In Depth: China’s Long March to Become a Consumer-Driven Economy
Four decades of reform and opening-up have turned China into the world’s second-largest economy. More than 700 million people have been lifted out of poverty, and the country now has more billionaires than any other nation apart from the U.S.
But as the investment- and export-driven economic model that served China so well now runs out of steam, the ruling Communist Party is doubling down on a strategy that was set in motion about a decade ago — shifting to a more sustainable model of slower, but higher-quality growth powered by domestic consumption, especially household consumption. The guiding principles for the latest phase of this strategy were set out (link in Chinese) by President Xi Jinping in his new development pattern (新发展格局) philosophy and dual circulation strategy (双循环战略) in April 2020.
Although there are many facets to the new development pattern, achieving the goals set out by Xi to achieve “common prosperity” will involve tackling two of the country’s thorniest pain points — reducing inequality and unlocking the latent spending power of hundreds of millions of people who are stuck in rural areas or in low-paying jobs. These potential consumers are saving too much of their income rather than spending it in part because they don’t have access to free public health care, unemployment benefits or a state pension.
The government’s own figures provide a stark reminder of the extent of the problem.
The average per capita disposable income of people living in rural areas in 2020 was 61% lower than those living in urban areas, data from the National Bureau of Statistics (NBS) show. In 2019, the per capita disposable income of the wealthiest 20% of urban households was 91,683 yuan ($13,268), almost five times higher than the 15,549 yuan average income of the poorest 20%, NBS data show. That’s almost the biggest gap in data going back to 2000 when the difference was just under three times.
Poverty alleviation and rural revitalization (乡村振兴) have been at the top of the policy agenda for years, and data show that the gap between urban and rural incomes has narrowed. The average per capita disposable income of urban residents stood at 43,834 yuan in 2020, an increase of 133% over the past decade, NBS data show. Over the same period, average per capita rural disposable income has risen 173% to 17,131 yuan. But although the differential has improved, the average income of city dwellers was still 2.6 times that of their rural counterparts.
China’s household consumption as a percentage of GDP is well below that of other countries at similar stages of development, which means there’s plenty of scope to catch up. Having fallen from 45.5% when China joined the World Trade Organization in 2001 to 34.3% in 2010, it has gradually recovered to 39%, World Bank data show. Brazil’s ratio stands at 65% while India is at 60% and Russia is at 50%. The U.S., the world’s biggest economy, has a ratio of 68%.
“It is essential for China to change its development model to nurture consumption and services, because the investment-infrastructure-credit-driven model is already deep into misallocation of resources, and inefficiency, and encouraging financial instability,” said George Magnus, former chief economist at UBS Investment Bank and now a research associate at Oxford University’s China Centre and at the School of Oriental and African Studies in London.
“The fundamental issue in China’s development model revolves now around the low consumption share of GDP, even though income per head in, say, Shanghai, is the same as in, say, Portugal,” Magnus said. “That low consumption share, despite some urban evidence to the contrary, has to be changed if the economic model is to become more robust.”
The recently published five-year plan (五年规划), a policy blueprint (link in Chinese) for economic and social development for 2021-2025, and an accompanying strategy that maps out long-term objectives for 2035, give an indication of how the party intends to tackle these challenges –– redistributing income through tax reform, reducing the gap between rich and poor, and tearing down the barriers that prevent hundreds of millions of people from enjoying the benefits of urban life where jobs are more abundant, wages are higher, and education and healthcare are better. Concrete policies are now being formulated by the various government ministries and agencies coordinated by the National Development and Reform Commission, the country’s powerful economic planning agency.
One priority will be to grow what’s known as the middle-income class (中等收入群体), those with potentially the greatest capacity to increase their consumption. In China, that’s typically a three-member family with an annual income in a range of 100,000 yuan to 500,000 yuan, according to the NBS, which has estimated (link in Chinese) this group covers around 140 million households comprising more than 400 million people, around 30% of the total population. The long-term plan through 2035 doesn’t give a quantitative target for the increase, only calling for a “significant” expansion, but various government officials and economists have estimated this group could double to 800 million people over the next 15 years.
One of the government’s key policies to achieve these objectives is urbanization, which researchers and officials say offers the greatest potential for raising incomes and boosting domestic demand. Moving hundreds of millions of rural residents to towns and cities and giving them, as well as migrant workers, official status as permanent urban residents will lead to higher wages, increased productivity and ultimately higher consumption, they say.
Around 40% of China’s 1.4 billion people still live in rural areas, but they account for only 22% of total household consumption, Cai Fang, an economist and then-vice president of the Chinese Academy of Social Sciences (CASS), a state-backed think tank, told (link in Chinese) an urbanization conference in Beijing in September.
China has already made significant progress with urbanization — the rate currently stands at around 60%, up from 36.2% in 2000. But it still lags behind (link in Chinese) the average 82% for high-income countries and 65% for upper middle-income countries. The target in the FYP is to push that percentage to 65% by the end of 2025.
