Author: Liu Xiaoshu, Chief Economist of Bank of Qingdao and Director of China Chief Economist Forum
Source: Originally published on Caixin
A professor pointed out in an interview, "There is a saying that our investment-led economic growth is unsustainable and that it should be changed to consumption-led economic growth. This viewpoint has aroused great controversy, and many economists have expressed opposition to it, and another professor has even been-for-tat, shouting that "opposing the expansion of consumption is misleading China", holding that the mainland has already invested too much, and that the mainland's economic growth in the future needs to be driven by consumption.
So, will it be driven by consumption or investment? Will consumption be a new model of China's economic growth?
First, the change of consumption rate is a historical process, which follows the U-shaped law
Compared with developed economies, China has a low consumption rate and a high investment rate. At present, China's final consumption accounts for about 53% of GDP, which is more than 20% lower than the United States, the United Kingdom, Japan and other countries, and there is a lot of room for growth. In the context of continued investment stimulus will cause overcapacity and waste of resources in the industry, many scholars support "consumption-led economic growth", and China's economic growth model should shift from investment-led to consumption-driven.
So, is the mainland's consumption rate really low?
In fact, a higher rate of investment, correspondingly, a lower rate of consumption, is a general law at a particular stage in the process of primitive accumulation of capital or economic development, and it is meaningless to simply compare China with developed countries such as the United States.
Theoretically, the change in the investment rate will show an inverted U-shape in the process of economic evolution from a lower level to a higher level. Naturally, this also means that the change in the consumption rate follows a U-shaped law. In the stage of low level of economic development, the newly created value of the whole society does not have much surplus except for basic consumption, forming a high consumption rate, When economic development crosses a low-level stage, there is still a surplus of the newly created value of the whole society in addition to basic consumption, and with a strong impulse for growth, social resources will be used more for accumulation and investment, and the investment rate will be high, while the consumption rate will be relatively low; when economic development has entered a relatively high stage, a highly developed industrial society has been formed, with abundant products, and people's incomes are abundant, and social attention has shifted from production to consumption, and consumption has extended from subsistence to pleasure, and the consumption rate has increased, while the investment rate has declined.
The experience of national economies also shows that changes in investment rates obey the inverted U-shaped law. The World Bank divides countries in the world into four stages of development according to per capita national income: low-income, lower-middle-income, upper-middle-income, and high-income. Taking 2019 as an example, before the pandemic, we can see that the capital formation rate of upper-middle-income countries is higher than that of lower-middle-income countries and low-income countries, and it is also significantly higher than that of high-income countries.
At present, the mainland is still in the stage of development of a middle-income country. This means that a relatively high investment rate and a low consumption rate are very necessary to support the mainland's economic development. In fact, although the capital formation rate of the mainland is much higher than that of the developed market economies, the per capita capital formation level of the developed countries is still much higher than that of the mainland on a per capita basis. According to World Bank data, China's annual per capita capital formation is still low compared to developed countries such as the G7, for example, in 2022, the per capita capital formation in the United States was even more than three times that of the mainland. Such a large gap shows that the mainland still has a long way to go in terms of capital accumulation, and from the perspective of per capita, the mainland's investment is not too much, but less.
At present, the mainland is still far from the standards of developed countries, and if the mainland prematurely lowers the investment rate and shifts to increasing the consumption rate, it may lead to the disaster of economic stagnation on the mainland. Countries that have fallen into the "middle-income trap", such as Argentina, are generally characterized by low investment rates.
Therefore, in order to judge whether economic growth is driven by investment or consumption, we must still proceed from the stage of development of the economy.
Second, stimulating consumption can correct the temporary deviation of the economy from the long-term supply curve, but it does not change the long-term supply curve
Investment has a multiplier effect on the expansion of domestic demand, which is often mentioned in economics textbooks. Some economists now believe that consumption has the same effect, that is, consumption also has a multiplier effect on the expansion of domestic demand. Like what
Peking University's Guanghua School of Management and Ant Group Research Institute jointly released a report saying that the government's consumption subsidy of 1 yuan can drive more than 3.5 yuan of new consumption on average. According to statistics from relevant parties, in the first half of 2022, various districts and counties (cities) in Hangzhou issued a total of 293 million yuan of various consumption vouchers, driving consumption by more than 3 billion yuan. The existence of the consumption multiplier effect has excited a considerable number of economists, especially in the context of the current consumption rate in China is much lower than that of developed countries. Although increasing investment can reduce the backlog of enterprises, once the investment is completed, new capacity will be formed, and if consumption cannot keep up, the original excess capacity will be worsened, while stimulating consumption is different, and consumption drives final demand. Therefore, scholars are more inclined to focus on expanding demand rather than investment but consumption.
