Don't Count on China's Consumers to Save the Global Economy


It's practically an article of faith in some economic circles that the households of fast-growing behemoths India and China will increasingly begin supporting not only their own economies, but those of the rest of the world as well.

That includes the U.S. economy, of course, and many analysts see China's continued growth as one reason why the U.S. won't sag into a double-dip recession. But such faith is not grounded in a firm understanding of the Chinese economy.

One single statistic completely undermines that idea that the Chinese consumer will lift the global economy: The proportion of China's GDP contributed by the household sector (wages, salaries and consumption) peaked at 56% in 1983 and has since dropped to 36% -- roughly half the size of the consumer economy in the U.S.

That means China's households are receiving a smaller piece of the pie as China's GDP grows, even though the annual average wages of workers in urban areas of China increased from 12,422 yuan ($1,832) in 2002 to 29,229 yuan ($4,311) in 2008.

And it's worth noting: According to the Social Security Administration, the average wage in the U.S. in 2008 was $41,335 -- almost 10 times the average urban wage in China, which is considerably higher than its rural wages.

Savings Takes Priority Over Consumption in China

It's not just that wages as a share of GDP are low in China: Other factors further reduce consumption. For example, China's households do not all enjoy ample health care coverage or retirement benefits, making savings of paramount importance.

While the leadership in Beijing is planning to offer bare-bones health care coverage to the 300 million Chinese citizens who lack health care insurance, that won't alleviate the need for Chinese families to save up for medical bills. The planned coverage will be basic, and won't pay for the long-term treatment of chronic diseases.

As a result, Chinese households are prodigious savers: China boasts a savings rate of 38%, fully 10 times that of the U.S. But Chinese savers have few choices about where to invest their money: They can either leave it in savings accounts, which earn 2.25%, less than the inflation rate of 3.1%, or invest in real estate or domestic stocks.

A Nation of Real Estate Speculators. . .Sound Familiar?

The money pouring into property has created a worrisome asset bubble in housing, which rose 12.4% year-over-year in May, according to China's National Bureau of Statistics.

Although owning vacant apartments is widely viewed as a form of savings in China, speculative real estate is inherently risky -- as Americans have learned to their sorrow: It can drop in value, decimating the owner's equity. Such a decline in Chinese real estate would cut deeply into household capital, further reducing the desire and ability of Chinese consumers to buy more goods and services.

Economist Michael Pettis, who lives and works in China, has explained how the Chinese banking authorities have in essence pushed the costs of cleaning up bad loans onto the Chinese households by reducing the interest rate paid on savings accounts to less than the inflation rate.

As a matter of policy, China's financial authorities have suppressed consumption by providing a weak social safety net and by channeling household savings into banks and paying a negative rate of interest on that capital.

Billions of Free Yuan for the Banks

By limiting the number of investment options, authorities funnel a large fraction of household savings into banks. Because these policies allow the banks to pay interest that is less than the inflation rate, the authorities are in essence handing banks billions of yuan of "free money" that they can reinvest or loan out at much higher interest rates, earning high profit margins on the nation's massive savings.

And therein lies the connection between low consumption and high savings rates: Because Chinese households earn a negative return on their savings, they are forced to save even more to compensate. As Pettis explained: "Chinese consumption dropped from a very low 45% of GDP 10 years ago to an astonishing 36% last year just as -- no coincidence -- Chinese households were forced to clean up the last banking crisis."

Whether it is the intended result or not, these policies encourage Chinese citizens looking for positive returns to speculate in real estate. As analyst Andy Xie recently noted, channeling China's household capital into real estate development is hurting the country's long-term prospects by diverting the capital from other, more productive, uses. Ultimately, Xie says, it decreases capital efficiency and thus lowers domestic consumption.

Relying on Debt-Fueled Investment

Investment, including foreign direct investment, accounts for 44% of China's economy, a higher level than Japan or South Korea ever reached in their modernization drives.

Even more startling, much of this investment is borrowed. China's mostly state-controlled banking system made loans last year that were worth one-third of the nation's economic output, and this year, it's on track to hit 20% of GDP -- a total of roughly $2.5 trillion in new credit over two years.

This means that the central state banks have made loans that cumulatively totaled more than 55% of the total household income of the entire nation. Clearly, the breakneck pace of growth in China is heavily dependent on debt-fueled investments. Should the return on investment drop due to weak demand for Chinese exports or declining real estate prices, that weakness will further weigh upon Chinese households' income.

Add up the households' small share of China's GDP, a dependence on risky real estate speculation for higher yields than those offered by savings accounts, and an overall economy heavily dependent on unprecedented levels of debt-based investment, and you get a picture not of a nation of robust consumers, but of hundreds of millions of vulnerable households with many reasons to save and few reasons to spend.