Yet the headline urbanization figure masks a deep-seated problem — restrictions stemming from the country’s household registration, or “hukou” (户口), system which classifies people as urban or rural residents depending on where they were born. A hukou entitles the holder to certain social welfare benefits and public services, such as medical care and education, but only within the area covered by their household registration.
Although 60.6% of the total population were permanent urban residents at the end of 2019, meaning they have lived in a city for more than six consecutive months, only 44.4% had an urban hukou, NBS data show. That means about 230 million people — mostly migrant workers — have lived in cities for more than half a year without access to the same social welfare benefits or public services as locals. As many cities are now restricting property purchases to those with a local hukou to prevent price bubbles, they are also in effect locked out of those housing markets.
These unofficial residents tend to have relatively low income and job security, and their status has lowered their expectations of future income and dampened their willingness to spend, according to some economists.
Closing that 16 percentage-point gap has the potential to unleash a wave of spending, according to CASS’s Cai, who has just been appointed to the central bank’s monetary policy committee as an academic adviser. Granting rural-born migrant workers the right to settle permanently in cities could raise their consumption by 27%, even assuming no change in their wages or other conditions, Cai said in his September speech, citing CASS research.
Calls have been growing to push ahead with reform and scrap residency restrictions. Although urbanization became a signature policy of Premier Li Keqiang after he assumed office in March 2013, progress on changing the hukou system has been patchy, partly because of opposition from local governments who can’t, or don’t want to, pay for the additional costs it will entail in terms of providing health care, welfare and education services.
In late 2019, the Central Committee of the Communist Party and the State Council took another stab at pushing forward change. They announced measures including the scrapping of residency restrictions in cities where the urban area has a permanent population of less than 3 million, and relaxing residency limits in those whose urban area has a permanent population of 3 million to 5 million. Megacities with more than 5 million residents were told to streamline a points system for household registration that’s based on factors such as social insurance payment records and length of stay. The measures also reiterated the need for equal treatment for migrants living in urban areas in terms of access to public services.
The FYP, in addition to reiterating these measures, calls for pilot programs to change the household registration system to one based on residence rather than birthplace in most urban areas. The exceptions are six megacities whose urban areas have a permanent population of more than 10 million (link in Chinese), namely Beijing, Shanghai, Chongqing, Guangzhou, Shenzhen and Tianjin. It also stipulates that megacities with a permanent population of more than 5 million in their urban areas should remove their annual quota on household registration.
At the end of 2019, 135 million (link in Chinese), or 31% of the 442 million people working in cities, were rural migrants, according to the NBS.
“Human-focused urbanization, along with making it easier for rural migrants to get urban residency, will on the production side, create more demographic dividends, namely by increasing the number of hours that workers work over their lifetimes,” Yang Weimin, a former deputy head of the general office of the Central Financial and Economic Affairs Commission, the country’s top economic policymaking body chaired by Xi, said in an interview with Caixin on Feb. 22.
“On the income side, it will help migrants build a lifelong career, move into the middle-income class and increase their total lifetime income. On the expenditure side, it will increase consumer spending among migrants, thus supporting the expansion of consumption nationwide,” said Yang, who is now deputy director of the economic committee of the national committee of the Chinese People’s Political Consultative Conference.
But despite the lofty ambitions, the key question of who foots the bill for the extra costs of urbanization such as education, health care, unemployment and pension provisions, has yet to be addressed. The burden so far has fallen mostly on local governments, which helps explain why many have dragged their feet.
Although in the long term, local governments will see benefits as their tax base grows, in the short to medium term, the additional fiscal spending on public services and social security will place greater budgetary pressure on local governments, analysts at Moody’s Investors Service wrote in a March 15 report.
Hukou reform could benefit wealthier regions and cities as they see higher population inflows, while outflows from less developed regions “would make infrastructure investments in these areas less valuable, potentially leading to a long-run debt overhang effect for the worst-impacted” local authorities, the analysts wrote.
The central government and local governments need to draw clear lines about how to share the costs of reform as well as the benefits, and the central government should pay the lion’s share and motivate local governments, CASS’s Cai said in his September speech. Local governments have to pay a large portion of the reform costs but cannot receive all benefits that flow from it, he said.
The central government is now providing financial support to local governments for granting urban residency, a move announced (link in Chinese) in 2016 and implemented (link in Chinese) the following year. The Ministry of Finance’s work report to the National People’s Congress in March budgeted 35 billion yuan for 2021 to support its hukou reform policy, improving mechanisms for sharing related costs, and ensuring that rural residents moving to urban areas have access to basic urban public services. But the figure was unchanged from 2020 and was only 5 billion yuan higher than in 2019.
“The division of responsibility and accountability between central and local governments needs reform and to be anchored in legal relations, along with greater revenue generation for the latter, for example through a property tax system which has been in effect dormant for a long time,” said Magnus from Oxford University’s China Centre. “The concern is that urbanization will become more complex and difficult than it was in the past without structural and legal changes in the relationship of the center to local and provincial governments.”
Contact reporter Luo Meihan (firstname.lastname@example.org) and editor Nerys Avery (email@example.com)
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