Many western experts have argued that China should switch from a model of investment-led growth to consumption-led growth. Some of their criticism of wasteful Chinese investment seems valid, but it’s not obvious that “more consumption” is the way to think about this issue.
Some articles give the impression that there is one group of economists that favors more consumption and another group that is opposed to the idea. In fact, almost all economists view consumption as the ultimate goal of economic activity, and investment as a means to an end, a way of producing more consumption goods.
Assume I’m a Chinese worker producing some sort of investment good; say a locomotive engine for their rail system. The Chinese government decides that I should switch from building investment goods to building consumption goods. They instruct me to stop building train cars and start building microwave ovens—a consumer good. But how do I do this? With my bare hands and some tools from my garage? First, someone has to build a microwave oven factory, and that requires more investment. It’s not obvious that there is any magical way of boosting consumption without first boosting investment.
[Here some insights from Austrian economics may be helpful. Changing what Arnold Kling calls “Patterns of Sustainable Specialization and Trade” can require new investment, even if the ultimate goal is a shift toward consumption.]
Some economists might argue for “demand stimulus”. Perhaps microwave oven factories already exist, but are underutilized due to a lack of aggregate demand. In my view, this sort of Keynesian reasoning is of little help when thinking about long run growth issues, especially in a developing country like China. In the long run, low income countries cannot get much higher levels of consumption by printing lots of money and boosting aggregate demand. China may well have a small demand shortfall at the moment, and perhaps its monetary policy should be a bit more expansionary. But this cannot be all that pundits have been debating for decades when they call for China to switch from an investment-led growth model to a consumption-led growth model. For developing countries, the important problem is not reaching the production possibilities frontier; the bigger need is to rapidly shift the PPF outward, so that the economy is capable of producing more output. And that requires lots of investment.
So how do we square the circle? China seems to be doing lots of wasteful investment, but it’s not clear how China can boost consumption without doing even more investment. In my view, China has only two ways of boosting consumption; investing in more productive ways, and using its existing capital stock more efficiently. Neither of those moves would normally be described as “consumption-led growth”, they’d be described as efficiency measures, or supply-side reforms.
Consider this recent article in the Financial Times:
For Beijing’s leadership, maintaining growth is of the utmost importance both economically and politically. In their eyes, the most viable way to keep the gross domestic product growth rate in the 4-5 per cent range in 2024 is to vigorously promote investment.
That sounds like the Chinese leadership is ignoring western experts. But then there is this:
But this year’s local investment programme, in contrast to previous initiatives, shows a notable shift in objectives. First, the 2024 projects have a distinctly scientific flavour, focusing on new-generation information technology, biopharmaceuticals, artificial intelligence and low-carbon energies. This suggests an ambition to ascend the value chain and develop new growth engines. Second, there is an emphasis on investing in public welfare. Third, there is a noticeable decrease in real estate investment projects. And last, there is an increased emphasis on private investment.
That sounds like an attempt at smarter investment—putting resources into areas that will do the most to boost living standards. But I would not call this a shift to consumption-led growth, just the opposite. When China builds apartment buildings, the Chinese public can immediately consume more housing. Thus the impact of consumption is rapid. Investment in science and technology also boosts consumption, but there is a much longer time lag.
The usual argument is that much of the real estate investment in smaller Chinese cities is wasted, as buildings stand empty. Rather than shift to consumption led growth, this fact suggests a need to shift to more efficient investment, in order to later boost consumption:
In the realm of public welfare, local investments are primarily targeting affordable housing, education, hospitals and environmental projects. According to the Chinese economist Yu Yongding, the country still has a significant gap in these areas compared with developed nations. Such investment will also boost consumption and the country’s economic growth.
The FT article also discusses the need to use the existing capital stock more effectively, by reducing protectionism and encouraging the private sector:
In the long run, the optimal strategy entails structural reforms aimed at eradicating local protectionism, fostering a fairer market and ensuring affordability in housing. A fairer market means creating an environment in which medium and small-sized private companies have opportunities to secure bank financing in the same way that state-owned enterprises do, and engage in competitive bidding processes.
I don’t believe it makes any sense to talk about consumption-led growth. As an analogy, suppose you wanted your child to be happy. Would you encourage your child to pursue a “happiness-led lifestyle”? Or would you encourage a set of behaviors that you believe over the long run would lead to greater happiness, such as the importance family and friends, of hard work and education, spiritual values, etc.
China needs supply-side reforms so that investment funds are spent more wisely, and it needs privatization and deregulation so that the existing capital stock is used more efficiently. Talk of “consumption-led growth” just confuses the issue.
READER COMMENTS
Matthias
Jan 12 2024 at 1:41am
They have more ways. They could just use more and more capital, even if they don’t use it more efficiently. Eg they could form more capital domestically, or they could make it easier for foreign capital to come in.
The conclusions in the rest of your article don’t change much, even with these additions. And I suspect opening the door to foreign capital wider would look a lot like the reforms you suggested.
