Life of Guangzhou - Fan Gang: China Needs a High Rate of Investment

Fan Gang – National Economic Research Institute, China Reform Foundation

In the first half of 2006, the expected outcome for China's near 11% growth in GDP and 30% growth in fixed investment should have been a boost in the demand for imports, and thus a reduced trade surplus. In contrast, we witnessed an enlarged surplus of .4 billion, a 20% increase over last year - which accounted for 7% of the country's GDP.

At this point, investment was over 45% of the country's GDP, while the national economy was over-heated by an increased money supply, a result of the enormous trade surplus and the accompanying foreign capital flowing in. This kind of imbalance between domestic economy and foreign trade was there, in the eyes of many, because the Chinese people save too much and spend too little of their money. A number of economists have also suggested solutions to make people reverse their frugal habits. In my opinion, however, it is difficult for these solutions to be effective in the short term; and for some of them the supporting analyses cannot withstand careful examination.

Fan Gang is interviewed with the reporters of dayoo.com in Guangzhou on April 14 before the "Asian Financial Crisis — 10th Anniversary Symposium" on April 15.

1. Low income causes people to spend less.

Consumption in China is not growing slowly. Unlike investment which can expand 50% overnight, it’s growing steadily: it has neither developed like its Korean counterpart - a drastic boom of credit card consumption - nor has it crept at a rate of 5% like investment in China did in 1999. At present, it grows at over 12% per annum, slightly higher than the usual 8%-10%. It grows as fast as the GDP, as its growth rate in proportion to the GDP (the increase of consumer goods) is 9%. As a result, it was not out-proportioned by investment because it slowed down; rather it was squeezed in the GDP as investment grew too quickly.

Here, slow consumption coupled with investment growing too quickly, lead to totally different questions: should China restrain investment, or boost consumption, in order to restore a proper proportion between them? If it boosts consumption when investment is soaring, it will further overheat the economy, so the right choice might be to curb investment.

Then, if consumption is to be boosted, how? It seems the problem could be solved if the Chinese people spend more money, especially if the government encouraged them to do so. Analysts say Chinese people buy far fewer consumer goods than Americans do; but since the GDP per capita in China is only around ,000, while that of the US is close to ,000, how can we compare the levels of consumption between the two countries? Chinese people do not buy that much, because they do not have enough money.

According to another popular idea in China, the level of consumption in the country is low because that of its farmers is low. My response to this is similar: it is not because they do not spend money; they simply DO NOT HAVE enough money. In other words, the cause of the problem is not low consumption, but low income. The farmers in China are actually the group of people who are most likely to spend their money, with the lowest rate of saving – if they run out of money, they are unable to afford education for their children, or health care for the family.

In this way, encouraging the farmers to spend money is not the way to boost consumption in China. As with the increase in farmer's income and consumption, it should rely on growth, including that of employment, investment, urbanization, and of the economy as a whole, rather than subsidies from the government.

2. It is impractical to boost consumption with government subsidies.

That the household saving rate in China is as high as 40% is true for good reasons. It's often said people save money as a buffer against the country’s underdeveloped social security system and inefficient capital market. However, since it takes decades for any country to reform and develop, these problems cannot be solved in the short term and thus should not be expected to be a key to boost consumption in the short term.

I believe the root cause of the high savings rate is the income gap, which is now large and getting larger. 80% of people with a job today are at low income levels. They are either industrial workers who earn ￥10,000 a year, or rural farmers on ￥3,000 a year. Though much more likely to spend than to save, they do not contribute much to the overall economy with their income, which accounts for only around 40% in the annual GDP growth. In addition, wage increases are not a major factor, as labor markets are fiercely competitive and wages don't rise much; such rises in the incomes of about 10 million farmers are due to those who migrate to cities for work.

The remaining 60% of the GDP growth is taken by the 20% high-income group, who are not very likely to spend it – according to a basic principle in economics, the more people earn, the less they tend to spend; where by contrast, people who do not earn much are less likely to save. Since a majority of the increased income is in the hands of the 20% who earn much more than the other 80%, it is generally difficult to encourage consumption.

In other words, I am afraid it is impossible make China’s population spend more in the short term. Increases in consumption, both in output and people’s tendency to buy, will come with decades of continued economic growth, not by increasing the income of the lower 80% with government subsidies, since it is impractical to subsidize them using taxes from the higher 20%. Policies intended to subsidize consumption have never worked.

Fan Gang is interviewed in Guangzhou on April 14 before the "Asian Financial Crisis — 10th Anniversary Symposium" on April 15.

3. China needs 20% growth in investment.

China needs to avoid overheating its economy with too much investment. Even so, investment and accumulation of capital constitute a major force for its growth, as well as the path it has to follow toward urbanization, industrialization, and modernization.

In close examination, a great portion of existing investments are in fact linked to consumption. For example, over 20% are in housing – this proportion is still increasing rapidly since 1998 when housing loans were introduced – which in essence is consumption of long-term durable goods. Nearly 30% are in infrastructure (mostly in the cities), which is categorized as public consumer goods.

As a point for the world to recognize, this means a great amount of investment in China is in public consumption, which is currently in short supply while individual consumption is soaring. Since it is at the primary stage of urbanization, the country does need enormous investment of this kind. To this extent, approximately 60% of the investments including those in housing and infrastructure are sustainable, as well as needed both in the short and long term.

What does this imply? It first implies that consumption is important. As with policies that encourage it, they are necessary at the moment, especially for the wealthy, since this group earn and save a lot. However, such policies cannot solve all problems. What China still needs is a certain scale of increase in investment. If a growth rate of 40% or 50% is impractical, 20% will have to suffice.

Therefore, my policy suggestion is to maintain steady and balanced growth on all fronts; not only in consumption, but also in exports and investment. This is what China needs in its current stage. As for the 35%-40% of its GDP in the form of capital, I am afraid it won’t change in the near future for it is a pattern of growth, not something extraordinary if compared with those in other countries whose GDP per capita is ,000-3,000.

It is wrong to point the finger at China, after comparing its economic structure with that of the US.

(By Jiang Jianming and David Kellaway)