So, how should we view the role of consumption in economic growth?
Economic growth is a cyclical process of reproduction. The process of economic operation includes four links: production, distribution, exchange, and consumption, in which the four links are organically linked, so that social reproduction can be recycled and social wealth can be increased. On the surface, it is the cycle of products and services from production to consumption, but behind it is all the factors that create social wealth, including land, capital, labor, data, technology, etc., all participate in the cycle.
Taking a two-sector economy that only includes investment and consumption as an example, there are several points worth paying attention to in the economic cycle: (1) There are two potential blockages. Blocking point (1): If the supply and demand structure is unbalanced, it may cause the total supply to be greater than the total demand, the phenomenon of overproduction, no one buys the product after the enterprise produces the product, the product is pressed, the capital can not be returned, and the reproduction is unsustainable, and the phenomenon of the Great Depression will occur in serious cases; 。 (2) In the smooth economic cycle, consumption must maintain an appropriate proportion. Total social production is divided into two categories: one is the means of production, and the other is the means of consumption. In the final analysis, the core problem of the realization of social reproduction is the problem of proportionality, that is, the appropriate proportional relationship must be maintained between the two categories of social production, and social reproduction can be carried out through "compensation in kind" and "value compensation". This ratio is not set in stone at different stages of development. As mentioned above, when economic development crosses a low level, social resources will be used more for accumulation and investment, and the investment rate is higher at this stage, while the consumption rate is relatively low; when economic development enters a higher stage, a highly developed industrial system has been formed, social attention has shifted from production to consumption, and consumption has also extended from survival to pleasure, and the consumption rate has increased, while the investment rate has decreased.
Insufficient demand and overproduction are not uncommon in the economic cycle of industrialized societies. In the long run, economic growth is mainly driven by population, capital, and technological progress. However, in the short term, due to demand shocks and supply shocks, a country's output is not only determined by the supply side, but also needs to take into account the balance between supply and demand. For example, when the effective demand in the market is insufficient, the aggregate demand < the aggregate supply, and the goods produced by the enterprise are not sold enough, resulting in a backlog of inventories and "surplus", and the actual output is therefore lower than the potential output, resulting in a negative gap in output, sometimes called a recession gap, and the economic operation temporarily deviates from the long-term economic growth trend.
The economy is self-correcting in the long run, that is, when there is a negative gap in the economy, the economy is pushed back to the potential output level, making the output gap back to zero. This self-correction process usually takes several years or even a dozen years or more.
In Keynes's time, most economists saw the short term as irrelevant, but Keynes pragmatically pointed out that "in the long run we are all dead", so he proposed that instead of waiting for the economy to self-correct, governments should use fiscal and monetary policies to push the total output of the economy back to potential output when it deviates from the potential output level. For example, when there is a recession gap, expansionary policies are used to stimulate investment or consumption.
In this diagram, SRAS is the short-term aggregate supply curve, LRAS is the long-term aggregate supply curve, AD1 is the initial aggregate demand curve, and on the initial short-term macro equilibrium point E1, the aggregate output level is Y1, which is lower than the potential output level Y2, what the government needs to do is to adopt active policies to increase aggregate demand, move the aggregate demand curve to the right position of AD2, so that the recession gap is closed, and the economy reaches a new short-term equilibrium point E2, which is also the long-term macroeconomic equilibrium point (see Macroeconomics (2nd Edition) by Paul Krugman and Robin Wells).
The mechanism of "consumption-driven economic growth" lies in the fact that, in the short term, stimulating consumption through expansionary policies can make up for the lack of market demand. The government has directly led to an increase in demand for products through the implementation of consumption stimulus policies, such as the issuance of consumption vouchers or consumption funds. The growth of product demand brought about by consumption stimulus policies will directly form real output and reduce the negative output gap caused by insufficient demand. At the same time, the increase in consumer demand will alleviate the problem of overproduction to a certain extent, promote the return of enterprise funds to achieve a reproduction cycle, form a positive feedback between consumption and production, promote the return of actual output to the potential output level, promote the return of the economy to the long-term growth trend, and correct the temporary deviation of the economy from long-term supply.
