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.
