The tariffs are starting to bite. Data out this week showed that China’s exports to the United States plunged by 34.4 percent last month, the sharpest drop since the Covid-19 pandemic, according to Bloomberg. This decline occurred despite the temporary trade war “truce” announced by US President Donald Trump in May.
This precipitous drop is undoubtedly a blow to China’s critical export machine. Yet, it underscores a broader and more important economic question: Can China pivot its massive economy away from export-led growth towards a more sustainable model predicated on higher domestic consumption?
Underlying the data is the strength of the Chinese export machine. Remarkably, despite the collapse in exports to the US, China’s total exports rose nearly 5 percent. But the bigger challenge lies in transforming the economic model that has driven China’s breakneck economic expansion for decades.
The call for China to rebalance its economy away from selling to consumers in other countries is not new. Economists have long warned that its reliance on domestic savings funding investment into manufacturing foreign exports is unsustainable. The Trumpian trade war has merely sped up the urgency of its need to make this transition across the economic Rubicon.
Scepticism is rife as to whether the Chinese Communist Party (CCP) has the means, or political will, to foster such a shift to a consumption-led economy. It would not be without its political and social risks. History has shown that when people become better off, and economically freer, they tend to demand equivalent political freedoms.
Yet, the question might not be whether the CCP wants or is able to allow such a shift. Rather, can it afford not to? Surely, it understands that hoping that the status quo can continue is a road to nigh certain economic, social and political ruin. China must, in a sense, evolve or die. And the signs are that it is indeed taking this plunge.
First, the narrative of weak domestic consumption is misleading. Consumer spending already makes up about 40 percent of China’s GDP. While this is well below the global average of about 60 percent, the share scale of China’s consumer market — already second only to the US — makes clear the upside potential if it is able to lift consumption to a level commensurate with an economy of its nature.
Replacing lost US export revenue with domestic demand then may not be as difficult as it seems. Thanks to high production and relatively low prices, consumer goods are widely affordable, and China is not as susceptible to difficult and fragile supply chains as, for example, the US. Moreover, young Chinese Gen Z and millennial consumers are prone to spend on travel, lifestyle and technology.
“The bulk of consumer credit goes to people under 35,” notes Keyu Jin of Hong Kong University of Science and Technology in the Financial Times. “With one click on Alibaba, you can borrow to buy a lipstick.”
Looking ahead, the potential for consumption growth is enormous. Boston Consulting Group estimates that by 2030, more than 500 million Chinese will belong to the middle and upper classes. That is more than the entire population of the US. Even a modest rise in their spending habits could drive a major increase in domestic demand, and indeed affect other emerging markets that sell to China — such as South Africa.
Second is the shifting dynamics of the real estate market. China’s zero-Covid-19 pandemic approach and its real estate crash did, undoubtedly, scare households. Consumer confidence remains significantly below pre-2020 levels, and precautionary savings are elevated. Yet, there are nascent signs of a turnaround. Research done by Absolute Strategy Research shows that households have now largely filled the hole in their balance sheets caused by the tanking property market, allowing them more room to spend. Home prices are stabilising, and consumer sentiment is slowly recovering. A recent Deutsche Bank survey showed 52 percent of respondents were ready to increase discretionary spending, the highest in a year.
Still, converting this momentum into long-term consumption growth will require deeper structural changes. Confidence must be boosted and precautionary “rainy day” savings, which are still so prized by a consumer market enduring post-Covid PTSD — should be depleted. But Beijing is listening to the economists on this. Xi Jinping’s economic doctrine — emphasising “dual circulation” and “common prosperity” — has begun to prioritise domestic demand.
Third, urbanisation is a critical factor. China’s hukou system — which restricts rural migrants’ access to benefits in urban areas thereby keeping a lid on the numbers of people that can move into the cities — puts a ceiling on consumption spending. But the August 2024 five-year reforms to ease this system could unleash enormous spending potential. Studies show that fully urbanised migrants increase their per capita consumption by as much as 60%. While this is not without its political risks for the CCP — studies also show that urban residents are more likely to prioritise liberal values such as free speech and democracy — it is a necessity for faster growth. Finally, China’s social safety net also needs strengthening. Beijing spends significantly less on social transfers than capitalist economies, and it collects very little income tax relative to GDP. This underdeveloped welfare system encourages excess savings and lower spending. But once again, despite some political resistance, reforms are being made. While Xi has spoken against “welfarism” that “encourages laziness”, recent reforms include childcare subsidies, public medical insurance, old age benefits, employment support, and consumption incentives.
While not enough, this is an impressive start, and a tacit acknowledgement that more needs to be done to shift the economy to be “consumption led”. Long-term growth hinges on sustained political and economic reforms. Redirecting household savings into real economy spending by further welfare and tax reforms would strengthen the domestic market and help China make that shift into a more mature consumer economy.
As the economic and geopolitical limits of the country’s existing growth strategy becomes clearer, China must leverage its centralised policy apparatus to turbocharge consumer spending.
“Beijing has time and again demonstrated the ability to do the unexpected to reach its longer-term goals,” says David Goodman, director of the China Studies Centre at the University of Sydney, quoted in the Financial Times. China’s consumers have struggled in recent years. But there is enormous spending power yet to be unlocked, and Beijing holds the key.
Whether Beijing has both the means and the will to engineer this shift remains uncertain. But for the global economy — and especially for resource exporting emerging markets like South Africa that rely heavily on Chinese demand — it is a question of enormous consequence. China is still South Africa’s largest single export market by far. Unlike Trump, who revels in signs of Chinese weakness, the rest of the world should hope China’s economy is more resilient than it appears.
