Both Western and Chinese commentators have documented the real increase in Chinese living standards and consumption levels. Since market opening in 1978, GDP growth averaged 10.2%. Per capita income has risen from $400 in 1978 to $5,414 in 2011, the most recent year for which data is available. Per capita income is to exceed $8000 by 2020. Chinese citizens now have access to a wider range and a higher quality of consumer goods and services than ever before, and many now enjoy a better quality of life than they did during the Maoist era. Yet these benefits are far from equally distributed. The increasing marketization of the Chinese economy has had the consequence that Chinese citizens can no longer be as reliant on the Communist Party for education, healthcare and pensions. For the 400 million or so Chinese citizens who still earn $2 or less per day, this has meant that, in many ways, their life is less secure today than it was during the Mao era.
Since 1978, shifting levels of fixed investment (buildings, plant, machinery and infrastructure such as roads, railways systems, ports, etc), net export (export minus imports), government expenditure (social services, infrastructure) and domestic consumption (purchases by households) have driven China’s economy. Since 2001, China’s fixed investment has increased significantly. In 2011, China’s fixed investment rose to 48% GDP, while household consumption hovered at 35%, and savings remained close to 50% GDP. These figures are out of line with international norms. Generally, a country’s consumption comprises two thirds or more of GDP, and investment one third or less.
China is now increasingly recognizing the need to rebalance the economy. China’s 12th Five Year Plan has made boosting domestic consumption a priority. Indefinite high fixed investment rates puts an economy at risk in many ways. Each additional capital expenditure has an increasing chance of being wasteful because of the law of diminishing returns. Unneeded excess industrial capacity can undermine corporate profitability. High fixed investment can also be inflationary and risks creating asset bubbles. It also causes trade frictions as it depresses domestic import consumption and encourages exports.
China’s 12th Five Year Plan lays out a variety of economic tools to generate higher consumer spending, including improving the social welfare system, boosting wages, and increasing consumer goods imports. Increased outlay on social welfare is especially important as without more spending on education, healthcare, pensions and affordable housing, Chinese consumers will continue to save to provide for their future.
Interesting research by Andong Zhu and David Kotz has shown that since the 1978 launch of market reform, shifting levels of domestic consumption, fixed investment and export growth have driven China’s economy. Zhu and Kotz break these shifts into four time periods: 1978-1988, 1988-1991, 1991-2001 and 2001-2007. Between 1978-1988, domestic and government consumption were the strongest drivers of China’s economy, with household consumption accounting for roughly 50% of China’s GDP. Income inequality climbed. China’s Gini coefficient – a number between 0 and 1 where 0 corresponds with perfect equality and 1 corresponds with perfect inequality – worsened from approximately 0.29 in 1978 to 0.38 in 1988 (though it actually improved slightly immediately after the reforms of 1978 were introduced) .
Between 1988-1991, in an effort to control 18% inflation and the social discontent that was beginning to accompany it, Beijing temporarily cut government fixed investment spending. Household income grew more slowly as well, resulting in lower private consumption. Instead, average 7.1% GDP growth during this period was driven by government consumption and by an export surge. Exports increased 50% between 1988-1991, spurred in large part by the 1990 devaluation of the RMB.
In 1992, Deng Xiaoping’s now famous southern tour cemented as the way forward the country’s experimentation with market reform. As a result, between 1991-2001 GDP growth averaged 10.3% and household income grew almost at pace, although rural income lagged, while urban income surged rapidly ahead. Overall, between 1991-2001, total private and public consumption accounted for 61.4% GDP and generated almost 85% GDP growth. An initial 1992-1993 surge in fixed investment of 30% caused the GDP growth rate to spike to 14.2%, but also rekindled inflation. As a result, Beijing reduce government fixed investment spending to 8.2% in 1994 and 6.3% in 1995. Yet, by 2001, fixed investment was back up to 34.7% GDP. Net exports played a relatively small role in economic growth between 1991-2001. While total exports reached 20.7% of GDP by 2001, imports also rose rapidly.
