Painful Choices Loom After China’s ‘Monumental’ Stimulus

Painful Choices Loom After China’s ‘Monumental’ Stimulus

Sub : Eco

Sec: Fiscal Market

China’s recent stimulus plan to shift towards consumer-driven growth marks a significant break from its traditional economic policies.

• Focus on Stimulating Household Demand:
  • Beijing plans to issue sovereign bonds worth about 2 trillion yuan ($284 billion) in 2024 to subsidize consumer goods purchases and child support, effectively transferring funds to households.
  • This marks a shift towards stimulating consumption, a move economist has been advocating for over a decade.
• China’s Long-standing Growth Model:
  • Since the 1980s, China has relied heavily on investment in property, infrastructure, and industry, often at the expense of consumer demand.
  • Economists argue that this model has led to overcapacity in sectors like infrastructure and manufacturing, and unsustainable debt since the global financial crisis.
• Economic Challenges and Potential Growth:
  • The current consumer-focused stimulus is expected to help China meet its 2024 growth target of 5%, despite recent below-forecast data.
  • However, China’s household spending remains less than 40% of annual economic output, 20 percentage points below the global average, while investment stands 20 points above. Bridging this gap will be a long-term challenge.
• Comparative Insights:
  • Historical data shows that it took Japan 17 years to increase its consumption share by 10 percentage points from its low point in 1991.
  • Analysts warn that China may face a prolonged period of low growth, similar to Japan’s experience in the 1990s.
• Structural Issues Hampering Consumption:
  • China’s socioeconomic structure has historically favored investment over consumption:
    • Low deposit rates, weak labor rights, and frail social safety nets have kept household incomes low.
    • The tax system encourages high investment with low wages.
    • Capital gains tax is 20%, compared to 30% in India and 37% in the U.S.
    • The upper personal income tax rate in China is among the world’s highest at 45%.
    • Strategic industries, like electric vehicles, green energy, and robotics, are frequently supported by tax exemptions and government incentives, reinforcing the focus on investment over consumption.
• Policy Rebalancing Challenges:
  • Rebalancing the economy towards consumer-driven growth will require a coordinated, long-term effort involving various policy changes.
  • Analysts argue that halting subsidies to manufacturing and shifting focus to households could lead to a recession due to reduced investment in the manufacturing sector.
• Likely Economic Outcome:
  • Experts predict that China may choose a protracted period of rebalancing, leading to a scenario similar to Japan’s “lost decade” or “Japanification”, with sluggish growth but gradual adjustment.
  • To support the current stimulus, Beijing is expected to issue more debt rather than significantly alter the income distribution mechanisms between businesses, government, and households.

In conclusion, China’s transition from an investment-driven economy to one focused on household consumption presents monumental challenges. While this strategy aims to spur growth in the short term, the long-term structural changes required for a sustainable shift will involve painful choices and years of rebalancing.

Japanification

It refers to the economic phenomenon that mirrors Japan’s prolonged period of stagnation and low growth following the asset bubble collapse in the early 1990s.

 This term describes various characteristics and consequences observed in Japan’s economy over the last few decades, which some analysts warn could befall other economies, particularly those facing similar structural challenges.

 Key Characteristics of Japanification

• Prolonged Economic Stagnation:
  • A sustained period of low or negative economic growth, often accompanied by persistent deflation.
• Low Interest Rates:
  • Central banks maintain ultra-low or negative interest rates in an effort to stimulate growth, which can lead to diminished effectiveness of monetary policy.
• Deflationary Pressures:
  • Falling prices can create a cycle of reduced consumer spending as people wait for prices to drop further, exacerbating economic stagnation.
• Aging Population:
  • A demographic shift towards an older population, resulting in lower workforce participation and increased social security and healthcare costs.
• High Public Debt:
  • Rising government debt levels, often as a result of stimulus measures aimed at reviving the economy.
• Corporate Sector Weakness:
  • Companies may become complacent, leading to inefficiencies and a lack of innovation, often referred to as “zombie companies” that rely on low borrowing costs to survive.
• Low Productivity Growth:
  • Stagnant or declining productivity levels, which can hinder economic growth potential.