world growth

world growth

Sunday, October 5, 2008

China must step up spending

Judged from a western perspective, China has an enviable problem. After expanding by 12 per cent in 2007, the Chinese economy will grow more slowly in the coming year, perhaps by around 8 per cent. A moderate reduction in growth would hardly spell disaster. But for all the talk of de-coupling, the Chinese economy still depends on how the US, Europe and Japan fare.

The longer the financial turmoil lasts in the US and Europe, the more severe will be any economic downturn. Credit markets are gummed up, curtailing company investment and consumer spending. Lower imports over the coming months look certain.

With more than a third of its exports going to the US and Europe, China will be affected. Low-cost exports may not collapse, but anecdotal evidence suggests that exporters are already feeling the pinch. A looming recession in Japan makes switching exports to other high-income markets a remote option.

It seems unlikely that the Chinese consumer – accounting for only about a third of Chinese output – could fill the gap left by a major drop in export demand.

Incentives for a substantial consumer spending spree are meagre. Share prices have fallen nearly 60 per cent over the past year and local property markets are now taking a dive. Wage growth has moderated. While retail sales measures suggested strong growth over summer, individual industries sagged. Car sales fell as much as 6 per cent in August.

But China’s leaders have the means to step in. Thanks to dwindling global demand, commodity prices have fallen from their peaks, and inflation in China eased to 4.9 per cent in August from 8.7 per cent in February. Looser monetary policy followed: the People’s Bank of China cut rates for the first time in six years in September in an effort to encourage spending.

Government spending should also be revved up. Public debt is small and Beijing is running a budget surplus. To stimulate growth, the government could increase investment in infrastructure. But expanding social safety nets would have a much bigger effect on consumption: by improving health care provisions and reforming the pension system, consumers would feel less need for individual saving.

The widening gap between rich and poor is resulting in social tensions. A sharply slowing economy is the last thing China’s leaders need. If they are committed to changing the focus of the economy from exports to domestic consumption, now is certainly the right the time to do it.

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