The 2001-2009 period saw China transition into the high fixed investment and export model that characterizes its economy today. After China’s 2001 entry into the WTO, exports grew at an average annual rate of 20.9% a year while imports increased at an average annual rate of 17.8%; by 2007, net exports accounted for 10.9% GDP. Between 2004 and 2009, China’s fixed investment accounted for approximately 41.2% GDP, while net exports were 8.6% GDP, government expenditure 14.7% GDP and private expenditure 35.5% GDP. The 2009 savings rate rose to 49.7% GDP. In 2011, China’s fixed investment increased further to 48% GDP, while household consumption hovered at 35%, and savings remained close to 50% GDP. These figures are out of line with international norms. Generally, a country’s consumption comprises two thirds or more of GDP, and investment one third or less.
An important factor that led to the high fixed investment was the privatization of many state-owned enterprises (SOE) starting in 1996. This resulted in SOEs shedding of approximately 50 million jobs, and handing back to the government their “iron bowl” responsibility of providing social services such as housing, healthcare, education and pensions for their workers. As a result, SOE profitability rose rapidly. SOEs put their profits into fixed investment. Rapid economic growth was a key political and therefore managerial objective. Low borrowing costs and minimal dividend payments supported the high fixed investment rate. In 2010, SOEs still distributed just 5-15% of profits. The government also directed their spending toward huge infrastructure projects, and less so to provision of social services.
The large unemployment caused by SOE privatization corresponded with a simultaneous expansion of the Chinese workforce. During the 1980s, China’s working age population increased 2.5% annually; coupled with high rural-to-urban migration, this has meant that since 1980, China’s overall urban labor force grew 4% annually. Work force productivity rose by over 9% annually. Production that had needed 100 people in 1990 required less than 20 people in 2009. The millions of newly unemployed, the labor force growth and rural-to-urban migration all have worked to push wages down. At the same time, the cost to households of housing, healthcare, education and pensions increased. Rising costs coupled with lower wages and greater economic uncertainty caused the Chinese savings rate to rise rapidly as Chinese consumers began saving for retirement, housing and medical expenses. Additionally, total taxes on labor income rose by 2.5% GDP, partly due to higher income tax payments, but mostly reflecting mandatory contributions to new pay-as-you-go pension system managed by the government sector that is being phased in across the country. Household interest payments also rose to about 1% GDP, as increased home ownership has led to an associated rise in mortgage related debt. High savings rates also reflected credit constraints and a greater incentive to save for business opportunities. Savings rate have also remained high as most of it large pool of depositors have no other place to rest their money.
Yet return on savings has remained low. Interest payments paid to these household savers have remained capped by the government, and have often been eroded because of inflation rates above the rate of interest. Households have thus not earned much interest income to supplement wages. Moreover, government capital controls and the lack of other investment and savings vehicles has meant that depositors have had few choices other than deposits in which to store their hard-earned money until enough accumulates so that they can purchase an investment asset such as a house or a car. By capping interests rates paid to depositors the government in effect has been quelling household consumption in favor of producers, many of which are state owned and benefit from the large savings rate by being able to access cheap loans. As a consequence, Chinese banks enjoy enormous reserves of cheap deposits. Moreover, by keeping is currency devalued, imports remain expensive and exports stay cheap, thereby discouraging the consumption of foreign goods, and encouraging the production of exports for foreign customers.
Government savings also increased during this period. Government revenue consistently exceeded government noninvestment expenditure. High government saving reflected a policy favoring government financed investment over government consumption. In large part, freedom from democratic pressures has enabled the Beijing to take a long-run view about the nature of its expenditure as it expects to remain in power for many years.
Private enterprise savings has also been high since 2000. This high savings rate can be explained in part by the imperfect credit market. Chinese bank lending and the Chinese equities market continues to favour SOEs, forcing private enterprises to rely on retained profit for future investment.
As a result of all these factors, GDP growth averaged 10.9% between 2001-2007 while the growth rate of household income was just 8.7% and rural income was only 3.4% per year. The ratio of consumption to household income also fell at a 2.2% per year. Income inequality also increased. By 2006, China’s Gini coefficient rose to 0.46 and in 2011, it had reached 0.48.
