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Consumption versus investment

By Lee Il-Houng | China Daily | Updated: 2013-04-02 13:58

This is also the model China has successfully followed. However, the Chinese economy has become too large to fit the model, and external demand will remain sluggish in the wake of global financial crisis. Besides, investment is becoming increasingly inefficient at a time when financing constraints are tightening. Already, China's investment level, close to 50 percent of GDP, is about 10 percent higher than that of other Asian economies before the Asian financial crisis.

A sudden reduction in investment, however, is not the answer because it will pull down consumption as well. This would be the case especially in inland regions, where investment has become increasingly excessive. In these regions, private consumption is dependent on investment (rather than vice-versa) and the impact is relatively short lived, necessitating ever-higher levels of investment to maintain economic activity.

In contrast, consumption has become more self-sustaining in coastal provinces, in large part because investment there tends to increase income of households more than in inland provinces. If the existing trend continues, valuable resources are likely to be wasted at a time when China's ability to finance investment is facing constraints because of dwindling land, labor and government resources, and the economy is becoming increasingly reliant on liquidity expansion. This is undesirable because liquidity expansion could lead to financial instability and asset bubbles.

Thus, investment needs to be reduced gradually and redirected toward sectors with greater and more lasting beneficial spillovers to household income and domestic consumption. In this context, investment in agriculture and services should be preferred to that in manufacturing and real estate, with due attention being paid to the comparative advantages of different provinces. Also, closed sectors should be opened for competition, including from abroad.

While inland regions continue to have large investment needs, there are important issues related to absorptive capacity and the traditional model that worked well in the past in coastal provinces, large investments in manufacturing and export-oriented sectors, may not be optimal. Through such a reorientation, China can increase capital efficiency in a way that economic growth does not fall precipitously as aggregate investment is lowered to a more sustainable level.

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