The Chinese Communist Party’s new pledge to fix the “demand side” of the economy has prompted expectations the leadership will implement more egalitarian policies to stimulate consumer spending.
The Party’s top leaders used the phrase “demand-side reform” for the first time this month, in a departure from its past focus on “supply-side” changes which involve upgrading industry and cutting capacity in bloated sectors.
Although China is the only major economy set to grow this year due to its effective control of the pandemic, the new slogan signals that the ruling party is worried about the uneven recovery in which household spending has lagged behind investment in real estate and infrastructure. Beijing has not detailed what the phrase means, but officials have dropped hints and economists have been quick to offer suggestions.
The term “demand side” is used to refer to investment, consumer spending and any trade surplus. Beijing turned to investment to replace exports as a driver of economic growth during the 2008 financial crisis when overseas orders slowed, and has since struggled to “rebalance” demand toward consumer spending.
Economists blame that imbalance on several factors, including pay inequality that means income accrues to richer households who are less likely to spend, and the relatively high share of gross domestic product paid as profits to capital owners rather than as wages to workers.
Top officials including President Xi Jinping and Vice Premier Liu He and have drawn attention to those issues this year. In a speech published in August, Xi spoke about the low share of wages in GDP and “outstanding problems in income distribution” and cited French economist Thomas Piketty’s “Capital in the 21st Century,” as showing the harmful effects of inequality. Liu has called for improving mechanisms to increase wages.
What Bloomberg Economics Says…
“In the short term, the aim will likely be to boost domestic demand with public consumption and investment. Longer-term policies will be aimed at spurring a structural shift in household consumption toward higher value-added products and services.”
— David Qu, economist
After an annual economic planning meeting this month, the party promised to “optimize the income structure and expand the middle-income group.” Shanghai’s city government included a “fair” income distribution in its next five-year plan, including “regulating excessively high-incomes.”
This will require more government intervention through taxes, some government-affiliated economists say. “When a country has a higher level of income, the government will intensify income redistribution efforts with taxation and transfer payments,” according to a speech in August by Cai Fang, vice president at the Chinese Academy of Social Sciences, an influential government think-tank.
Specific measures could include raising income taxes on the wealthiest, providing income-tax credits to lower earners, imposing taxes on wealth such as property, and levying capital gains charges on financial transactions, most of which are exempt from tax.
“I think the income tax is already pretty progressive. The key is the capital gains tax,” said Gan Li, director of the Survey and Research Center for China Household Finance at China’s Southwestern University of Finance and Economics.
Beijing has vowed to reduce the large gaps in quality and coverage of public services such as healthcare and education between different regions. Shifting government spending to such services could encourage households to save less of their incomes and spend more on goods and services.
“China’s social security expenditure is about 10% of GDP, which is much lower than 19% in Europe. In the future, it will be the trend to invest more in the social security system, and the structure of fiscal expenditure will be adjusted,” analysts at securities brokerage Guotai Junnan wrote in a report on demand-side reform.
The reform of the resident registration system may also increase access to social welfare. In April, the government said that all cities with populations smaller than 3 million should abolish rules which limited access to government services only to people officially registered to live in the city. Similar changes could cut out-of-pocket social service costs for millions.
With Beijing this year saying it would rely on a “dual circulation” strategy in which economic growth will become increasingly dependent on domestic demand, rather than exports, economists expect the government to maintain high-levels of investment spending, while shifting away from transport infrastructure and housing toward technology and environmental projects.
However, any shift in emphasis is likely to be gradual.
Beijing has struggled to move forward with a property tax it has planned for more than a decade due to resistance from the wealthy and fears about declining asset prices. And the recent Communist Party meeting stated that supply-side reforms would continue to be the “main line” of policy.
“China’s policy makers have been talking about increasing consumption and demand-led growth for decades,” said Terry Sicular, a China-focused economist at Western University in Canada. “But all the talk about it hasn’t made it happen.”