Despite China’s high fixed investment rates, overall capital expenditure has remained profitable. This is due to several factors including the fact that China started at such a low fixed investment base, particularly in terms of infrastructure; China experienced a rapid growth in its human capital over the same period; and China keeps shifting its production into new markets which opens up new investing opportunities. Moreover, China’s overall capital stock is still small relative to its population, and medium-sized relative to its economy. That said, it is hard to sustain such high fixed investment rates indefinitely without waste and bad investments. This risk increases as China’s capital stock accumulates. The modern “ghost” city of Kangbashi, Inner Mongolia has oft been cited as an example of excessive investment where local officials designed a city and infrastructure for 1.5 million residents, yet less than 150,000 people have come to fill it.
The constraints on consumption and the prioritization of fixed investment and exports has resulted in a significant imbalance in the structure of China’s GDP. Research by John Knight and Wei Wang show that these figures made China an outlier compared to other economies. Indeed, China’s investment ratio far exceeds that of other industrialized countries, and even that of Japan – 32% GDP 1960-1985- and Korea 30% 1970-1995 during their rapid growth periods.
In 2011, China’s fixed investment rose further to 48% GDP, while household consumption hovered at 35%, and savings remained close to 50% GDP. Part of the reason that fixed investment as a percentage of GDP rose after 2009 was because of the RMB 4 trillion or $586 billion 2008-2009 Chinese Economic Stimulus Plan that China launched in response to the breaking 2008 financial crisis. The government directed the majority of this stimulus into fixed investment. RMB 1.5-trillion was dedicated to infrastructure construction including railway, road, irrigation networks, and airports. RMB 1 trillion went to reconstruction works in regions hit by the 8-magnitude Sichuan earthquake. RMB 370 million went for rural development including building public amenities, resettling nomads, supporting agriculture works, and providing safe drinking water. RMB 370 million also went to technology advancement programs mainly targeted at upgrading industrial sector technology. The Chinese government allocated some RMB 210 billion to improving energy saving, cutting gas emission, and building environmental engineering projects. RMB 150 billion was allocated for educational, cultural and family planning purposes. Other funds were invested funding for social welfare plans, including the construction of low-cost housing, rehabilitation of slums, and other social safety net projects.
Rebalancing China’s domestic consumption is a key theme of China’s 12th Five Year Plan. Yet a key difficulty to boosting domestic consumption is the fact that Chinese citizens now face higher education, healthcare and pension costs due to the dismantling of educational and social security systems that existed under the planned economy. Premier Wen Jiabao recently recognized this challenging by noting that the government must increase spending on healthcare and social services to free up more Chinese disposable income.
China’s current educational system is undoubtedly in a better position now than it was during the Maoist era. This is specifically true during the Maoist era’s final years when the Cultural Revolution convulsed China. Launched between 1966-1976 the Cultural Revolution was to strengthen socialism in China by reducing capitalist, traditional and cultural elements from Chinese society, and to impose Maoist orthodoxy within the party. To achieve this end, in June 1966, middle schools and universities throughout the country were shut as students devoted all their time to Red Guard activities. The government sent many educated youth to the countryside in order to engage in manual labor. When schools and universities reopened in the early 1970s, students often won places at university not by being the most academically able, but by having good political credentials, and by being recommended by their work unit. As a result, by the late 1970s, the quality of Chinese university education declined sharply. In 1975, Deng Xiaoping reportedly complained to Mao Zedong that university graduates were not even able to read a book in their area of study by the time their university education was completed.
