Economic numbers that won't add up

The new government has only been in power a short period. It has therefore not made a comprehensive statement on economic policy, although key guidelines such as urbanization have been outlined. However sections of the media are agitating for it to embark on a set of policies involving a reduction of the percentage of investment in GDP - alleging that this can be compensated for in economic development by an increase in efficiency and productivity. This would allegedly form 'Likonomics'.

Unfortunately the economic numbers involved in these proposals cannot be made to add up. Consequently they would lead to economic and social crises. It is therefore to be hoped economic policy does not embrace such an incoherent course.

The first key proposal is that China should embark on something termed 'consumer led growth'. This is a claim that increasing the percentage of the economy devoted to consumption, which necessarily means reducing the percentage of investment, will lead to an increase in consumer demand, more rapid growth of consumer production, and a more rapid rise in living standards.

Factually this proposal doesn't understand that investment is the main source of economic development, accounting for half of total growth in an advanced economy. Conceptually it doesn't understand what a market economy is.

A market economy can necessarily only be 'profit led growth'. In a market economy output does not increase due to 'demand' but only because of profit - increasing demand consequently only increases output if it increases profit.

But the key proposal in 'consumer led growth' is in direct contradiction with this. It proposes that the percentage of consumption in China's GDP be increased, and to finance such consumption the percentage of wages in GDP should increase. This policy, however, leads to an economic crisis and a lower rate of increase in living standards.

The reason is that increasing the percentage of wages in GDP would necessarily mean cutting the percentage of profits. Consequently the proposal for 'consumer led growth' in reality advocates that a profits squeeze should be applied to companies via wages growing more rapidly than GDP.

The practical consequences of such a proposal were seen in the first part of 2013 when consumption contributed far more to GDP growth than investment – also indicating wages were rising more rapidly than GDP.

The more rapid rise of wages than GDP necessarily squeezed company profits. By May 2013 overall profits increase reported by companies listed on China's A-share market was zero - they were falling in inflation adjusted terms. As a consequence both private and state-owned companies starting cutting back investment projects. In the first five months of 2013 growth in fixed asset investment was 0.2% lower than growth in the first four months, and private investment growth dropped by 0.1% compared to a year earlier. This in turn led to economic slowdown. GDP growth fell from 7.9% in the last quarter of 2012 to 7.7% in the 1st quarter of 2013 - placing still greater pressure on profits.

This produced the only possible consequence in a market economy – a chain reaction leading to crisis, which duly broke out in June in credit markets.