What's Missing in China's Stimulus Package?

By Li Qi and Rosemary T. Cunningham

As the world begins to emerge from the worst economic recession in recent memory,  stimulus packages enacted by various governments around the world are very much in the spotlight. The early verdict on China's massive stimulus is favorable. The Wall Street Journal reports that "spending by Chinese consumers is holding up pretty well, partly because of heavy stimulus spending by a government flush with cash. Urban household spending in China was up 9.2% in the first half of 2009."1

But will the stimulus bring lasting change?

China unveiled its 4 trillion RMB (US$586 billion) stimulus package at the end of 2008.  The center piece of this plan is fiscal spending on public infrastructure development and social welfare.   Some of the key areas include housing, rural infrastructure, transportation, health and education, environment, industry, disaster rebuilding, income-building, and tax cuts.  The massive scale of government spending was visible everywhere on the authors' recent trip in 2009 to China. For example, the photo included here shows major redevelopment work on the Bund in Shanghai.

The essence of the stimulus package is government-led spending.  Government-led behavior often generates growth spurts (as confirmed by recent consumer spending figures mentioned above).  This stimulus package will no doubt increase China's GDP.  It is also a smart strategy to adjust an economy that relies too much on exports and too little on domestic demand.  Investing in public infrastructure and the social welfare system will further strengthen domestic demand and serve the economy well in the long-run. 

However, what China needs is to stimulate the more sustainable force of domestic demand - household consumption – and make sure that this new increase in consumer spending is not just a temporary growth spurt.  China's households have always had a rather low consumption rate compared not only with advanced economies like Japan and the U.S. but also with other large developing economies such as India and Brazil2. In 2007, household consumption expenditures were 60.8% of GDP in Brazil and 55.0% in India but only 35.9% in China.3

Moreover, our recent field interviews with households in Beijing, Shanghai and Xian indicate that Chinese consumers are still not buying or planning to buy more goods in the future.  For example, one of our survey questions asked households: if they suddenly earn 50,000 Yuan, how they would spend the money?  There were five possible options: savings or investment; pay debt; give to children or relatives or donate to social causes; buy a house, car, furniture, or electronic appliances; and spend on travel and other leisure activities. The average response was to save nearly 60 per cent of the 50,000 Yuan, instead of spending it on durable goods or vacations.

The low consumption rate to GDP poses challenges to China's new balanced growth strategy, under which shifting the source of growth from export revenues to domestic demand is a key factor for the success of adjusting China's economic structure.  This low consumption rate also demonstrates that the allocation of economic resources (a core issue to economics) is not largely determined by households.  As an economy moves from a planned to a market mode, one expects resource allocation decisions to shift from the state to households or private hands.  In that regard, China has a long way to go. The state still has a high command on China's economy after decades of market reforms.

Nevertheless, the stimulus package is sensible and should help increase household spending.  Studies have shown that low social security and health care benefits do contribute to a low consumption ratio (Qi and Prime 2009).  Households may not have to save as much for the future once a more effective and generous social welfare system is built.  Moreover, this package also introduces creative ways to stimulate consumer spending.  The recent 7 billion Yuan subsidy for households to trade in outdated cars and color TVs is working to increase domestic sales.

Yet once again, what happens after the sales spurt powered by this one-time subsidy?  Taking care of the future (social welfare) alleviates households' burden for retirement, but increasing current household incomes is necessary and urgent.  Unfortunately the stimulus package is silent on this.

Chinese people have enjoyed unprecedented income growth by virtue of the success of market reforms.  Thousands have been lifted out of poverty.  Compared to the past, household incomes have been growing tremendously.  However, investigating the composition of China's growth in income for 1997 to 2007 (the last year for which the data is available), we see that in 27 of the 31 regions identified in the China Statistical Yearbook4, compensation of laborers experienced the lowest average annual growth rate compared with that of depreciation of fixed assets, net taxes on production and operating surplus.   In all 31 regions, the average annual growth in operating surplus is higher than the increase in compensation of laborers.  On average, the growth in operating surplus exceeded the growth in compensation by 9.7 percentage points each year. 

The large differential between the growth in operating surplus and compensation of laborers may also be adding to the income inequality among regions in China.  The differential growth in compensation compared with the growth in operating surplus appears to be inversely related to the region's gross domestic product per capita.  For example, in Guizhou, which had the lowest income per capita in both 1997 and 2007, the annual average growth in operating surplus was 18.25 percentage points higher for the 1997 to 2007 period than the average annual growth in compensation; whereas, in Shanghai, the wealthiest of the regions in both 1997 and 2007, the difference was only 0.21 percentage points.  The correlation coefficient for GDP per capita by region in 1997 and the difference between operating surplus growth and compensation growth is -0.49.

Indeed, many scholars have voiced concerns over the low growth rate of laborer compensation and the small share of individual income out of overall GDP income.  Wei Jie stresses that "individual income as a share of GDP has continuously been too small. Meanwhile, government tax revenue has grown faster than national GDP.  The most unfair issue of income distribution is that the state has taken too much, and individuals have received too little."5   Zheng Xi, another economist, emphasizes that to increase household consumption, ways must be found to raise household income, especially for farmers and those in the lower and middle income brackets.6

The Chinese government, in fact, has started to consider new policy initiatives targeted to improve overall GDP, income distribution, and household income, especially for farmers, who generally have much lower income than urban residents.  One of the boldest moves is to head toward privatization in rural areas. Under a draft law set to be enacted in 2020, China's more than 800 million farmers would be able to trade, purchase or sell their land rights under a new land policy, which addresses the most serious grievance for Chinese farmers – violation of their land rights by corrupt, local officials who often seize their land and get rich through rapid industrialization schemes.

Policies to put economic decision-making into farmers' hands are efforts to reach the government's goal to "double the per capita disposable income of rural residents by 2020."7 Theoretically privatization could lead to much more efficient use of China's arable land and bring economies of scale that would lower agriculture production costs. But details about how land transactions would be regulated are still being debated, and many are doubtful that farmers will truly benefit in the end. Further, this potential change years from now will not have any immediate effect on improving the very low consumption rates of poor households. Fortunately, there are some other policies in effect now that can help improve the living standards and incomes of the poor.  Among them: increasing unemployment and social welfare benefits for low-income households and training programs for unskilled labor in rural areas.
Chinese officials and scholars view the global recession as more of a golden opportunity than a threat.  They see it as a chance to adjust China's economic structure domestically and their relationship to the world market.  Further, the current situation confirms that their recent move to a balanced-growth strategy is not only necessary but also strategically beneficial for China's long-term development.  However, identifying that the source of future growth lies within domestic demand is only the first step.  Stimulating and sustaining the source of domestic demand that relies on increasing household consumption is a more challenging task, which cannot be fixed by simply building more roads or bridges.  In addition to establishing social welfare, China needs to balance its income distribution to channel more income to its households.

References:

China Statistical Yearbook (Zhongguo Tongji Nianjian), various years. China Statistics Press, Beijing.

Qi, Li. and Penelope B. Prime, Market Reforms and Consumption Puzzles in China, China Economic Review 20.3 (2009):388-401.

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Li QI is Assistant Professor of Economics at Agnes Scott College (lqi@agnesscott.edu), and Rosemary Cunningham is Hal & Julia T. Smith Professor of Free Enterprise at Agnes Scott College, in Decatur, Georgia (rcunningham@agnesscott.edu).