The Chinese Crash and the Chinese Dream
July 13, 2015
What a white-knuckle ride it continues to be for Chinese equities. Despite myriad interventions by Chinese leaders (many questionable, such as crafting People’s Daily editorials that intone, “Rainbows always appear after rains”), stock prices have plummeted. At the time of writing this missive, the Shanghai Composite Index had fallen from its June 12 peak by nearly 33 percent—and the smaller Shenzhen composite Index by about 40 percent. At one point on the Shanghai index, $3.5 trillion in market capitalization has been destroyed.
Yes, $3.5 trillion is a lot of money to you and to us. But Chinese stock prices have fallen back to where they were … just four months ago, in March. Over the past 12 months these prices have risen, even with the recent tumble, by more than half. What’s more, these vertiginous ups and downs are not new to Chinese equities. The Shanghai index rose from about 1100 in fall 2005 to nearly 6000 in fall 2007—only to tumble back to 1700 by fall 2008.
So does this latest crash foretell economic woe in China and the global economy? We don’t think so. But the crash does matter, not because of impending woe (as recent chatter suggests), but because the country is going to find it more difficult to realize the Chinese Dream.
One of the most important policy challenges facing China is to reorient its economic growth away from exports, and related capital investment, toward consumption. For any country in any year, its output of gross domestic product is accounted for by four basic sources of aggregate demand: (1) consumption spending by households, (2) capital investment by companies, (3) government purchases, and (4) exports to foreigners. To jog the memory of those of you who once took an economics course, such as those of you who took Global Economics for Managers in earning your Tuck MBA, the previous sentence is represented by the accounting identity Y=C+I+G+EX−IM (where imports are subtracted off from aggregate demand to avoid double-counting purchases by domestic actors of imported products).
The fact that China’s economic miracle arose largely from building factories to export goods to the world is strikingly borne out by the data. Last year, exports accounted for 23.9 percent of Chinese GDP—and capital investment a remarkable 47.1 percent. The comparable U.S. data? Exports were just 13.4 percent of U.S. GDP, and investment (excluding intellectual-property investment, to be comparable with the Chinese data) was only a foreboding 12.4 percent.
Massive capital investment in, and exports from, China have caused great stresses both within and beyond China: environmental degradation and fears of ghost cities in China, and policy clashes with multiple countries over charges of unfair dumping and currency manipulation. Thus did President Xi voice aspirations early in his tenure for spreading a Chinese Dream centered on a burgeoning middle class consuming its way to greater happiness and prosperity.
The room to expand Chinese consumption is massive. Consumption spending by Chinese households last year was just 36.8 percent of GDP—barely half the 68.5 percent of U.S. GDP accounted for by free-spending American consumers. Chinese households consume so little because they save so much. Personal saving as a share of disposable personal income by American households was just 4.9 percent last year. The comparable Chinese saving rate? In recent years it has been about 33 percent—one of the highest of any country in the world. If China’s total GDP last year of about $11 trillion had mirrored the demand mix of the United States, then its households would have spent about $3.5 trillion more than they actually did.
How to encourage Chinese families to save less and consume more is thus a central challenge facing China. Chinese families save so much in part because they face such high uncertainty about the future. Remarkable though China’s economic liberalization has been since 1978, it has radically altered its social safety net. Where the Communist Party once provided education, health care, and pensions, now these basic needs are provided by a fluid, ever-shifting mix of the market and the government. In the jargon of economics, amidst all this flux the “precautionary savings motive” is very high in China.
Allaying this urge to save will also require a lot of time: shifting trillions of dollars of aggregate demand is not like flipping a light switch. It will also require a range of prudent public policies. One such policy will need to be capital-market liberalization that provides Chinese families with a wider range of more-transparent, more-reliable savings options. Thus the potential long-term damage of China’s latest stock-market crash—both the zigs and zags in valuations and the clumsy government responses. The more chaotic China’s underdeveloped equity markets remain, the more Chinese households will continue to save—and the more remote the Chinese Dream will remain.
Articles © 2015 Matthew Slaughter and Matthew Rees. All rights reserved.
Publication © 2015 Trustees of Dartmouth College. All rights reserved.