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China needs more reforms to make a consumption-driven economy
By Jonathan Woetzel, Lillian Li and William Cheng |
November 27, 2012, Tuesday
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CHINA'S economy is starting to shift to a more consumption-driven and service-driven model that should help to sustain the country's growth, albeit at a slower rate, over the next decade and beyond.
Over the past two decades, the growth in China's GDP has been largely powered by investment by government and the corporate sector - primarily state-owned enterprises that retained or reinvested their relatively high returns on investment.
Investment has increased at such a fast rate that although household income has risen consistently over the period since 1990, as a percentage of GDP, it has fallen from 70 percent in 1990 to 57 percent in 2011. However, our projections suggest that within the next five years, the household income share of GDP will start to rebound.
Three drivers
We see three drivers for this acceleration in household income growth.
First, wages are likely to rise due to government policies and structural changes in the labor market. Policy makers have set a clear target that per capita disposable income should rise at least as fast as GDP in the 12th Five-Year Plan. The main steps are focused on increasing minimum wages and the reference wage.
Supply and demand dynamics are pushing in the same direction as government policy. China's labor pool is shrinking due to demographics and a reduced flow of migrant labor from rural areas, and this is exerting upward pressure on wages.
Second, financial reforms are likely to stimulate additional employment growth and thus income generation. Steps by the government to open financial markets and increase competition in the economy could also help expand private-sector activity that in turn could boost employment and accelerate household-income growth.
Interest-rate deregulation could be the first such step. Higher deposit rates would raise household incomes, while loan rates would fall for borrowers.
The insufficient competition in the financial sector currently restrains private enterprises from getting bank credit. The combined impact of having more financial players and more market-driven regulation could make financing transactions easier and more efficient, and the resulting higher level of economic activity could increase returns that would in turn boost incomes.
Third, opening up wider areas of the economy to private enterprise could encourage more productivity growth, lower costs, and allow greater income to accrue to households.
The government could encourage competition there by opening them up to private capital, which would help to boost productivity and resource optimization.
The government is already making progress in opening up resource-focused areas such as mining, electricity transmission and distribution, and water to more competition.
Under consideration are steps to encourage greater competition in the ownership and management of China's infrastructure, including roads, railroads, bridges, city water pipelines, and city power-distribution networks.
Income growth
Should all these drivers play out as expected, income per household would nearly tripple by 2030, according to our projections. This means that household income growth will narrowly outpace GDP growth from 2012 to 2030.
Once household income reaches a certain level and is backed up by rising confidence in sustained growth, Chinese citizens would be more willing to increase consumption instead of simply saving.
Other factors will reinforce this greater propensity to spend once a certain income level is in reach.
First, government subsidies to social security are expected to triple by 2015, strengthening China's social safety net.
Second, an increase in local-government-provided housing supply and stricter regulation of property prices could make it less essential for Chinese citizens to save at such high rates.
Third, urbanization and modernization could be expected to encourage China's population to spend more, in particular on discretionary goods.
Last, an appreciating yuan could provide stronger purchasing power for acquiring imported goods, again promoting consumption.
In our estimate, consumption per household will increase nearly threefold, from 39,000 yuan (US$6,240) for urban households and 30,000 yuan for the national average in 2012 to 112,000 yuan for urban households and 92,000 yuan for the national average in 2030.
Just as household income and consumption will displace investment as the key driver of China's growth, so the service sector of the economy is expected to expand to match and then overtake the scale of the industrial sector.
Development of the service sector is not only a natural progression as societies move up the income ladder but is also a considered policy of the Chinese government, intended to create employment.
In the 2000s, services did see some acceleration in growth with the expansion of the real-estate and financial-services industries that supported urbanization. This expansion is set to continue and indeed to accelerate beyond these industries.
In business-related services such as finance, logistics, and IT, the government wants to drive innovation.
In consumer-and household-related services such as retail, real estate, and legal services, drivers will include standardization of processes and service-level quality improvement.