After the government launched market reform in 1978, renewed emphasis was placed on scientific training, and the overall quality of Chinese education began to improve. Since that time, China has undergone a major expansion in the quality and availability of education throughout the country. The number of university and doctoral degree graduates has risen fivefold between 1995 and 2005. Chinese government spending on education has risen approximately 20% per year since 1999, now reaching $100 billion annually. The results from this investment have been outstanding. The best Chinese students now lead the world in math, science and reading. There were 33 million Chinese in higher education in 2010, up from 12 million in 2000. 82.5% of all Chinese children now complete secondary education, up from 21.9% in 1990, and more children than ever are having the opportunity to gain a formal education. On average, Chinese students spend 40 when more days a year being educated than their US counterparts, although western educational analysts criticize the rote learning system employed in Chinese schools.
Much as with all social services, the quality of Chinese education varies greatly throughout China. There is still a large discrepancy between urban and rural education and between education standards in the eastern and western provinces, in terms of quality and quantity of education, including progression to higher education. It is indeed the cities, as opposed to rural areas, that receive the highest percentage of government spending, as well as having the highest quality of education at all levels. The exact numbers are hard to come by, as spending is split at various levels down the bureaucratic chain, but it has been suggested that spending per primary school child in Beijing and Shanghai was 18 times that of the poorest Chinese provinces.
Yet, those Chinese citizens migrating to China’s prosperous cities in search of better opportunity are often not allowed to take advantage of superior urban teaching for their children. The Mao-era Hukuo residential permit system means that local governments refuse school access without official documentation. This is a subject of huge contention for the almost 250 million migrant workers (a figure that is projected to grow to 400 million by 2025) who must leave their children behind in their towns and villages. For those that do choose to bring their children with them, many are forced to send their children to sub-standard private schools, which have no state funding. Fees can run as high as $165 year, the equivalent to several weeks’ wages. In 2011, local authorities closed several schools for the children of migrant workers, as they did not meet official safety standards, leaving an estimated 14,000 children without access to schooling. Notwithstanding the social injustice that this may present, needing to save for education costs reduces domestic consumption. Many Chinese senior-level middle schoolers must also pay tuition, as after completing the compulsory nine years of education, students who wish to continue on to senior-level middle school, must pay a small tuition fee. University students are also required to pay a part of their education. There is growing pressure within China for reform to this hukou system, though no significant changes have been enacted.
The Chinese government is taking increasing initiatives to reduce the gap in educational standards throughout the country. In 2011, the Chinese government announced a 20% increase in rural education spending. Yet, improving rural education and education availability generally will take time. Until then, being born in an urban environment gives the average Chinese child a far better chance at a decent education. Until then, migrant workers bringing their children with them to the city, and parents of those students wishing to pursue higher education will need to save in order to finance future education costs.
Like education, China’s healthcare, today faces many challenges. After 1949, CCP created the Ministry of Public health to take charge of all healthcare activities in China. The new system provided healthcare in both rural and urban areas through a three-tiered system. The first level of healthcare comprised China’s “barefoot doctors” that practiced in the village medical centers. These doctors focused on hygiene, preventative health care, family planning in the treatment of common illnesses. The barefoot doctors were primarily farmers who received minimal medical and paramedical training to serve rural areas that urban-trained doctors could not reach. The next tier of healthcare was the township health centers that were primarily outpatient clinics, each with a capacity of serving up to 30,000 people. Assistant doctors were the primary healthcare providers at these clinics. These two rural collective healthcare tiers comprised the majority of China’s Communist healthcare. The third tier, county hospitals, treated only the sickest rural patients, and was staffed by senior doctors trained at medical schools.
In urban areas, neighborhood health centers delivered the first tier of healthcare. These were staffed by personnel with minimal training and focused predominantly on hygiene and preventative medicine. These urban caregivers sent sicker patients to district and municipal hospitals. Often, however, connected employees could get medical care directly from district or municipal hospitals, bypassing neighborhood medical clinics.
Overall, Mao’s Communist China provided a good basic medical care for its rapidly expanding population. Average life expectancy increased from 36 years in 1949 to 68 years in 1980. While this increase in life expectancy was also due to improved nutrition and other factors, the focus on hygiene, preventative medicine, and the nationwide eradication of epidemics such as cholera, plague, typhoid, and scarlet fever certainly contributed significantly to China’s improved longevity during this period.
