Posted by: Richard | July 25, 2010

China’s economic transition

Like many people, I view China as a place where a lot of ‘stuff’ is made.  I admit ignorance at  never having thought about what Chinese people buy themselves.  I was surprised to find out that Chinese people don’t actually buy much of their own stuff.  Instead, they prefer to save their RMB, putting cash away to save for a rainy day.

Now, you’d likely think that a Communist country would have a significant social safety net.  In fact, they don’t.  Migrant workers have virtually no social safety net while they are working, away from their home village.

What this means is that almost 65% of income is saved against potential future needs, leaving only 35% to be spent.  This level of savings is virtually the inverse of developed economies, where up to 65% of income is spent on basic consumption.

The free-spending ways of foreigners (notably the EU and the US – China’s two biggest trading partners) is likely coming to an end, as individuals start to repay their numerous debts and lenders tighten access to credit.  The change in consumption by the EU and US poses a serious problem for China as there is nobody else who can pick up the slack and keep Chinese factory workers employed.

With dropping exports, China will have reduced employment which leads to the dangerous potential for political unrest.  It is clear that the Communist party will hang onto power with every available trick, so a range of responses is expected to compensate for the drop in exports.  The most notable response is the desire of Chinese leaders to increase domestic consumption.  Essentially, China will sell Chinese goods to Chinese.  How radical!

China will promote domestic consumption through the following efforts:

  • Subsidizing consumption – an example has been the recent incentives rolled out for the purchase of ‘white goods’.  Expect more incentives, such as automobiles and apartments in tier 2 and tier 3 cities;
  • Providing a social safety net.  The government can loosen the robust savings rate by providing social services.  Expect to see health benefits and old age support start to roll-out over the coming decade.  As these policies reduce future cash needs, expect savings to drop as Chinese buy tv’s, stereo’s, automobiles and ultimately services!
  • Appreciating the RMB.  Currently, a low RMB means that commodities and imports are very costly.  As the RMB appreciates, the cost goods will drop and demand will rise.

Ultimately, while Chinese officials are hoping for a rapid increase in internal consumption, I believe that old habits die hard, and internal consumption within China will appreciate modestly in the coming decades.

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