As the debate in Beijing intensifies over the quality and sustainability of China’s economic growth, a shift in thinking is taking place. China’s most thoughtful economists are increasingly skeptical about the need for high gross domestic product growth rates.
China’s leadership has always put great stock in its GDP numbers. This year’s growth target is 7.5 percent; when Finance Minister Lou Jiwei said in Washington earlier this month that “the 7 percent goal should not be considered as the bottom line,” China’s state-run media first reported, and then hastily whitewashed, his statement. According to Xinhua News Agency, Lou had actually used the 7.5 percent figure -- coincidentally, the exact number reported July 15 for the second quarter.
Such shenanigans are pointless. GDP growth rates over the next few years of 7.5 percent, or even 7 percent, will be impossible to achieve. Until now, such gaudy statistics have been produced by ballooning investment. With so much of that investment now creating less economic value than debt, China has experienced an unsustainable expansion in credit. The country is perilously vulnerable to a chaotic adjustment.
This cannot continue. Growth will drop to well below 7 percent one way or another because credit growth must slow sharply. Ultimately, though, GDP growth rates are the wrong target. For China to successfully rebalance its economy toward a healthier and more sustainable model, the measure that really matters is how fast median household income is growing.
Why? Consider what it means for China to rebalance. With household consumption at an astonishingly low 35 percent of GDP, in order to raise that figure to even 50 percent of GDP within a decade -- still by far the lowest proportion of any major economy in the world -- consumption growth would have to exceed GDP growth by close to four percentage points every year.
An average annual growth rate of 7.5 percent, in other words, would require growth in consumption to exceed 11 percent. How could China possibly get citizens to start spending that much faster? In fact, consumption now contributes less to GDP growth in China than it did during the first half of 2012.
It is now widely understood that the reason for China’s very low household consumption share is the very low household income share of GDP, which, at around 50 percent, is among the lowest ever recorded. To raise that figure while maintaining GDP growth of 7.5 percent, or even 6 percent, would require a ferocious surge in Chinese household income, even as China and the world slow down. This will be impossible to achieve without a continued, and very dangerous, surge in debt.
As a number of prominent Chinese economists have noted, it is not the GDP growth rate that matters for ordinary Chinese people. Ordinary Chinese, like people everywhere, do not care about their per-capita share of GDP. They care about their real disposable income.
In recent decades, real disposable income has grown at well above 7 percent a year, which, although much lower than China’s GDP growth rate, is nonetheless a tremendous feat. This is the growth rate that must be maintained. Beijing’s policies should aim for average annual growth in household income of 6 or 7 percent.
This would ensure social stability and would continue to drive China’s economy forward. It implies, however, that if China is to rebalance meaningfully, GDP must grow by “only” 3 to 4 percent, which -- although low by recent Chinese standards -- is consistent with rapid growth in the income of ordinary Chinese and a real and sustained rebalancing of the Chinese economy, as well as consistent with almost zero investment growth.
Maintaining the growth rate in disposable household income while reducing investment will not be easy, of course. This is the biggest challenge Beijing faces. In principle, it can be done by reversing hidden transfers from the household sector to the state -- raising deposit rates to a level at which household savers are fairly compensated, for instance -- and transferring resources directly from the state to the household sector (by privatizing state assets), as well as by changing China’s over-reliance on cheap capital to make its growth more labor-intensive. But there will be tremendous opposition from the political elite to many of these measures.
Still, the critical point is that China does not need to grow at 7.5 percent. This myth should be discarded. What matters is that ordinary Chinese people continue to improve their lives at the rate to which they are accustomed and that the Chinese economy begins to let the air out of its credit bubble. Current targets are appropriate for household income growth. They are meaningless for GDP growth.
(Michael Pettis is a finance professor at Peking University and author of “The Great Rebalancing: Trade, Conflict, and the Perilous Road Ahead for the World Economy.”)
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