's fast growth since the late 1990s has essentially been investment-driven, controlled by the government and fueled by the steady inflow of FDI, resulting in a long-existing "investment bubble".

According to the National Statistics Bureau, the investment rate in China's GDP has kept increasing since the beginning of the century - from more than 38 percent in 2001 to nearly 50 percent in 2007 - despite the country's constant effort to cool it down. Given the looming crisis of industrial overcapacity, massive investment, especially in infrastructures, could sow the seed for future economic crisis if there's no good planning, careful coordination and effective execution of the stimulus plan.

Moreover, the success of the massive investment to stimulate the economy will rely on good coordination between the central and local governments. In China, policymaking, and to a large extent policy implementation as well, has to be centralized in order to ensure policy effectiveness. But it is necessary to decentralize in order to promote economic development, especially in times of crisis, while maintaining a socialist market economy.

Given the pressing situation and the unprecedented scale and complexity of the stimulus plan, it seems that the country has to bring localities' initiatives into full play in order to achieve the desired policy goals. As such, the government's capability and effectiveness of macro-management, fraud prevention, and policy coordination will all be put to test.

But the massive stimulus plan is not just to keep the economy going amidst the global recession. Its essential aims are to develop a strong and balanced internal market (so as to amend the structurally unbalanced economy) and, more importantly, to maintain socio-political stability by creating jobs for millions of laborers who would be otherwise unemployed.

In the long run, however, the remedies for China's economic problems are to increase the consumption level while developing a sufficient socio-economic welfare system. And the two aspects are essentially interrelated.

Indeed, despite a steady increase in investment, China's consumption rate has kept falling in the last three decades, from around 55 percent of the total GDP in the 1980s to merely 35 percent last year. While this is certainly an unmistakable indication of an underdeveloped internal market, a more serious reason is the slow increase in personal incomes despite the fast economic growth. Yet it is highly arguable that there would be a rise in consumption should personal incomes increase.

Compared with the extra-low consumption rate, the saving rate in China has remained high. This is not necessarily because the Chinese people are economically super-prudent, but because the insufficient socio-economic welfare system makes them feel insecure about healthcare, children's education, unexpected rainy days and eventual retirements.

This problem is perhaps best demonstrated by the government spending on public goods. To this date, China is yet to develop national programs on healthcare, housing (subsidy) schemes, retirement, and social welfare. Amidst rapid expansion of the market economy, people's expenditure on life's necessities, especially on healthcare, education and housing, has increased dramatically. Without a complete government-sponsored safety net, it is but wishful thinking that an increase in personal incomes - if the stimulus plan achieves its desired goals - would automatically boost consumption.

Given the government's recent decision on deficit spending to ensure the success of the stimulus plan, it is high time for the central government to address the long overdue problem of socio-economic welfare system in China. After all, when people have to count on their own savings as their safety net, consumption is more a luxury than a necessity.

The author is a visiting senior research fellow, East Asian Institute, National University of Singapore

(China Daily 01/15/2009 page8)