In a typical economy consumer expenditure is usually the largest component of Gross Domestic Product (GDP), making up around sixty percent of total output, this however is not the case in China, where consumer expenditure accounts for only thirty five percent of GDP. A very surprising fact when you consider that China has almost a fifth of the world’s population. China however, makes up for this shortfall in consumer expenditure with high levels of investment, which make up around forty percent of China’s GDP. While large amounts of investment are necessary for a growing economy, it also brings with it a large number of problems.
Investment is considered very volatile and fluctuates wildly with the business and stock cycles, this means that relying on investment as a large component of GDP leaves China’s economy’s growth at risk of fluctuating with the business and stock cycle. In addition to this due to the high levels of Foreign Direct Investment (FDI), caused by China’s open door policy the majority of investment in China is controlled by external factors. This leaves China at a higher risk to exogenous shocks then countries with a more balanced economy. For instance a rise in interest rates in the United States could stifle investment due to the higher costs of borrowing thereby resulting in a fall in China’s GDP and possibly a recession. By relying too much on investment China limits its long term sustainable economic growth, as is with most countries developing countries experience high levels of economic growth but once past a certain threshold those levels of investment begin to fall until they reach a steady level, as is with most MEDCs, with regards to China this means that currently firms are willing to invest more and more since they see potential, however once these firms see China’s economy start to stabilize the levels of investment will start to fall, this means that China will have to fill the void left in order to maintain its economy.
In this case the only viable option is to increase consumer expenditure to normal levels.
But, what is the cause of China’s weak domestic demand, and how can it be resolved?
Most argue that due to the high levels of corruption and the general level of distrust in the banking system, resulting in poor access to consumer credit. Increased access to consumer credit would be very likely to stimulate consumer expenditure. Problems in China’s financial system also means that domestic consumption is limited in that due to consistent poor decision making by the state China has been left with large numbers of non-performing loans which inevitably has been left to the Chinese households to deal with. Another factor is a cultural affinity to high levels of saving, it can be argued that deep set in the Chinese mind is the importance of saving, this aspect is further entrenched by the low levels of “safety nets,” in China. This of course refers to items such as unemployment benefits, health care, etc. This makes saving almost essential for Chinese households. These facts are shown in the increase in demand for gold in China, which overtook India in 2013, this is mostly likely due to the fact that Chinese households see Gold as a solid investment or a safe way too store wealth . If the Chinese government wants to increase its domestic consumption it is clear what it has to do. It must increase confidence in the banking system thereby allowing more domestic lending, and saving which in turn will help boost internal investment. It must also try and change the cultural affinity to saving by increasing its benefit system and by making it reliable. By increasing domestic consumption China also increases its scope for FDI, for instance if it is seen that Chinese households have a high consumption level, firm are more likely to invest in China in order to access that market. For example the coca cola industry. This possibility is increased due to the high population levels in China.
In conclusion if the Chinese government wants a more sustainable economy it must reduce its reliance on foreign injections and increase its domestic infrastructure.
The Economic Times-China overtakes India in Gold demand 2013 http://articles.economictimes.indiatimes.com/2014-02-18/news/47451264_1_gold-demand-jewellery-demand-wgc-managing-director
China’s consumer spending rebounds http://www.china.org.cn/english/140.htm
Low consumption needs serious reforms http://www.eastasiaforum.org/2011/11/22/low-consumption-china-needs-serious-reforms/
The economist-The world’s second biggest consumer http://www.economist.com/blogs/analects/2014/02/chinas-economy
List of countries by population http://en.wikipedia.org/wiki/List_of_countries_by_population
Consumption expenditure-The world bank http://data.worldbank.org/indicator/NE.CON.PETC.ZS