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Domestic Consumption Driven Economy is the Key

Sigma Investment Counselors

June 12, 2012

After having been born and raised in China, I believe I have some unique observations regarding this sprawling economic juggernaut.  It is well known that China was a contributing factor in pulling the global economy out of its slump in 2009.  This year, China’s growth target is 7.5%, which was announced by Premier Wen Jiabao at the opening of the National People’s Congress in March.  For the past seven years, the Chinese economy has grown at an average annual rate of 10.9%.  My interpretation is that China is going through an economic transformation stage and the Chinese style super growth miracle is not sustainable.

The growth of the Chinese economy has been built on two pillars: government spending on infrastructure and export oriented expansion.  Since the Chinese government is authoritarian, it does not have to report back to the public or parliament, and it has been able to boost economic growth by government spending much more easily than Western governments.  But, you can only build so many bridges, expressways, and airports.  Eventually, you have to create demand to consume those public goods and services.  As for exports, the traditional target markets such as Europe, US and Japan either are growing slowly or in recession.  The bottom line is that the leaders from Beijing have to acknowledge the fact that they can’t rely on the previous economic stimulus model any longer; they have to switch to a domestic consumption driven model.

A number of measures can be considered to boost domestic consumption growth.  The most important element is to build strong consumer confidence.  Tepid confidence results in high savings rates.  A government focus to boost employment, pension and healthcare benefits, provide student loans, and make private sector housing affordable, could increase consumer confidence and a willingness to spend. Unfortunately, these initiatives take time and require major economic structural reforms.

After years of high rate growth, the more direct methods of stimulating economy have already been taken.  There isn’t a quick fix for China’s growth.  The transition to a domestic consumption driven economy will not be easy, but it has to be done.  We will monitor developments and incorporate our observations into our investment strategies.

Comments or questions are welcomed.

Wenma Gorman, CFA

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