Financial repression sires dangerous imbalance
This “implied tax” imposed on households by low state-regulated interest rates amounts to the financial repression of consumers by the government
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Tom Holland
12 September 2008
A concerned reader writes in from Shanghai to ask if I inadvertently got my lines crossed in one of the charts accompanying Wednesday’s Monitor.
The graph in question, shown again below, illustrated the relative importance of fixed asset investment, household consumption and exports to the mainland’s economy.
Had I perhaps, the reader wonders, got my labels for the lines showing investment and consumption the wrong way round? “Being on the ground, I really have a hard time believing that consumption has shrunk by almost 20 percentage points over the past 27 years,” he writes.
His incredulity is understandable. But I am happy to confirm that, unbelievable as it seems, the lines were indeed the right way around. Alone among major economies, China relies more on investment than consumption to power its growth.
Last year, investment in roads, buildings, machinery and the like made up a hefty 40 per cent of output, whereas household consumption contributed just 36 per cent (in Hong Kong the proportions are a more usual 20 per cent and 60 per cent). More to the point, the relative importance of ordinary mainland consumers has declined steeply over recent years, dropping from about 52 per cent in the early 1980s.
Of course, in absolute terms consumer spending has grown, which accounts for the proliferation across China of fancy shopping malls. But despite mainland consumers’ fondness for Louis Vuitton, household spending hasn’t grown nearly as quickly as total output, which means that the share of consumption in the overall economy has fallen - not grown - in recent years.
This decline is a big problem. It means China is overly reliant on exports and export-led investment to generate growth, which leaves the economy dangerously vulnerable to a slowdown in its major export markets. The bigwigs in Beijing are well aware of the threat. Last year, Premier Wen Jiabao called the mainland’s growth path “unbalanced, unco-ordinated and unsustainable” and promised to re-orient the economy more towards domestic consumption.
However, according to one view, this dangerous imbalance in the economy is the fault of the government itself: the result of Beijing’s “financial repression” of consumers.
In a new paper, Nicholas Lardy at the Peterson Institute in Washington points out that because of Beijing’s manipulation of interest rates, the inflation-adjusted or “real” return on time deposits in China has fallen from plus 3 per cent at the beginning of 2002 to as low as minus 4 per cent this year.
He estimates that this drop effectively picked 255 billion yuan (HK$291 billion) out of consumers’ pockets in the first quarter of this year alone, more than three times what households paid in personal income tax and a sum equivalent to 4 per cent of the gross domestic product.
At first, it might look as if mainland companies are the big beneficiary of this policy because real lending rates have also fallen steeply, from 10 per cent to nearly minus 3 per cent. But companies are also large depositors, which means they are also disadvantaged by low interest rates.
Nor do the country’s banks gain that much. Although they benefit from artificially wide spreads between deposit and lending rates, they lose out because the government forces them both to buy low-yielding central bank bills and to keep 17.5 per cent of their funds on deposit at the central bank, earning a minimal interest rate.
In fact, estimates Dr Lardy, the big gains go straight to the government, which ended up pocketing slightly more than half the 255 billion yuan filched from consumers in the first quarter.
This “implied tax” imposed on households by low state-regulated interest rates amounts to the financial repression of consumers by the government, he argues. The resulting loss of interest income is a main reason why consumption has been falling as a share of GDP and explains why it looked at first as if the lines on our chart may have been mixed up.