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Is investment-based stimulus needed?

By Lee Houng (China Daily)

08:27, August 16, 2012

The Chinese government took its foot off the brake earlier in the year in response to the deteriorating external environment facing the nation's economy. It front loaded its fiscal spending, eased access to credit, and accelerated investment approvals. Local governments started announcing stimulus packages and relaxed some property measures. Against these developments, the debate continues whether China should again ratchet up investment.

The government, on the other hand, has been relatively firm in its resolve to moderate investment growth and promote consumption, keep property market measures in place, and address income inequality. Can such a position be justified in the face of the current uncertain global environment? Yes.

Let us look at China's consumption, which is at the center of the government's rebalancing efforts and often accused of being too low. At about 47 percent of GDP, consumption in China is indeed low compared with 63-68 percent in Japan and South Korea when their respective per capita GDP was around the same level as China in 2011.

However, a different comparison, taking into account each country's 20-year peak growth period, tells a different story. China's consumption spending from 1991 to 2011 rose 9.0 percent a year in real terms, well surpassing the 6.3 percent in South Korea (1966-86) and 6.9 percent in Japan (1956-76). This, by any measure, is a very impressive achievement.

The reason for the low share of consumption to GDP is because of China's own success. Led by investment, China's GDP growth during its peak growth period averaged 10.4 percent, well exceeding the 8.2 percent in Japan and 9.5 percent in South Korea. This is even more remarkable when one considers that China was able to lift its economy at this speed with a population that is 35 times larger than that of South Korea and 13 times larger than that of Japan.

Unfortunately, like everything else in life, there are side effects of this success story that may be becoming increasingly unsustainable. In fact, China's ratio of investment to GDP was high, but not excessive, until the early 2000s and broadly comparable with those of Japan and South Korea during their peak growth periods.

Acceleration of investment started in 2000 and in more recent years, it was further lifted by the need to contain the spillover from the global financial crisis. Well aware of this, efforts were geared toward rebalancing under the 12th Five Year Plan (2011-15). However, there are no easy policy solutions to the challenges facing the economy, and shifting its reliance from investment to consumption will take time.

In fact, declining consumption as a share of GDP in and of itself is not a problem. But the purpose of economic growth is ultimately to maximize social welfare, which, in turn, means making goods and services available to people, that is, consumption, to improve public quality of life. If consumption falls relative to income, it means people are expecting more consumption in the future, including after their retirement, through investment now. If that future consumption cannot be realized, then foregone consumption today will have been wasted.

Future consumption can only be guaranteed if current investment is efficiently allocated. This is best achieved by relying on market price signals. Market signals work properly only if there are no rigidities in prices and when competition is encouraged. This does not mean an absence of regulations, but rather, a regulatory system that is transparent and simple.

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