The de-collectivization of agriculture in the 1980s, and the privatization of SOEs in the 1990s, caused fundamental changes in the way that healthcare was delivered throughout China. While in urban areas, most Chinese citizens with residential permits still have relatively inexpensive access to medical coverage for themselves and their families. Additionally, they have often also taken out some form of medical insurance. Nevertheless, an estimated 36% of the urban population finds healthcare costs prohibitively expensive. Workers that lose their jobs also lose their medical insurance coverage. Migrants relocating into China’s growing cities have no medical care coverage as they lack a residential permit. The government has recently tried to respond to this challenge by creating the Urban Employee Basic Medical Insurance System (UEBMI) to include the non-state owned sector and self-employed workers. In 2008, UEBMIs covered an estimated 200 million people.
Those citizens in China’s rural regions face even greater healthcare challenges. By 1984, for instance, only 40-45% of the rural population was covered by an organized cooperative medical system, down from 80-90% in 1979. The number of barefoot doctors decreased. Authorities monitored village water and sanitation supplies less frequently, while a still rapidly expanding population created greater waste treatment challenges. Moreover, the cost of even the most basic medical treatment increased, forcing citizens to save more to pay for medical care, and often to forgo medical treatment.
Partly spurred by the SARS epidemic scare, in 2003, the Government established the New Rural Co-operative Medical Care System (NRCMCS). NRCMCS costs about $7 per person annually, half of which the government provides. As of September 2007, 80% or approximately 685 million rural Chinese citizens had signed up for the new initiative. Like China’s old health delivery system, the care is tiered. The plan covers the cost of small hospitals or local clinics to 70-80% and county hospitals to 60%. Yet specialist hospitals in modern system cities are only reimbursed 30%.
Despite these efforts to provide greater coverage for all its citizens, China’s healthcare system still faces enormous challenges. As doctors are paid low wages, and as hospitals are responsible for covering a significant portion of their operating costs through revenue-generating services, over prescription of drugs and x-rays and other tests is rife. China’s new rural and urban health care initiatives still only cover a part of the drug and testing prescriptions, meaning most patients still face high out-of-pocket costs – some estimate as high as 60% of their total medical care. Additionally, most doctors still have minimal basic training. This is particularly true in rural areas. A 2001 study of 46 counties and 781 village doctors in 9 Western provinces found that 70% of the village doctors had no more than a high school education, and had received an average of only 20 months of medical training before beginning to practice. China’s healthcare system is also struggling to balance the delivery of Western versus traditional Chinese medicine. As China’s population begins to age rapidly in coming decades, even more strain will be placed on a medical system already struggling to cope with the citizens it is currently treating. Finally, like all countries today, China will need to find the right balance between spreading scarce medical resources as widely as possible versus providing each of its patients with the most advanced medical care available.
As it has with education and healthcare, the Chinese government has taken real steps towards combating the ticking time bomb of the Chinese pension system, which is poised to come under enormous strain as China’s population rapidly ages over the coming decades. Currently, China has an estimated 160 million citizens over the age of 60. By 2050 that figure is likely to increase to almost 400 million, which will represent more than a quarter of the population. Part of the reason that the country is ageing so rapidly is that China’s “One Child Policy” has meant that fewer young people have been born since the 1980s. In 1975, there were six Chinese children for every one elder. By 2035, there will be two Chinese elders for every one child.
Before market reform in 1978, urban workers at China’s state owned enterprises received generous pensions upon retirement. Yet, these workers always constituted a minority of the total Chinese population. In the 1990s, the privatization of state owned enterprises has meant that these companies no longer fund their employees’ pensions. The government tried to launch a basic pension system for urban workers to replace the state owned enterprise funded system, yet as of 2007, just 65% of the urban workforce earned any benefit from the basic pension system. Coverage is highly concentrated among workers at SOEs that account for dwindling share of total employment. Much of the fast-growing private sector workforce, including China’s rural migrants, remains uncovered. Indeed, if urban employers made social welfare contributions on behalf of their migrant workers, their payrolls could rise by an estimated 35-40%.
