The approach of Lunar New Year is a good moment to look back over the economic inheritance being left by president Hu and premier Wen as they handover to Xi and Li next month in China. Their strategy was to exploit the opportunity provided by China having finally joined the World Trade Organisation in December 2001 after 15 years of negotiations.
They set off on a ‘dash for growth’, based on making China the ‘manufacturing capital of the world’. The policy was to gain ‘quick wins’ by focusing on infrastructure spend at the expense of domestic consumption. Meanwhile, they aimed to turn city-dwellers into a new middle class via the creation of a ‘wealth effect’ based on rising property prices. As the yellow highlight shows in the chart, this led to drastic changes in the main components of China’s GDP:
• Infrastructure investment (green line) is now 46% of GDP compared to 35% in 2001
• Rural consumption (purple) has nearly halved from 14% to 8%
• Urban consumption (red) has also fallen, from 31% to 27%
• Thus total domestic consumption is now only 35% versus 45%
Unfortunately, the strategy proved flawed. Exports (black) initially rose strongly from 2% of GDP to peak at 9% in 2007. But they are now back at 3% of GDP. Infrastructure spend has instead been left to carry the burden of growth since 2008. And how many ‘bullet trains’ does a country like China really need, when half of its population (the rural half) remains desperately poor, with average incomes of just $1451 in 2012?
Hu and Wen also overlooked the fact that the West’s need for Chinese imports was already fading in 2001. The oldest Boomers were then joining the New Old 55+ group when consumption begins to dip sharply as people prepare for retirement. China’s extensive investment in high-end export manufacturing is thus ill-suited to today’s domestic market need for $100 smartphones, not $750 Apple iPhones.
The house price boom has proved similarly flawed. Prices were very low in 2001, as individual home ownership had only been allowed in the cities from 1998. But today, China’s house price to earnings ratios are double those seen in the US subprime boom. Sales of one-bed apartments in Shanghai for $460k may seem normal locally, but they are not sustainable.
The new leadership seems to recognise these problems, and is also focused on trying to clean up the corruption that has accompanied them. Its challenge, however, is immense. Reversing Hu/Wen’s policies means developing products and services focused on stimulating rural consumption, whilst reducing wasteful infrastructure investment. They also have to deflate the house price bubble without causing riots on the street.
No wonder vice premier Wang has apparently encouraged his Politburo colleagues to read up on the history of the French Revolution, in an effort to alert them to the scale of the task ahead.