Nicholas Lardy: Private consumption is playing a larger role in China’s economy

Today, we're joined by esteemed economist Nicholas Lardy, a prominent voice on matters of international economics and an expert on China's economic dynamics.

In our discussion, Nicholas challenges the prevailing view that China's economic growth is in a state of permanent decline. He argues that China's economy is more resilient than many believe, highlighting the crucial role of consumer spending and the service sector as major drivers of future growth.

Nicholas also touches on the strategic shifts in investment from private to state-led initiatives and the implications for China's global economic competitiveness.

Wall Street Frontline: I've just read your article on foreign affairs, and you argue that China's economy is more resilient than many may believe. Could you please elaborate a bit more on this? What key factors do you think will be important to sustain this resilience over the next decades?

NicholasLardy:I think there's a good chance we're moving into an era where consumption will play a greater role in driving economic growth in China. This was certainly true in 2023, with very strong consumption growth and a falling household savings rate. In the first quarter of 2024, we also saw very strong consumption growth. If you look at a longer-term perspective, consumption as a share of GDP has been increasing every year since around 2010. I think this is a reflection of the fact that, with the exception of the COVID pandemic period, and I think increasingly that's a reflection of the shrinkage of the working age population. As the economy grows and the working age population is shrinking, wages tend to go up, and wages do drive consumption. Of course, this was very strong particularly in 2023 and the first part of 2024. So maybe we're moving away from the traditional emphasis on investment driving economic growth.

Wall Street Frontline: I noticed that in your article, you refute the idea that Chinese consumer confidence is weak. Consumer confidence is highly associated with consumption. So, what indicators should analysts focus on to better understand the trends in consumer behavior in China?

NicholasLardy:I think the most crucial relationship to understand in economic behavior is between the growth of disposable income of households and the growth of their consumption. Typically, when consumer confidence is low, it indicates that people are apprehensive about the future, often expecting it to be worse than the present. This usually leads consumers to cut back on their spending and save a larger portion of their income. However, what we observed in 2023 and in the first quarter of this year presents a different scenario. Consumption has been growing significantly faster than disposable income, which implies that households are actually reducing the share of their income that they're saving. Essentially, the only way spending growth can outpace income growth is if there's a cutback on savings relative to income. This situation creates a fundamental contradiction: surveys published by the People's Bank show very weak consumer confidence, yet the most telling indicator of consumer behavior suggests that they are quite confident. They are cutting back on their savings and are more comfortable with increasing their spending.

Wall Street Frontline: Which industries or sectors are the consumers in China spending more of their savings or their income on?

NicholasLardy:Probably the most significant growth area for consumption in China is in services, particularly healthcare, which saw a substantial increase in 2023. There was likely a pent-up demand for healthcare services during the lockdown periods when people may have struggled to secure medical appointments or procedures. As a result, there's been a bit of a catch-up, leading to household healthcare expenditures growing at a double-digit rate. Additionally, other sectors are also experiencing rapid growth. A broad category encompassing education, culture, and entertainment, as referred to in data sources, is also expanding very quickly.

Wall Street Frontline: In your article, you challenge the view that China's economic growth has permanently slowed. So, what do you think are the most common misconceptions about China's economic conditions, and why do you think these views persist in international discussions?

NicholasLardy:I think the idea that China's economy is permanently slowing was most forcefully put forward last year by “The Economist”. The magazine highlighted that China's GDP, as a share of the US GDP, declined by 10 percentage points in 2022 and 2023. However, this decline can be attributed to two main factors. Firstly, the US GDP grew very rapidly, influenced significantly by high inflation rates, and such comparisons usually start by examining nominal GDP figures. In contrast, China's nominal GDP grew more slowly than its real GDP due to a bit of deflation. Secondly, starting in March, the Federal Reserve in the United States began raising interest rates substantially, leading to capital outflows from China as the dollar became a more attractive asset and many global currencies weakened. I don't believe these two factors will continue; inflation in the US is decreasing, and I don’t foresee the Renminbi depreciating by 10% every two years. Therefore, I anticipate that China’s economic convergence in terms of absolute output with the United States will resume this year and is likely to continue in the short and medium term.

Wall Street Frontline: You just talked about the Federal Reserve's monetary policy, and I'd like to know how you foresee the future movements in interest rates impacting the economies of China and the US. At the beginning of 2024, the market consensus was that the Federal Reserve would cut interest rates probably five to six times this year. However, this expectation has been pushed back.

NicholasLardy:Yes, I think expectations on US interest rates have been in flux over the last few months. There has been a very large gap between the interest rates in China and the US, which I think is likely to diminish starting in the latter part of this year and continuing into 2025. This anticipated change will provide China with a bit more flexibility in its monetary policy. They have cut interest rates slightly, but not very much, primarily because they are concerned about further capital outflows weakening their currency, which contradicts their policy objectives. Therefore, I believe we are going to see some reduction in the large gap in interest rates between the two countries, and this adjustment will afford Chinese authorities more leeway in managing their monetary policy.

Wall Street Frontline: You also highlighted a significant shift in the landscape of private investment in China. So, what long-term impacts might this shift from private to state-led investments have on China's global economic competitiveness?

Nicholas Lardy:Well, if you look at the long term since the reforms began, the share of private investment in China grew extremely rapidly. It was minuscule back in 1978 or the early 1980s, but by around 2012 to 2013, private firms accounted for more than half—actually something like 58 percent—of all investment. Private investment generally tends to generate higher returns, and if you look at the estimates about total factor productivity, they were generally pretty positive up to around 2010 to 2013. However, after that time, private investment slowed down relative to state investment, and consequently, productivity growth slowed as well. So, I think one of the lessons is that if you want high productivity growth, you need to ensure that private firms are the dominant source of investment growth.

Wall Street Frontline: So, what are the biggest challenges and opportunities you see for China in maintaining its role as a major contributor to global economic growth?

NicholasLardy:Well, obviously, there are a number of well-documented headwinds that many people have focused on and written about. Certainly, in the short run, the adjustment in the property sector is one of these headwinds. I agree that it's a negative, but I think it's a very welcome negative because China had been over-investing in property for many years. The economy needs to transition to a situation in which property will still be important, but it won't be as crucial as it was four, five, or six years ago. Other sources of growth need to emerge, and as I suggested earlier, one of the possibilities is a larger role for private consumption.

Wall Street Frontline: Considering these challenges, where do you think the greatest opportunities lie?

NicholasLardy:Well, I think there's still enormous opportunities in the service sector. China's service sector has expanded its share of total output, but I believe it has a long way to go. Obviously, as per capita incomes rise, we would expect a shift in consumption by households away from goods and towards services, and to some extent, we've already been seeing that. Areas such as vacations, travel, and entertainment are the fast-growing sectors and are likely to continue to be so. Another significant area is medical care. As people have higher incomes, they tend to spend more on maintaining and improving their health, which is especially pertinent in China due to the aging population. As people age, the need for medical care increases. So, I think there are plenty of areas where demand is growing and will continue to grow.

出品：南方财经全媒体集团

策划：于晓娜

统筹：向秀芳

记者：周蕊

制作：段伊航（实习生）

设计：林军明 廖苑妮