Additionally, the basic pension systems inherited from SOEs have large unfunded pension liabilities. This means those workers contributing to the plan must do so at high rates, often causing workers to try to avoid payment. In addition, a lack of portability of the pension plan has meant that workers often need to choose between job mobility and losing their retirement savings. While private pension systems are beginning to take shape in China, in 2007, only 9.3 million employees contributed to “enterprise annuities”, or just 1.2% of the total Chinese workforce.
As for the countryside, in 2006, formal retirement protection was still virtually non-existent Indeed, all told, just 31% of China’s total workforce is estimated to be earning a public pension benefit of any kind. Part of China’s challenge is that its population is ageing at a much earlier stage of economic and social development compared to developed countries. This means that China will have to support its elderly with a fraction of the per capita income and wealth of developed nations. Despite high savings rates, the majority of Chinese workers are not accumulating sufficient financial assets to support themselves in retirement.
Traditionally, the young have cared for you old in China. In the coming decades, the great majority of workers will have to continue to rely on their children for financial support. Indeed, in 2006, an estimated 56% of elders lived with their grown children or other relatives. Even those who do not reside with their children often depend on their extended family for financial support. The importance of this safety net was reinforced when the government passed a 1996 law obligating children to care for their ageing parents. By 2050, the average pension burden supported by each Chinese worker is estimated to quadruple from today’s levels.
Yet, as more workers migrate to cities in search of opportunity, as China’s birth rates decline, and as China’s population begins to rapidly age, this traditional informal safety net is facing new strains. Indeed, while multigenerational families are still the norm, there are less common than they were a generation ago. Older workers will also need to remain in the workforce longer. While in the countryside, 76% of men aged 60-64 and 38% men aged 65 or older continue to work, in the cities, older labor force participation is much smaller. Only 34% of men aged 60-64 and 13% work past the age of 65. This low urban elder work participation rate is a result of the fact that SOEs downsized its obsolete workforce in part by offering them early retirement.
The government will continue to be under enormous pressure to introduce initiatives to provide minimal Social Security for the ageing population, so the majority of worker disposable income is not funnelled into carrying for ageing parents future worker disposable income is not spent solely on the care of grandparents.
China’s domestic consumption was expected to have grown 15% through 2012, a rate double that of China’s projected GDP. Indeed, in a recent speech in 2012, Premier Wen Jiabao confirmed the government support of this trend by noting that boosting domestic consumption will be crucial to China’s future as it rebalances its economy. China’s 12th Five Year Plan reinforced the importance of domestic consumption. Future growth in consumption will be driven not only by rising per capita income, but also by continued government domestic consumption subsidies. Recent subsidies have included programs for rural households to buy electric appliances and automobiles. The government will also support more paid vacation, expand consumer credit, and increase agricultural subsidies. Specifically, the VAT on cars and a number of other items has been reduced, and vouchers for certain durable good purchases by the rural sector have been provided.
The government is also taking steps to moderate the high household savings ratio and support consumer growth over time. The government’s 2011 spending on education increased 14.6%, on social security and unemployment 14.2%, on medical and healthcare 13% and on public housing spending 9.6%.
China’s central government is also developing policies to stimulate the growth of small and medium-size enterprises. These policies include providing guarantees on their borrowing, reducing small and medium-size enterprise taxes reductions and offering subsidies. Small and medium enterprises are typically a large share of total employment in other countries. Their expansion, especially in the retail and wholesale sectors currently dominated by SOEs, could significantly boost both employment and household income over time. The government is also considering the increase in dividend distributions from SOEs so that they might help finance higher government social spending and reduce the level of retained earnings in these enterprises that can be plowed back into investment. It also plans to raise the minimum wage.
The government is also considering raising interest rates on savings accounts. Market level interest rates could increase Chinese consumption. Chinese households are generally saving toward a goal such as a down payment on a house or the cost of potential medical emergency. Increasing disposable income by creating investment income in the form of bank interest could allow households to meet their savings objectives more quickly, and thus could encourage increased discretionary spending.