Xi wants to create a nation of consumers to prevail in a Sino-US trade war

Our briefing for Friday, 17 January, 2025.

Jan 16, 2025

Our briefing on critical economic and financial developments in China as of Friday, 17 January, 2025:

China wants to create a nation of consumers correct deep-seated economic imbalances, as well as deal with economic tensions between Beijing and Washington.
The Chinese central bank flags greater support for private enterprise and the tech sector via the use of structured monetary policy tools in 2025.

The avowed mission of Beijing in 2025 is to step up levels of domestic consumption, in order to correct deep-seated economic imbalances and maintain the momentum of growth even if trade relations with the US worsen.

The need to supercharge Chinese consumption has already become general consensus amongst top policymakers in Beijing.

The Central Economic Work Conference held in December called for “vigorously spurring consumption,” to deal with weak domestic demand and over reliance on exports.

Teng Tai (滕泰), head of the Wanbo New Economics Institute who holds positions at Renmin University and Fudan University, is a leading economist advocating for China’s transformation into a consumer society.

“Consumption is the starting pointing and the end point of the economic circulation process,” Teng wrote in a recent opinion piece (“滕泰：家庭消费占比偏低，中国如何向消费型社会转型.”)

“It’s the end purpose of human investment and productive activity.

“For both investment or production, the final goal is to raise the scale and level of consumption, and improve quality of life for the people.”

21st century China characterized by economic imbalances

The Chinese economy has been characterized by a severe imbalances throughout the 21st century, consisting of over-dependence on investment and exports to drive growth, in tandem with weak domestic consumption.

This imbalance was lamented in a landmark speech made by then Premier Wen Jiabao way back in 2007, and remains as much of an issue today as it did nearly two decades ago.

China saw only lacklustre consumption growth last year, while also posting a record-breaking annual trade surplus of nearly USD$1 trillion.

The outsize contribution that exports make to the Chinese economy remains a major vulnerability, on the eve of a new Trump presidency in 2025 that could heighten trade tensions with the US and EU.

While China is gradually clambering towards high-income status, end consumption’s share of GDP remains low relatve to advanced economies.

According to Teng, in 2022 it was 37% of Chinese GDP, as compared to figures of 68% for the US and 56% for Japan.

In 2023, China’s household end consumption was 39.2% of GDP, well below the global average of 56.5%.

End consumption of both government and households was 53%, compared to 82% in the US, more than 70% in the EU and Japan, 67% in South Korea and 72% in India.

Covid pandemic further undermines Chinese consumption

The Covid pandemic put heavy pressure on the trajectory of Chinese consumption growth.

Teng says the average consumption propensity ratio of Chinese households had already slipped to around 70% before the pandemic, and to 66% for urban households.

It’s continually fallen ever since, to around 63% for China’s urban households.

While low levels of consumption are currently a challenge for China’s economy, they are also a potential advantage, given they point to a huge source of yet untapped growth.

“The sustained growth of consumer demand will not only raise short-term economic growth, but can also raise potential economic growth via further division of labour and innovation,” Teng wrote.

Increasing consumption promises to make China’s economy more resilient in the face external uncertainties, by reducing its dependence upon exports.

This could prove critical in 2025, if President Trump opts to direct more protectionist trade measures at China, or other advanced and emerging economies decide to follow suit.

Out-dated industrial policy blamed for low consumption

This all begs the question of what’s stifling growth in Chinese consumption, and how Beijing plans to fix the issue.

According to Teng, the key problem is that China retains outmoded policies designed for the rapid industrialisation phase that it’s already completed.

These policies channel a greater volume of resources to investment and capital formation, at the expense of household consumption.

For this reason, to achieve the transition to a consumer society, China needs to overhaul its “macroeconomic policies, concepts and incentive mechanisms,” and drive its own transition from the investment-driven economy of the past to the consumption-driven economy of a more affluent future.

Teng says this will firstly involve removing all the old industrial policies that provide investment, manufacturing and export subsidies to Chinese businesses.

He estimates that this can save tens of trillions of yuan in funds for the Chinese government.

These tens of trillions of yuan in government funds can then be used to drive Chinese consumption via consumer subsidies and improvements to social welfare.

Improvements to social welfare are especially critical, as they will reduce the need for Chinese households to save for health contingencies or their retirement years.

The Chinese propensity to save directly undermines consumer spending, while also driving up levels of investment and exports given the nature of the GDP identity.

Monetary policy plays a role in correcting imbalances

Teng also believes monetary policy needs to play a role in driving China’s transition towards a consumer society.

This will “provide even more ample liquidity to the development of the capital market and “enable capital markets to create wealth effects that spur flourishing consumption.”

The wealth effect means Chinese households will be more likely to consume if the rising value of their stock and real estate holdings make them feel more affluent.

“Raising the household share of consumption and accelerating the transformation into a consumer society…is the fundamental goal for the development of a socialist market economy,” Teng wrote.

“Developed nations have already successfully completed the transformation into consumer societies, and consumption expansion provides a sustained demand driver for economic growth.

“China’s household consumption has long been low, and for a long time we haven’t employed the foundations for consumption to drive economic growth.”

China’s central bank wants targeted monetary policy to support private enterprise and tech innovation

Senior officials from China’s central bank made key statements on the future direction of monetary policy on 14 January, at a press conference held by the State Council.

They reaffirmed their commitment to “moderately loose monetary policy” - a phrase last used back in 2010, when China was still grappling with the aftermath of the GFC.

The Chinese central bank plans to reduce the cost of financing across the board in 2025, by employing a diverse array of monetary policy tools.

These include both traditional quantitative methods, as well as structured instruments that target specific parts of the economy.

“[China’s] macro-economic policies will further strengthen counter-cyclical adjustments, to support achieving full-year economic and social development targets,” said Xuan Chang (宣昌), central bank deputy-governor.

Central bank kicked off loosening in 2024

China’s monetary policy achieved major cuts to loan rates in 2024, to prop up growth and revive the housing market.

In December, rates for new enterprise loans stood at 3.43%, for a YoY decline of 0.36 percentage points. Rates for new personal home loans were 3.11%, for a YoY fall of 0.88 percentage points.

In terms of quantitative measures, the Chinese central bank cut its short-term policy rate twice in 2024,for a cumulative reduction of 0.3 percentage points.

It also reduced the required reserve ratio - the amount of money commercial banks need to stow with the Chinese central bank, by one percentage point. This paves the way for far more lending by China's commercial banks.

At the start of January, the Chinese central bank said that when the time is appropriate it will pursue further reductions to both its official policy rate and the required reserve.

These measures will serve to further loosen up credit conditions, helping to support structured monetary policy as well as ambitious program of fiscal stimulus flagged by Beijing in December.

China’s central bank uses structured tools to direct credit

When it comes to structured monetary policy, the focus is on driving growth in lending to the manufacturing sector, tech companies and small private businesses.

As of December, medium and long-term manufacturing sector loans had risen 11.9% YoY, while micro-and-small enterprise loans were up 14.6%, both well ahead of growth in all lending for the same period.

The Chinese central bank also launched a 500 billion yuan tech innovation and upgrade reloan scheme in 2024, to channel credit to innovative small-scale tech companies.

This was accompanied by a 300 billion social housing reloan program - to fund home purchasing by state-owned enterprises, alongside two new instruments to support the capital market by encouraging lending for stock market investment.