In December 2004 at the annual Central Economic Work Conference, China’s top political leadership agreed to fundamentally alter the country’s growth strategy by rebalancing the sources of economic growth. In place of investment and exportled development, they endorsed transitioning to a growth path that relied more on expanding domestic consumption.1 Since 2004, China’s top leadership, most notably Premier Wen Jiaobao in his speeches to the annual meetings of the National People’s Congress in the spring of 2006 and 2007 and at the Central Economic Work Conference in November-December 2006, have reiterated the goal of strengthening domestic consumption as a major source of economic growth.
China’s announced decision to rebalance the sources of economic growth is laudable. It increases the likelihood of China’s sustaining its strong growth of recent years, achieving more rapid job creation, improving income distribution or at least slowing the pace of rising income inequality, and reducing its outsized increases in energy consumption of recent years. It also would help reduce global economic imbalances and thus lessen the risk that China would be subject to protectionist pressure, especially in Europe and the United States.
But at least through early 2007 China’s policy initiatives have been relatively modest, with only a slight change in China’s underlying growth dynamic. As a result, China’s economic expansion remains disproportionately dependent on rising investment expenditures and an expanding trade surplus. China’s external surplus continued to balloon to a global record in 2006 and, short of a U.S. recession, seems almost certain to expand further in 2007. China also is falling short of meeting several of its key domestic economic objectives.
What Are the Sources of China’s Economic Growth?
China has been the fastest growing economy in the world over almost three decades, expanding at 10 percent per year in real terms. As a result, real GDP in 2005 was about 12 times the level of 1978, when Deng Xiaoping launched China on the path of economic reform (National Bureau of Statistics of China 2006a, 24). China is now the world’s fourth-largest economy and its third-largest trader and highly likely, within a year, to move up a notch in each category. Given this stunning long-term success, why would China’s leadership even entertain the idea of shifting to a new growth paradigm?
In all economies the expansion of output is the sum of the growth of consumption (both private and government) plus investment plus net exports of goods and services. Expanding investment has been a major and increasingly important driver of China’s growth. As shown in figure 1, investment averaged 36 percent of GDP in the first decade or so of economic reform, relatively high by the standard of developing countries generally but not in comparison with China’s East Asian neighbors when their investment shares were at their highest. But since the beginning of the 1990s, China’s investment rate has trended up. In 1993 and again in both 2004 and 2005, investment as a share of GDP reached 43 percent, a level well above the historic experience of China’s East Asian neighbors in their high-growth periods.3 Rising investment has been fueled by a rise in the national saving rate, which reached an unprecedented 50 percent of GDP in 2005. Rising investment was particularly important in 2001–2005, when it contributed just over half of China’s economic growth (National Bureau of Statistics of China 2006b, 70), an unusually high share by international standards.
The growth of both household and government consumption has been rapid in absolute terms throughout the reform period, but has lagged the underlying growth of the economy. As shown in figure 2, in the 1980s household consumption averaged slightly more than half of GDP. This share fell to an average of 46 percent in the 1990s. But after 2000, household consumption as a share of GDP fell sharply—and by 2005 accounted for only 38 percent of GDP, the lowest share of any major economy in the world. In the United States, household consumption accounted for 70 percent of GDP in the same year. In the United Kingdom, the household consumption share was 60 percent. In India, it was 61 percent. Even in Japan, famous for its high household savings, household consumption in 2005 accounted for 57 percent of GDP, half again as much as the share in China (IMF).