Over the past twenty years, as professional and academic, I estimate that I have read over four billion articles, monographs, research reports and books about China, give or take a few hundred million. Whether they’re lengthy treaties or short OpEds, whether they’re written for a general readership or an academic one, whether they were written in the mid-nineties or last week, they’re all about the same. I can spare you a great deal of reading by summarizing them as follows. They recognize the successes and/or opportunities that China has, but they highlight the risks to further gains if China doesn’t reform its financial, property or miscellaneous sector. Sound familiar already?
Reform, reform, reform. I suggest that future Sinologists get very used to that word because they’ll need it a great deal throughout their careers. But consider this. Is that really any great insight? Think about it. Isn’t it the job of any country’s leadership to be reforming something? The word reform simply means to change for the better. If aspiring world leaders don’t have ideas about changing their country for the better, they could hardly ascend to leadership. Just ask President Obama. Just ask Prime Minister Abe. Just ask Chancellor Merkel. Just ask whoever’s in charge in Italy. They would all tell you many things that need reforming about their country.
And China’s no different. China’s no different because in the human world, things can always be made better. Therefore, to suggest that China needs to reform is merely to state the obvious. The entire world could use reforming. The suggestion to reform is so universal and so inarguable that it has little value by itself.
I can just imagine President Xi getting frustrated at a cabinet meeting, “Enough already about reform! I get it! Now can we go on?” Yes, China needs to reform. Yes, especially its financial sector. No, it’s not impossible. The United States has done so twice in the last twenty years. President Xi could give the world’s markets and economists tremendous comfort just by coming out with an annual update on his progress in that endeavor. I mean this literally. In fact, I believe he could send the Asian stock markets soaring by 40-50% just by producing some clear evidence of early success, such is the importance of Chinese financial sector reform to the entire region.
With that acknowledged, let’s consider two further inarguable economic truths about China’s economy:
1) China’s growth was bound to slow down at some point because no country
can grow at a double digit pace forever.
2) The low-hanging fruit of export-led growth driven by cheap labor isn’t
quite so plentiful anymore.
No one can possibly deny either truth so simply stating them hardly suffices as useful commentary. However, given them, there is a rather simple conclusion that practically presents itself to President Xi. In place of declining growth in exports, China must beef up domestic consumption.
But not just any old consumption will do. China requires the actual fulfillment of Chinese consumers’ needs, wants and desires. China emphatically does NOT need any more creation of real estate monstrosities which no end user ever demanded in the first place. Asia has seen far too often the tragic result of such non-market driven building.
Over my years of teaching international finance, there is one idea which has been the single most difficult to get students to appreciate, especially since they hear almost the opposite from other professors. It is not anything mathematical. It is merely an understanding that although exports do indeed benefit a country’s GDP, it does so to the detriment of that country’s standard of living.
Students inevitably comment that GDP growth and standard of living surely must correlate. I need to tell them that this is not necessarily the case. Consider a bakery which produces ten cookies. The bakery can sell them in the neighborhood or “export” them to sell to the next neighborhood. If the bakery exports them (necessarily at a higher price than could be obtained locally or else there’d be no point), the baker will get richer. This will be reflected in the neighborhood’s GDP. But is the neighborhood’s standard of living higher? At least initially, haven’t the neighbors actually been deprived of goods? I admit that in the longer term, the baker’s “export wealth” might get “repatriated” but that won’t necessarily be so or soon.
In this example, it is the neighborhood people (the Chinese population) who have not benefitted from the baker’s wealth (China’s export earnings). The solution is something that the United States knows very, very well. To replace China’s declining exports, China needs to increase domestic consumption. In other words, China needs more of what America has too much of. That’s good ol’ fashioned American-style consumer spending. America may indeed have overdone it, but there’s no question that American spending has provided more than adequate incentive for local and foreign producers to continue to invest here to serve the market. That is precisely the dynamic that China needs much more of now.
Chinese demand for goods is definitely there. And finally, after centuries, even the ability of the people to pay for them is largely there. But much like in Japan in the seventies and eighties, the consumer demand isn’t being met because so much of the country’s factors of production and supply of goods have been dedicated to the export markets. That’s made the country richer, but has deprived the Chinese consumer.
If China were to appoint me Lord High Counselor to President Xi (and I’m quite open to this), I wouldn’t waste any time urging him to reform the financial sector. He’s surely heard that enough. Instead, I’d encourage him to move toward satisfying consumer demand. I’m pretty sure he doesn’t hear that nearly enough.
Michael Justin Lee is a lecturer in the University of Maryland’s Department of Finance. A veteran Chartered Financial Analyst, he served as Financial Markets Expert-in-Residence in the United States Department of Labor from 2003 to 2005. Professor Lee is the author of “The Chinese Way to Wealth and Prosperity” (McGraw-Hill, 2012).