Economic numbers that won't add up

The second, interrelated, erroneous claim of 'consumer led growth' is that such a decline in investment will be at least compensated for by an increase in productivity. But quantitative examination shows this will not work.

Econometric studies show that as an economy becomes more advanced the percentage of its growth contributed by investment increases. For example in the US, in the last 20 years, 50% of growth was due to investment, 29% due to increases in quantity and skills of labour, and only 21% due to productivity increases. Given investment contributes more than twice as much as to growth as productivity, even in the US it is almost impossible for a decline in investment to be compensated for by an increase in productivity.

In China the situation is even less favorable for such a policy. China's rate of productivity growth is one of the world's highest and its efficiency of investment, in terms of producing economic growth, is far higher than the US. China only has to invest approximately 4% of GDP to grow by 1% whereas the US, even prior to the financial crisis, had to invest over 7% of GDP to grow by the same amount. As China's productivity growth is already the highest of any major economy, the concept that this can be increased further sufficiently to compensate for a fall in investment is wholly unrealistic. A decline in investment will therefore translate directly into a decline in growth.

The consequence would be that the rate of growth of China's living standards would also fall. No economic redistribution can compensate for a decline in GDP growth. Internationally over 80% of consumption growth is due to GDP growth. A slowdown in China's GDP growth, due to a smaller share of investment in GDP, and productivity's inability to compensate for this, would therefore necessarily mean slower growth of living standards. The attempt to apply 'consumption led growth' would, paradoxically, actually lead to a lower rate of growth of consumption and living standards!

The consequences for employment and productivity of such policies would be equally negative. In the past, due to its very high productivity growth, China had difficulty in creating enough employment even with rapid economic growth – the average annual increase in labor hours worked has only been about 0.5%. If the proposed policy of increasing productivity, but with lower GDP growth, were successful then necessarily jobs would be even harder to create – China would become a high productivity, lower growth, high unemployment economy. But if instead priority were given to creasing sufficient jobs, by adding low productivity employment, then the proposed increase in the rate of growth of productivity would not occur - China would become a slower growth, lower productivity growth economy. Either outcome would be undesirable economically and socially.

For reasons of social stability the government's priority is likely to be to create enough jobs. Consequently, with slower GDP growth, China would become a lower productivity growth economy – that is, the proposed policies would not lead to productivity acceleration but to a productivity slowdown!

Lin Yifu, China's former Senior Vice-President of the World Bank, recently stated: "Those who advocate that China's economy should rely on consumption are, in fact, pushing the country into a crisis.” Given the focus of his writings Lin Yifu probably had in mind medium term dangers but as noted above substantial problems would be likely to emerge even in the short term.

Given the incoherence of any such proposed 'Likonomics' hopefully the government will ignore such policies proposed in the media.

The author is a senior Fellow of Chongyang Institute for Financial Studies, Renmin University of China.