China’s recent move to boost household consumption marks a significant departure from its long-standing investment-driven growth strategy. Beijing’s plans to issue sovereign bonds worth approximately 2 trillion yuan ($284 billion) in 2024 to subsidize consumer goods purchases and child support are aimed at stimulating domestic consumption and achieving a growth target of around 5%. While this pivot toward fostering consumer demand is a step in the right direction, economists warn that transforming household consumption into a sustainable driver of economic growth will require more than short-term measures. The shift signals a break from a decades-old policy playbook that has prioritized investment in infrastructure, property, and industry, but the road ahead is fraught with tough choices and structural challenges.

A Break from Tradition: Stimulating Consumption Over Investment

For decades, China’s economic growth has been largely powered by massive investments in infrastructure, manufacturing, and property. While this investment-driven model helped China achieve remarkable growth, it has also led to overcapacity in certain sectors, ballooning debt, and diminishing returns on investment. Since the global financial crisis of 2008, economists have called for China to reorient its economic policy toward consumption to avoid the fate of Japan, which has struggled with stagnation since the 1990s due to similar overreliance on investment.

The plan to issue sovereign bonds to fund subsidies for consumer goods and child support marks a significant shift in China’s policy direction. “It’s monumental – a landmark event that the policy mindset has reversed,” said Tianchen Xu, an economist at the Economist Intelligence Unit. This move represents the Chinese government’s recognition that household demand must play a more central role in driving the economy. However, transforming this recognition into a long-term shift in the economic structure will be a complex and gradual process.

Structural Challenges in Shifting to a Consumer-Driven Economy

Despite the recent stimulus efforts, China’s household consumption remains far below global averages, accounting for less than 40% of annual economic output—about 20 percentage points lower than the global norm. Meanwhile, investment continues to account for an outsized portion of economic activity, with its share being 20 percentage points above the global average.

Closing this consumption-investment gap is no small feat. Michael Pettis, senior fellow at Carnegie China, notes that Japan took 17 years to raise its consumption share of economic output by just 10 percentage points after its economy began to stagnate in the early 1990s. He argues that China’s current fiscal efforts “aren’t really part of a real structural rebalancing,” as true rebalancing would require profound changes to China’s economic model, which has long favored investment over household spending.

A major barrier to such a rebalancing is the socio-economic policy architecture in China. For years, the system has propped up investment by offering various incentives and subsidies to businesses, particularly in strategic industries like electric vehicles, green energy, and robotics—sectors Beijing views as vital for national security. Meanwhile, households have faced low deposit rates, weak labor rights, and inadequate social safety nets, all of which have contributed to stagnant income growth and limited purchasing power.

China’s tax system also plays a role in perpetuating the investment-heavy model. Capital gains are taxed at a rate of just 20%, compared to 30% in India and 37% in the United States. Meanwhile, China’s top personal income tax band is among the highest in the world at 45%, further dampening household spending.

The Risks of Rebalancing: “Japanification” of China’s Economy

While the shift toward consumption may be necessary to sustain long-term growth, it is not without risks. Juan Orts, a China economist at Fathom Consulting, suggests that the “correct” way to rebalance the economy would involve stopping subsidies for manufacturing companies and redirecting those resources to households. However, he warns that this approach could lead to a shrinking manufacturing sector, a sharp drop in investment, and potentially a recession.

Orts predicts that China is more likely to take a cautious approach to rebalancing, opting for a protracted period of gradual transition. This slow shift could lead to what some analysts call the “Japanification” of China’s economy—a scenario where growth stagnates for an extended period due to the delayed implementation of structural reforms.

Even with the issuance of additional debt to fund fiscal stimulus this year, Beijing’s ability to sustain these efforts over the long term is limited. Pettis notes that while the central government may be able to fund fiscal transfers for a few more years, failure to transform the growth model will only exacerbate the current imbalances. “If Beijing doesn’t transform the growth model, the imbalances will continue to build, in which case China risks facing the same problem in the future as it does now, only without a clean central-government balance sheet to help it manage potential disruptions,” Pettis warns.

The Long Road Ahead

China’s pivot toward stimulating consumer demand is a welcome change for many economists who have long argued for a rebalancing of the economy. However, achieving a sustainable, consumer-driven growth model will require far more than issuing bonds and subsidizing purchases. Deep, structural reforms are needed to shift the balance of economic power away from investment and toward households. This will involve rethinking tax policies, enhancing labor rights, and strengthening social safety nets to increase disposable incomes and boost consumer confidence.

In the short term, China’s stimulus efforts may help the country reach its 2024 growth target of 5%, but the long-term outlook remains uncertain. Whether Beijing can successfully navigate the difficult choices required to transform its economic model will determine the future trajectory of the world’s second-largest economy. For now, the path toward a consumption-led economy remains long and filled with potential risks, but it may ultimately be the key to China’s sustainable development in the decades to come.

(Adapted from Reuters.com)

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