Prof Zhang Jun

The View | China should save less, stop protecting industries and liberalise instead, to unleash domestic consumption

Zhang Jun says opening up markets – from telecoms to education and insurance – would be a massive boost to an economy struggling with declining productivity and a trade war

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Tourists take a ferry across the Huangpu River in front of the Lujiazui Financial District in Shanghai. Finance is one sector of the Chinese economy that experts say needs to be opened up. Photo: Bloomberg

Prof Zhang Jun

Published: 10:30am, 30 Jan 2019Updated: 12:58pm, 5 Jun 2019

In his influential 1954 article “Economic Development with Unlimited Supplies of Labour”, the future Nobel laureate economist Arthur Lewis concluded that “the central problem in the theory of economic development is to understand the process by which a community which was previously saving and investing 4 or 5 per cent of its national income or less, converts itself into an economy where voluntary saving is running at about 12 or 15 per cent of its national income or more”. That process, Lewis argued, “is the central problem because the central fact of economic development is rapid capital accumulation (including knowledge and skills with capital)”.

Lewis’ insight is highly relevant to China’s rapid investment-led growth in recent decades. But China’s growth has been based on much higher levels of national savings than Lewis could ever have imagined. And now this development has become unbalanced and appears increasingly risky. In a reversal of the process that Lewis described, China must now find a way to reduce its excessive savings by moving to an economic development model based more on the sheer size of its domestic consumption.

This would represent a major shift. For 30 to 40 years, China has relied on export-led industrialisation to sustain rapid economic progress. Like Japan and other fast-growing East Asian economies before it, China successfully channelled its high savings into investment in export-oriented manufacturing. And as surplus labour continued to move within China from agriculture to export sectors, the savings rate continued to increase.

Like Japan and other small, fast-growing East Asian economies, while manufacturing exports boomed, domestic service and non-tradeable sectors (including telecoms and finance) were highly protected and suppressed in China. The level of this protection was usually unnecessarily high. Such a structurally unbalanced strategy kept the shares of labour income and domestic consumption in GDP relatively low. This led to an ever-increasing Chinese trade surplus, especially with the United States, and a rising risk of trade frictions or even trade wars.

About 15 years ago, China, under enormous pressure from the US and other leading Western countries to reduce its trade surplus, was forced to expand substantially its spending on investment in domestic infrastructure and housing and let the renminbi appreciate, thereby making its exports more expensive. As a result, China’s trade surplus has fallen from a peak of around 8.6 per cent of GDP a decade ago to near-balance today.

But China has paid a heavy price for this rebalancing adjustment. Although a surge in infrastructure investment can help to reduce excessive savings, too much of it can lead to macroeconomic volatility and fragile “razor-edge” growth. And this is what has happened. Before the 2008 global financial crisis, China’s economy had already been drifting on an unhealthy growth trajectory. Since then, it has gone further in the wrong direction, with accelerating credit expansion pushing investment in the construction of infrastructure and real estate to record highs.