Richard W Fulmer
Jan 13 2024 at 2:27pm
How do you form more capital without increasing investment?
Arqiduka
Jan 12 2024 at 3:47am
I always thought of ‘consumption-led growth’ as an euphemism for intentionally limiting the portion of your value-added total that comes form external trade.
Warren Platts
Jan 12 2024 at 11:01am
Running big, chronic export surpluses entails your households can’t afford to buy their own production. Whether that’s good or bad is a value-judgement I guess..
Arqiduka
Jan 13 2024 at 4:23am
Not necessarily.
Chronic export surpluses merely mean an accompanying chronic investment outflow.
To your households *could* afford to buy your own production if they were to stop investing overseas.
Whether they’d buy exactly the same type of stuff foreigners like, or if the entire production chain would have to be updated to suit the local needs is something else.
Scott Sumner
Jan 12 2024 at 12:17pm
Good point. Exports could be diverted to domestic consumption.
Knut P. Heen
Jan 12 2024 at 9:14am
All growth is consumption led in the sense that the purpose of producing more is to consume more. To produce more you have to produce more capital or use the current capital stock more intensively (either more labor hours or more efficient use of the current capital stock).
Communist regimes have had a tendency to produce too much steel and too little butter. It would not surprise me if the marginal unit of butter has a much higher value than the marginal unit of steel in China.
Thomas L Hutcheson
Jan 12 2024 at 10:01am
That the Chinese need “more consumption” never made much sense as a development strategy. On might believe that from a utility maximizing POV that China should be investing more in, say health care than manufacturing capacity. I certainly wish they would not spend so much on military consumption.
Dale Doback
Jan 12 2024 at 11:26am
If a central bank is currently causing a demand shortfall, doesn’t that imply that future shortfalls are also more likely and should be expected? In other words, how could a demand shortfall not have long term effects?
Scott Sumner
Jan 12 2024 at 12:18pm
“In other words, how could a demand shortfall not have long term effects?”
Wages and prices eventually adjust to a demand shortfall, and output returns to its natural rate.
Thomas L Hutcheson
Jan 13 2024 at 6:29am
But a Central Bank exists to facilitate the change in relative prices needed to restore full employment when some prices are more downwardly sticky than others. As someone said, to make Say’s Law true in practice even though it is not true in theory. Mechanically this may mean creating more “aggregate demand” but excesses and shortfalls of aggregate demand (or supply) are not the best way to think about macroeconomic management.
Warren Platts
Jan 12 2024 at 11:43am
We’re talking about Michael X. Pettis of course. I think he would say that (in terms franker than he uses) is that there’s no need to print money for demand-side stimulus: just that the distribution of the national income needs to be redirected from the Communist kleptocracy to households either in the form of higher wages (preferably) or direct social security payments. Of course this will never happen willingly, but if it did, then consumers would decide through their buying habits whether more electric locomotives or microwave ovens are needed from the economy, and thus no need for top-down technocrats to figure out how to spend investment funds more wisely. Remember the invisible hand?
As for the People’s Republic still being a developing country in 2024, that’s hard to believe given that the PRC supposedly has had the world’s biggest GDP for the last 10 years and has been the world’s largest carbon emitter for at least as long. The mere fact that they seem have a hard time finding productive investment opportunities is a proof that there just aren’t many new such opportunities. Thus doubling-down on investment led growth is simply going result in more malinvestment. I hear the doubling-down is now in the manufacturing sector — as if the world needs more Chinese exports. Thus, expect more trade wars as countries rightly or wrongly resist reducing their own manufacturing sectors.
Scott Sumner
Jan 12 2024 at 12:22pm
I think Pettis and I agree that China needs to reform its economy. Not sure what point you are trying to make.
“As for the People’s Republic still being a developing country in 2024, that’s hard to believe given that the PRC supposedly has had the world’s biggest GDP for the last 10 years and has been the world’s largest carbon emitter for at least as long.”
You forget that China has more than 4 times the US population, and thus its per capita GDP makes it a developing country–about on par with Mexico.
Warren Platts
Jan 12 2024 at 2:32pm
Just that Pettis is the guy who’s been saying for years that China needs consumption-led growth rather than investment-led growth. His favorite quote is from Marriner Eccles that goes something like mass production requires mass consumption. The economy is like a poker game: the losers require a constant income stream or else the game ends and then the winners lose.
Respectfully disagree here. Granted China has about a billion very poor helots. But it also has 40,000 miles of high speed rail — enough to go around the Planet twice in two different directions. They have a space station, astronauts & nuclear tipped hypersonic missiles. Their navy, hull-wise at least, is bigger than the U.S. Navy. They have Tsinghua University and graduate more engineers than anywhere, even are publishing more scientific papers than anywhere else. People tell me “Beijing is nicer than New York City” but not many say that “Mexico City is nicer than the New York City.” Their steel production is off the charts. Let’s face it, the whole “developing nation” notion is just a disingenuous ploy to further their mercantilist trade policies and thus skate WTO rules.
