The problem of high investment and low consumption began when China was still under a planned economy. Back then, this disequilibrium, considered a vestige of the economic system, supposedly would eventually be resolved after China transitioned to a market-based economy. It did not. Household savings surged with the implementation of reform and opening-up policy in 1978. High savings supported the high investment that fueled China’s economic development, yet also generated excessive capacity and hampered the improvement of people’s living standard.
Obviously, high savings and high investment have little to do with whether China’s being a planned or market economy. Instead, this phenomenon derives from China’s development strategy, unique systems, income distribution structure, and social psyche.
Building domestic demand is both the pillar of economic growth for China as well as a long-term challenge. For most years since 2000, China’s export dependency (in terms of net export’s share in GDP) has been above 50 percent. Between 1978 and 2010, however, the dependency stayed below 10 percent, and the share of domestic consumption in total demand exceeded 90 percent. Econometric modeling indicates that the period between 2005 and 2007 saw the greatest contribution of net export to economic growth (23.1 percent, 16.1 percent, and 18.1 percent annually). Moreover, since 2008, the contribution of net exports to economic growth has plunged (9.0 percent, -40.6 percent and 7.9 percent for 2008, 2009, and 2010, respectively). These figures suggest that China’s economic growth is driven mainly by domestic demand (consumption and investment).
Large annual exports of industrial goods, however, cannot be overlooked. In 1978, the year market reform started, export share in China’s GDP was a mere 5 percent. This figure jumped to 35 percent in 2007. During the height of the global financial crisis in 2009, this figure dropped to 24 percent. Later, in 2010 it increased to 27 percent. With one fifth of the world’s labor force and tremendous capacity brought about by international capital, China must manufacture and export industrial goods to balance supply and demand and achieve effective resource allocation. In this sense, external demand, i.e. net export, is a major driver of China’s economic growth. However, since the international financial crisis struck in 2008, China has faced an austere external environment of slowdown and sluggish demand. A multi-trillion-yuan stimulus plan, though expedient, intensified the high savings and high investment dilemma.
China’s investment ratio and consumption ratio in 2010 were 48.6 percent and 47.4 percent, respectively. The message is clear: investment is high, and consumer demand is lacking. Excessive reliance on investment for economic growth has given rise to a series of imbalances. Now that China is widely considered the manufacturing capital of the world, its next target must be to embrace consumption. Expanding domestic consumption is the key to addressing uneven, uncoordinated, and unsustainable elements in the economy.
Specifically, China should stabilize exports, adjust income distribution, and increase wage share to boost domestic consumption. Reforms should regulate government expenditures and revenue and focus on limiting governments who spend beyond their means. Reform must also focus on addressing imbalance between consumption and investment, especially at the local level. At the same time, to better the income distribution system and reform monopolistic sectors should be taken as opportunities to narrow income gaps. State-owned enterprises and public companies should make equitable dividend distribution a priority. Finally, public services and social protections should be enhanced in order to provide residents with security for education, healthcare, and pension that currently restrain consumption.