Jonathan Woetzel is a director in McKinsey's Shanghai office, where Lillian Li and William Cheng are consultants. The article is condensed by Shanghai Daily from their report What's next for China? The opinions are their own.
Over the past two decades, the growth in China's GDP has been largely powered by investment by government and the corporate sector - primarily state-owned enterprises that retained or reinvested their relatively high returns on investment.
Investment has increased at such a fast rate that although household income has risen consistently over the period since 1990, as a percentage of GDP, it has fallen from 70 percent in 1990 to 57 percent in 2011. However, our projections suggest that within the next five years, the household income share of GDP will start to rebound.
Three drivers
We see three drivers for this acceleration in household income growth.
First, wages are likely to rise due to government policies and structural changes in the labor market. Policy makers have set a clear target that per capita disposable income should rise at least as fast as GDP in the 12th Five-Year Plan. The main steps are focused on increasing minimum wages and the reference wage.
Supply and demand dynamics are pushing in the same direction as government policy. China's labor pool is shrinking due to demographics and a reduced flow of migrant labor from rural areas, and this is exerting upward pressure on wages.
Second, financial reforms are likely to stimulate additional employment growth and thus income generation. Steps by the government to open financial markets and increase competition in the economy could also help expand private-sector activity that in turn could boost employment and accelerate household-income growth.
Interest-rate deregulation could be the first such step. Higher deposit rates would raise household incomes, while loan rates would fall for borrowers.
The insufficient competition in the financial sector currently restrains private enterprises from getting bank credit. The combined impact of having more financial players and more market-driven regulation could make financing transactions easier and more efficient, and the resulting higher level of economic activity could increase returns that would in turn boost incomes.
Third, opening up wider areas of the economy to private enterprise could encourage more productivity growth, lower costs, and allow greater income to accrue to households.
The government could encourage competition there by opening them up to private capital, which would help to boost productivity and resource optimization.
The government is already making progress in opening up resource-focused areas such as mining, electricity transmission and distribution, and water to more competition.
Under consideration are steps to encourage greater competition in the ownership and management of China's infrastructure, including roads, railroads, bridges, city water pipelines, and city power-distribution networks.
Income growth
Should all these drivers play out as expected, income per household would nearly tripple by 2030, according to our projections. This means that household income growth will narrowly outpace GDP growth from 2012 to 2030.
Once household income reaches a certain level and is backed up by rising confidence in sustained growth, Chinese citizens would be more willing to increase consumption instead of simply saving.
Other factors will reinforce this greater propensity to spend once a certain income level is in reach.
First, government subsidies to social security are expected to triple by 2015, strengthening China's social safety net.
Second, an increase in local-government-provided housing supply and stricter regulation of property prices could make it less essential for Chinese citizens to save at such high rates.
Third, urbanization and modernization could be expected to encourage China's population to spend more, in particular on discretionary goods.
Last, an appreciating yuan could provide stronger purchasing power for acquiring imported goods, again promoting consumption.
In our estimate, consumption per household will increase nearly threefold, from 39,000 yuan (US$6,240) for urban households and 30,000 yuan for the national average in 2012 to 112,000 yuan for urban households and 92,000 yuan for the national average in 2030.
Just as household income and consumption will displace investment as the key driver of China's growth, so the service sector of the economy is expected to expand to match and then overtake the scale of the industrial sector.
Development of the service sector is not only a natural progression as societies move up the income ladder but is also a considered policy of the Chinese government, intended to create employment.
In the 2000s, services did see some acceleration in growth with the expansion of the real-estate and financial-services industries that supported urbanization. This expansion is set to continue and indeed to accelerate beyond these industries.
In business-related services such as finance, logistics, and IT, the government wants to drive innovation.
In consumer-and household-related services such as retail, real estate, and legal services, drivers will include standardization of processes and service-level quality improvement.
Jonathan Woetzel is a director in McKinsey's Shanghai office, where Lillian Li and William Cheng are consultants. The article is condensed by Shanghai Daily from their report What's next for China? The opinions are their own.
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