Jim Glass
Jan 13 2024 at 12:31am
600 million people living on less than $5 a day, according to the mur^h^h deceased recent Premier. That’s about twice the population of the USA.
Over 42,000 km, 26,000 miles, but why quibble? Yes, and the World Bank says of the 31 lines, five cover their cost. The rest fail to do so by varying amounts down not even being able to pay for the electricity that moves the trains. The system’s debt is >$900 billion and growing (in 2019, surely >$1 T today). “Great waste” may be impressive, but does not mean “rich”.
The USSR had far more nukes than China, a bigger space program, an army occupying far more foreign countries. How developed was its economy when it collapsed into ruin?
Who are being pushed into menial jobs by the gov’t so as to not further boost the >21% unemployment rate they face (which the govt has stopped publishing). Rather than that, many grads now are becoming “full time children“. The Soviets emphasized producing a great many engineers too. Communist parties think alike.
I was in Moscow and Leningrad in USSR days, and they were very nice compared to New York City. (The subways, oh!) But the Tsar making sure his home town looks good does not a developed economy make.
Mercantilist, sure. When did “mercantilist” and “developed” start going together?
Scott Sumner
Jan 13 2024 at 12:35pm
If you think Beijing is richer than New York, then you’ve obviously never been to China. I was in Beijing a few months ago.
And production doesn’t require consumption, it makes consumption possible.
Warren Platts
Jan 14 2024 at 2:02am
You can’t have one without the other. If you make something that no one wants to buy, you haven’t produced anything. So if your country is massively overproducing more than your own citizens can possibly buy, well, then you better hope you can export the excess. This depends on other countries willing to accept your imports, and even if they do, the overproduction will drive down prices enough to kill your profits and hence the golden goose. Granted, such considerations perhaps do not apply to Communist economies.
Warren Platts
Jan 14 2024 at 8:20am
Sorry. Actually, now that I’ve had a chance to think about it some more: hypothetically, let’s suppose the Chinese government were to sponsor the construction of a humongous stone pyramid out in the middle of the Gobi Desert to honor the ancient gods. That would count as production and add to the GDP. But if nobody ever went out there to see the monument, there would be no consumption. Thus, that would be a clear case of production that doesn’t require consumption. Sort of like the fast train to Urumqi…
Richard W Fulmer
Jan 13 2024 at 2:58pm
Socialists seem to fixate on the production of certain, very visible goods. Gavin Newsome is focused on building high-speed rail, Mao-era China on steel, and the USSR on steel and farm tractors. One of the USSR’s big goals was to produce more tractors annually than did the U.S., a goal they eventually achieved. Their achievement, however, left something to be desired.
First, the amount of food produced per tractor was far higher in the U.S. than in the USSR. Second, focused as it was on machine count, the USSR neglected to produce spare parts. As a result, many of their tractors had to be cannibalized to keep the others running. Third, the USSR tended to build single-purpose tractors, whereas the U.S. built tractors that had multiple uses because they could pull and power a variety of farming implements. The USSR didn’t bother to build such implements because they weren’t tractors, and the USSR was focused on tractors.
We tend to produce what we measure – whether it’s miles (or kilometers) of high-speed rail, the number of tractors, tons of steel, or the quantity of nuclear tipped hypersonic missiles – regardless of the utility of such production. Be careful what you count; bean counters get beans.
vince
Jan 12 2024 at 1:23pm
Western experts also believe China should not be Communist. Isn’t it a little arrogant to try to tell them what they should value?
Jon Murphy
Jan 12 2024 at 3:17pm
I don’t think anyone is “telling them what they should value.” The question is about whether the concept of “consumption-led growth” makes sense.
Of course, with a highly centralized society like China, it is difficult to tell what people value, moreso given recent repressions in the marketplace. In a relatively free society, how people act in accordance to their own will provides insight into what they value. Whenever something happens to override that choice (eg protectionism and economic nationalism), it obscures people’s values.
vince
Jan 12 2024 at 4:26pm
Makes sense to whom?
Jon Murphy
Jan 12 2024 at 6:04pm
In general as a concept.
Jim Glass
Jan 12 2024 at 10:51pm
Investment-led, consumption led, supply side reform-led, whatever — it looks like it’s time for them to do something….
“A 2023 survey of 100 pension and sovereign wealth managers by London-based think-tank Official Monetary and Financial Institutions Forum found that none of them, 0%, have a positive outlook on China. I had to triple check to be sure that was correct. Zero percent.”
— China Update
Mr Econotarian
Jan 15 2024 at 3:24am
As someone who has worked with Chinese companies, I feel that China will never “ascend the value chain” if you can’t trust their products. Trust loss comes from a totalitarian surveillance state government, and unclear methods of solving contract law in courts.
You don’t need to trust someone to sell you socks. A sock is a sock. Even many consumer electronic devices can be fully tested to see if they work.
Airplanes? You aren’t able to test them enough. Chinese biotech after Chinese stalling on COVID investigations is questionable as well.
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