China needs middle-class growth and consumption to sustain economic success

Higher incomes for the bottom tiers in society and a stronger middle class are essential for a sustainable consumer economy
If China can deliver on these, the newly minted middle class will be a driver for greater consumption as well as continued, improved industrialisation

Shirley Ze Yu

Published: 1:30am, 9 Jan 2022

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Last year was the fin de siècle for the Communist Party. The party proclaimed it had achieved the first 100-year plan and eradicated absolute poverty. China delivered GDP per capita of close to US$10,500 with some 400 million people now middle class.

Beyond being the world’s largest trading nation, China is now the largest recipient of foreign direct investment. President Xi Jinping announced his ambitious drive to double the economy again between 2020 and 2035, and at the same time he has taken a hard line on the drivers of China’s modern economic rise, the digital economy and the real estate industry.

In parallel with the diplomatic showdowns with the West, China has exposed its own Achilles’ heel: it has clearly lost its labour premium. The country’s fertility rate is the lowest in the 43 years since the one-child policy began. One national newspaper even said that giving birth to three children was a moral obligation for Communist Party members.

China’s capital-intensive growth model has bred overreliance on the massive real estate industry. China’s addiction to capital expansion is akin to drinking poison to quench one’s thirst. Real estate means employment, banking profits and a fiscal lifeline for local governments.

When the music stops, the pain is born by individuals, governments and various commercial sectors, spreading from banking, construction and commodities to real estate itself. Few areas of the economy are left unscathed.

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In 2021, Beijing told its most successful companies – including Alibaba, Tencent, Pinduoduo and Meituan – to make donations to China’s drive for common prosperity.

Hundreds of millions of dollars were pledged against their corporate balance sheets or future profits. In essence, Wall Street will bear the lion’s share of this wealth redistribution to finance China’s state objectives.

Of the “three horses” of the Chinese economy – trade, investment and consumption – China’s new economic philosophy has resolutely pinned its prosperity to the latter two. Even so, trade contributed 19.5 per cent to China’s GDP growth in the first 10 months of 2021.

China has served as the world’s factory, meeting global demand in the face of supply shortages. Amid its stellar trade performance, though, China’s consumption recovery has been sluggish, with total consumption remaining nearly flat for the past two years.

How important is consumption to China’s economy?

China’s structural economic transition will be challenging, but the government’s intervention in the private market could be fatal.

In July, China launched an investigation into leading ride-hailing company Didi Chuxing, two days after its ill-fated IPO in New York. Didi’s departure from the New York Stock Exchange may well mark the beginning of the end of Chinese technology listings in the United States, largely due to Beijing’s data security concerns.

The US, meanwhile, has run out of patience with Chinese listed companies keeping their financial records secret. Chinese technology companies are thus being squeezed between the world’s two economic giants. US-listed Chinese tech behemoths have flocked to the Hong Kong stock exchange for security, only to make it among the world’s worst-performing markets in 2021.

China’s whole-of-government approach to its state technology drive has not delivered the intended results, either. Beijing has vowed to achieve 70 per cent chip independence as part of “Made in China 2025”. In 2020, China imported more chips than oil and iron ore combined. It relies ever more heavily on such imports and is drying up global supplies.

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Tsinghua Unigroup fell into financial distress over its exuberant acquisition activities. SMIC, China’s leading state-owned chip maker, has seen an exodus of its top executives and engineers.

SenseTime, Asia’s largest AI software company, debuted on the Hong Kong exchange only after replacing its US investors with a full panel of Chinese state-backed investors. The company’s cash-burning business model only makes sense in light of a steady, patient flow of capital from the state.

Does China still have its golden goose in 2022? Beijing wants growth backed by consumption and tech-powered industrialisation.

The key to a sustainable consumer economy is higher incomes for the bottom tiers in society and a stronger middle class. China says it plans to lift another 400 million to 500 million Chinese into the middle class.

China’s plan to avoid the middle-income trap is a challenging one

If it can deliver, the newly minted middle class will continue to urbanise, purchase homes and cars, utilise services including food delivery, tourism and education, and add to the urban industrial workforce. They are not only the drivers of China’s consumption but the power behind its industrialisation.

Premier Li Keqiang shocked many people with his openness about China’s economic reality when he said that more than 40 per cent of the country’s population made less than US$150 a month in 2019. The fate of these hundreds of millions of people will determine whether China can succeed in doubling the size of its economy by 2035.

Global technological competition is centred on technology and supply chains but primarily on talent. Technology and supply chains are far less mobile than human capital.

Although China educates far more STEM students than the US, Chinese tech giant Huawei has been determined to recruit elite global scientists. Once China has the talent, it will only be a matter of time until it has the chips it needs. Whether the strategy is successful will be dictated by the global talent market, not governments.

China will continue to stimulate its economy using what a state-centric system excels at: building massive infrastructure ahead of the demand curve. It needs to invest in infrastructure, predominantly digital and green technologies, to sustain a predictable level of Keynesian growth.

It can reap the broader economic benefits from 21st-century digital and environmental infrastructure later. In addition to the US$5 trillion digital infrastructure outlay in 2020, China projects US$15 trillion in renewable energy infrastructure expansion through to 2050.

China’s golden goose got stabbed in 2021, and the financial profits of its largest digital and internet companies have faltered. Fortunately, it still has more golden geese hatching. China’s party is far from over.

Shirley Ze Yu is a political economist and a senior practitioner fellow with the Ash Center of Harvard Kennedy School