It can be seen that both fiscal and monetary policies to stimulate consumption are only economic stabilization policies, tools for managing short-term economic fluctuations, and means of closing short-term output gaps. Although fiscal and monetary policies have a more important impact on the economy in the short run, the impact of the rightward shift in the demand curve driven by these expansionary policies on aggregate output is temporary and does not affect the potential output of the economy, but only by pushing the level of aggregate output to the level of potential output.
Third, to promote long-term economic growth, it is necessary to exert efforts from the supply side and reconstruct the long-term aggregate supply curve
Demand-side management, whether to stimulate investment or consumption, is a short-term response to allow production to continue. A short-term response is of course important and necessary, otherwise the economy will shut down, as Keynes famously said, "In the long run, we are all dead". Keynes famously satirized economists who only looked at the long term and ignored the short-term problems. However, today, people's observation and analysis of the economy only sees the short-term but not the long-term, and local governments are often confined to the KPI assessment of stable growth, falling into excessive attention to short-term economic growth, but ignoring long-term economic growth. Part of this stems from the misconception that long-term economic growth is "long-term." Generally speaking, long-term economic growth is about economic growth over several decades, so it is easy to have the idea that long-term is long-term, and long-term economic growth is economic growth in the distant future. When the economy is in a downturn, the first thing that comes to mind is how to get through the current difficulties, put aside the matter of long-term economic growth, and think that it is something to consider in the future. As everyone knows, since the economy always tends to return to the level of potential output, and the actual total output level will fluctuate around the level of potential output, and rarely deviate too much, the trend of economic growth rate is very close to the trend of potential output growth rate in the long run, such as several decades. In fact, the "long-term" in long-term economic growth is consistent with the "long-term" in the long-run aggregate supply curve, which represents the level of potential output in the economy. In other words, long-term economic growth is talking about the level of potential economic output.
The fundamental reason for the decline in the mainland's real economic growth rate in recent years is the decline in the rate of growth of potential output. The real challenge for China's economy lies in the reconstruction of the long-term supply curve, rather than the short-term lack of demand, and it needs to continue to exert force from the supply side.
In the past few decades, the mainland has adopted a factor-driven economic growth model, with demographic dividends and large-scale investment leading to a rapid increase in domestic production capacity. However, in the process of economic growth, the contribution of capital and labor input to the growth rate will gradually decrease. With the gradual disappearance of the mainland's demographic dividend and the diminishing capital returns, the factor-driven high-speed growth model has come to an end. Only by improving total factor productivity and reshaping the long-term aggregate supply curve can we embark on a new path of high-quality development.
The decline in total factor productivity is an important reason for the slowdown in the mainland economy in recent years. According to the calculations of the University of Groningen, China's total factor productivity has been declining since 2014. In 2021, China's TFP was only 40% of that of the United States, 44% of Germany, and 63% of Japan.
The improvement of total factor productivity mainly comes from technological progress and the improvement of resource allocation efficiency, both of which are inseparable from effective investment. Technological progress does not exist alone, it is necessarily attached to physical and human capital, and in order to use new technologies, capital must be accumulated. Therefore, improving total factor productivity through technological innovation means investing more in new productive forces such as strategic emerging industries and future industries that will support the continuous progress of total factor productivity in the future.
In the short term, investment is an important part of aggregate demand, and increasing effective investment will directly bring about the growth of demand and close the short-term recession gap caused by insufficient demand; in the long run, through deepening reform, the decisive role of the market in the allocation of resources will be brought into play, and social capital will be shifted from low-efficiency industries to high-efficiency industries, and economic development will be driven by factors to efficiency.
At present, China needs to solve the problem of both short-term and long-term effective supply of power. The former needs to strengthen management on the demand side, while the latter needs to continue to exert force on the supply side. Consumption-driven economic growth is more of a prescription put forward by scholars on how to solve the problem of economic recovery in the short term. However, in the long run, only by giving full play to the role of the market and increasing effective investment can we provide a more sustained impetus for stable growth. In essence, expanding effective supply is also expanding domestic demand.