As a new set of leaders come into power in China, the question of economic rebalancing has come to the forefront. The current Chinese economic model is straining and a broad consensus has emerged amongst Chinese economists that more reform is necessary. The content and pace of this reform, however, is still very much under debate.
To get a better idea about how economic rebalancing in China might unfold, it is useful to sketch out some possibilities. We have modeled what we think are some possible paths for Chinese economic rebalancing based on changes in investment, consumption and net export growth over the next decade.
Below are three rebalancing scenarios, a bearish case, a bullish case and one that is in between but a bit on the optimistic side. For each scenario we have highlighted the implications of the differing paths for average GDP growth, the share of investment, and the role of housing.
It should go without saying that rebalancing is not a given. If reforms stall or backtrack, the already large imbalances in the Chinese economy will continue to grow. This would result in higher GDP in the short-run, but a much larger chance of a painful correction later on.
Average GDP Growth (2013-2021)
Investment Share GDP (2021)
Residential Real Estate Investment Share GDP (2021)
Bearish Scenario: sharp slowdown in investment and a steady decline in consumption growth
Bullish Scenario: rapid consumption growth and a steady decline in investment growth
Intermediate Scenario: moderate consumption growth with a steady decline in investment growth
The Bearish Scenario: The bearish case involves a marked slowdown in investment growth that also leads to a slowdown in consumption. This is a case in which there is no policy change to promote consumption. The fall in both investment and consumption growth is a significant drag on GDP growth.
In addition to having the lowest average GDP growth rate, the bear scenario also make the least progress on rebalancing.
This should reinforce the point that a sharp drop in investment growth, in and of itself, is insufficient to achieve effective rebalancing. It must be accompanied with faster consumption growth.
The Bullish Scenario: The bullish case involves a more gradual slowdown in investment growth, winding down over the course of a decade. In this scenario, however, growth is supported by continued strong consumption growth.
This is the scenario that is possible if China rapidly adopts the full suite of consumption promoting policy reforms we have outlined before. This results in 8 percent GDP growth and a much more marked decline in the investment share in GDP.
Intermediate Scenario: The final scenario falls somewhere between the previous two, leaning towards the optimistic side. Investment growth declines steadily, but there is no rapid drop in investment growth like in the bear scenario.
The difference here is that consumption does not grow nearly as rapidly as in the bull scenario. The result is lower growth rates and less progress made on economic rebalancing.
This is similar to the course China is currently on. Investment growth is gradually slowing and consumption is becoming more important for growth. However, policy reform remains incremental and timid and consumption continues to grow below potential.
Takeaways: Rebalancing will be a long term project. Imbalances that have accrued over the past decade cannot be removed quickly.
Attempts at a rapid rebalancing create the bearish case in which the slowdown in GDP growth is so marked that the investment share of GDP declines only a couple of percentage points and thus remains quite elevated.
The bullish case is within reach if strong policy reforms are pursued by the incoming leadership. There is plenty of room to maintain strong consumption growth. Real private consumption expanded by an average of almost 10 percent per year over the last decade and last year it rose by more than 11 percent.
Importantly, while the growth of real investment has fallen below its decade average in the past two years the pace of real consumption growth has been above its decade average. This is a testament to the potential for more robust consumption growth to offset slowing investment growth.
The most likely path, given the current trajectory, is somewhere in between (the intermediate case). While not the hellish economic collapse predicted by some analysts, it does nevertheless represent a missed opportunity for China to grow faster and raise living standards for its citizens more quickly.