Natale Labia writes on the economy and finance. Partner and chief economist of a global investment firm, he writes in his personal capacity. (DM)
This precipitous drop is undoubtedly a blow to China’s critical export machine. Yet, it underscores a broader and more important economic question: Can China pivot its massive economy away from export-led growth towards a more sustainable model predicated on higher domestic consumption?
Underlying the data is the strength of the Chinese export machine. Remarkably, despite the collapse in exports to the US, China’s total exports rose nearly 5 percent. But the bigger challenge lies in transforming the economic model that has driven China’s breakneck economic expansion for decades.
The call for China to rebalance its economy away from selling to consumers in other countries is not new. Economists have long warned that its reliance on domestic savings funding investment into manufacturing foreign exports is unsustainable. The Trumpian trade war has merely sped up the urgency of its need to make this transition across the economic Rubicon.
Scepticism is rife as to whether the Chinese Communist Party (CCP) has the means, or political will, to foster such a shift to a consumption-led economy. It would not be without its political and social risks. History has shown that when people become better off, and economically freer, they tend to demand equivalent political freedoms.
Yet, the question might not be whether the CCP wants or is able to allow such a shift. Rather, can it afford not to? Surely, it understands that hoping that the status quo can continue is a road to nigh certain economic, social and political ruin. China must, in a sense, evolve or die. And the signs are that it is indeed taking this plunge.
First, the narrative of weak domestic consumption is misleading. Consumer spending already makes up about 40 percent of China’s GDP. While this is well below the global average of about 60 percent, the share scale of China’s consumer market — already second only to the US — makes clear the upside potential if it is able to lift consumption to a level commensurate with an economy of its nature.
Replacing lost US export revenue with domestic demand then may not be as difficult as it seems. Thanks to high production and relatively low prices, consumer goods are widely affordable, and China is not as susceptible to difficult and fragile supply chains as, for example, the US. Moreover, young Chinese Gen Z and millennial consumers are prone to spend on travel, lifestyle and technology.
“The bulk of consumer credit goes to people under 35,” notes Keyu Jin of Hong Kong University of Science and Technology in the Financial Times. “With one click on Alibaba, you can borrow to buy a lipstick.”
Looking ahead, the potential for consumption growth is enormous. Boston Consulting Group estimates that by 2030, more than 500 million Chinese will belong to the middle and upper classes. That is more than the entire population of the US. Even a modest rise in their spending habits could drive a major increase in domestic demand, and indeed affect other emerging markets that sell to China — such as South Africa.
Second is the shifting dynamics of the real estate market. China’s zero-Covid-19 pandemic approach and its real estate crash did, undoubtedly, scare households. Consumer confidence remains significantly below pre-2020 levels, and precautionary savings are elevated. Yet, there are nascent signs of a turnaround. Research done by Absolute Strategy Research shows that households have now largely filled the hole in their balance sheets caused by the tanking property market, allowing them more room to spend. Home prices are stabilising, and consumer sentiment is slowly recovering. A recent Deutsche Bank survey showed 52 percent of respondents were ready to increase discretionary spending, the highest in a year.
Still, converting this momentum into long-term consumption growth will require deeper structural changes. Confidence must be boosted and precautionary “rainy day” savings, which are still so prized by a consumer market enduring post-Covid PTSD — should be depleted. But Beijing is listening to the economists on this. Xi Jinping’s economic doctrine — emphasising “dual circulation” and “common prosperity” — has begun to prioritise domestic demand.
Third, urbanisation is a critical factor. China’s hukou system — which restricts rural migrants’ access to benefits in urban areas thereby keeping a lid on the numbers of people that can move into the cities — puts a ceiling on consumption spending. But the August 2024 five-year reforms to ease this system could unleash enormous spending potential. Studies show that fully urbanised migrants increase their per capita consumption by as much as 60%. While this is not without its political risks for the CCP — studies also show that urban residents are more likely to prioritise liberal values such as free speech and democracy — it is a necessity for faster growth. Finally, China’s social safety net also needs strengthening. Beijing spends significantly less on social transfers than capitalist economies, and it collects very little income tax relative to GDP. This underdeveloped welfare system encourages excess savings and lower spending. But once again, despite some political resistance, reforms are being made. While Xi has spoken against “welfarism” that “encourages laziness”, recent reforms include childcare subsidies, public medical insurance, old age benefits, employment support, and consumption incentives.
While not enough, this is an impressive start, and a tacit acknowledgement that more needs to be done to shift the economy to be “consumption led”. Long-term growth hinges on sustained political and economic reforms. Redirecting household savings into real economy spending by further welfare and tax reforms would strengthen the domestic market and help China make that shift into a more mature consumer economy.
As the economic and geopolitical limits of the country’s existing growth strategy becomes clearer, China must leverage its centralised policy apparatus to turbocharge consumer spending.
“Beijing has time and again demonstrated the ability to do the unexpected to reach its longer-term goals,” says David Goodman, director of the China Studies Centre at the University of Sydney, quoted in the Financial Times. China’s consumers have struggled in recent years. But there is enormous spending power yet to be unlocked, and Beijing holds the key.
Whether Beijing has both the means and the will to engineer this shift remains uncertain. But for the global economy — and especially for resource exporting emerging markets like South Africa that rely heavily on Chinese demand — it is a question of enormous consequence. China is still South Africa’s largest single export market by far. Unlike Trump, who revels in signs of Chinese weakness, the rest of the world should hope China’s economy is more resilient than it appears.
Natale Labia writes on the economy and finance. Partner and chief economist of a global investment firm, he writes in his personal capacity. (DM)
