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Why Is China’s Consumption Rate So Low? Chinese government provides many services that households elsewhere might have to purchase themselves
Jul 15, 2024When it comes to household consumption expenditure, China is probably not lagging as far behind other major economies as official data suggest. Nonetheless, as the relative importance of capital accumulation declines, and returns on investment continue to fall, more must be done to boost disposable household income.
SHANGHAI – In May, US President Joe Biden’s administration accused China of “flooding global markets” with “artificially low-priced exports.” Such accusations are not new, nor are they likely to stop any time soon. But many of those complaining about Chinese overcapacity overlook a critical fact: China’s net exports have been falling relative to GDP since 2008, and its trade surplus in goods has shrunk to less than 2% of GDP.
For years, China has been committed to rebalancing its economy and reducing its dependence on exports by boosting domestic demand, not through increased investment, which it has been discouraging, but rather through higher household consumption. And yet, despite rising labor income, which constitutes the bulk of household disposable income and accounts for about 56% today compared to 48% in 2007, household consumption expenditure has remained stubbornly low. According to official figures, total household consumption accounts for just 38% of GDP, compared to 60-70% in most developed countries.
But, as anyone who has studied China’s economy can attest, when using official figures, international comparisons can be misleading. For example, in a 2015 study, Tian Zhu and I found that official figures underestimate Chinese households’ consumption expenditure on housing (as a share of GDP) by at least six percentage points.
Moreover, as Asian Development Bank (ADB) senior economist Juzhong Zhuang recently showed, China’s total household consumption expenditure appears much smaller than that of high-income economies (as a share of GDP) largely because of differences in services consumption. Using input-output data compiled by the OECD and the ADB, he found that services consumption amounted to only 67% of total household final consumption expenditure in China in 2018-19, equivalent to about 26% of GDP. Compare that with the share of services consumption in the United States (more than 80%, or about 55% of GDP); the European Union (72%, or 38% of GDP); and 75%, on average, in East Asia’s three high-income economies, Taiwan, Japan, and South Korea (about 38-39% of GDP). Even in Asia’s five major developing economies – India, Indonesia, Malaysia, Thailand, and the Philippines – services consumption accounted for more than 54% of total household final consumption expenditure, on average, equivalent to 33% of GDP.
China’s under-estimation of services consumption is further compounded by large price distortions in services. According to the World Bank’s International Comparison Program, services prices in China at purchasing power parity are lower, on average, than overall prices. In other words, when Chinese households are purchasing services, their expenditure on them appears lower, complicating cross-country comparisons.
Further disparities might also arise from the fact that the Chinese government provides many services that households elsewhere might have to purchase themselves. A significant share of the recent growth in Chinese public expenditure represents in-kind transfers to households, including spending more on education, health care, and pensions, as well as social services like cultural facilities. Given this, in making cross-country comparisons of household consumption expenditure, it might well be worth including government consumption expenditure, which in China amounts to about 16% of GDP, in accounting that of households.
If we exclude government transfers to households, the disposable income of Chinese households amounts to about 60% of national income. This is 10-15 percentage points lower than in most high-income countries, where in-kind social transfers are included in household disposable incomes. But if one removes such transfers, the levels of disposable income in Japan, South Korea, Germany, and the eurozone as a whole fall to Chinese levels. In 2020, household disposable income in Denmark was even lower than that in China.
Therefore, when it comes to the real level of the household consumption-to-GDP ratio, China is probably not lagging as far behind other major economies as it seems. Nonetheless, as the relative importance of capital accumulation declines, and returns on investment continue to fall, more must be done through policy changes to support consumer spending. For policymakers, this means not only channeling more income and transfers toward households, but also increasing subsidized or free in-kind transfers to them.
A strong social safety net is particularly important in China, where decades of family-planning policies have encouraged households to save at exceptionally high rates, partly in anticipation of supporting parents and, ultimately, themselves in old age. If households can be certain that they will have strong family-based support and welfare programs from governments, so that they don’t need to save so much today, they are likely to consume more and might even have more children, thereby helping to stem China’s demographic decline. (The current fertility rate – about 1.1 births per woman – is well below the replacement level).
Ultimately, China must shift to a growth model that supports the growth of household disposable incomes, rather than continuing on the path of excessive capital accumulation. To that end, the government must encourage higher-wage economic activities, such as in the service sector, and strengthen the business environment, not least by expanding the decisive role of market forces in resource allocation.
