Wang Xiaoying / China Daily

China's 2008 stimulus was intended to buy time while the economy made the transition to sustainable, consumer-led growth. But it hasn't worked out as planned. The next few weeks are likely to reveal how little progress has been made.

The unsustainability of China's investment-led growth model was already well understood three years ago. But when the global financial crisis hit, the government responded by unleashing a wave of loan-fuelled investment. In the circumstances, the decision made perfect sense. Exports were in freefall and the flood of spending produced jobs and allowed the economy to continue growing at a rapid rate. China's economy is nearly one-third larger today than it was three years ago.

In contrast, US output has only just returned to its pre-crisis level and even relatively fast-growing emerging economies such as Brazil have grown by less than one-tenth.

But if the government's efforts to keep the economy moving were a success, its attempts to steer China onto a consumption-led growth path have not been so fruitful. Stimulus spending has wound down, and the government until recently was trying to slow bank lending. But investment this year has still risen faster than spending by consumers.

Targeted efforts to boost the amount that Chinese households spend, for example by subsidizing purchases of cars, made a difference for a while but the effect did not last. Surveys show that most people would still prefer to save any extra income rather than spend it.

Just as important in holding back household spending are economic distortions that channel a rising share of income into corporate profits rather than the pockets of ordinary workers. These distortions range from the cheap credit available to favoured companies to the existence of State-owned monopolies in many sectors.

The failure to make significant progress in re-orienting the economy toward household spending is now being exposed as foreign demand is again slowing. We are not facing a rerun of 2008. European growth has stalled and the eurozone is teetering on the edge of a break-up. But the US economy at least is still on its feet.

Furthermore, after three years of slow global growth, China's exporters are not as important to the health of its economy as they previously were.

However, there are other headwinds from closer to home. Property developers in China are sitting on a glut of finished or nearly finished property, the legacy of a surge in new housing projects started early in 2009. They are likely to hold off from launching new projects until the excess supply of new property has thinned out. In 2008, the government was able to boost investment to offset weakness in exports. Now one of the key investment sectors is facing a slowdown too.

So what can the government do? It has already signalled a policy shift, first with talk of "fine-tuning", then with a reduction in the level of reserves banks must hold relative to their deposits, which gives them more space to lend. But it is still unclear how far policymakers are willing to go.

They could choose to stick with policy fine-tuning, accepting that any efforts to shore up growth with more investment, as happened three years ago, would only risk feeding overcapacity, push up debt and potentially destabilize the banking system. That would also mean accepting the risk of a period of much slower growth than China has been used to. The slowdown could itself be used as a catalyst for a policy shake-up to nurture much stronger household demand.

The recent decision to raise China's poverty line is a small move in this direction. The step makes 100 million more people eligible for benefits and since poorer families tend to spend more of their income, the effect will be to boost overall spending.

But the risk of a sharp slowdown may be hard to bear. Officials are most likely to choose to err on the side of maintaining growth. Unfortunately, tinkering with consumer subsidies and raising handouts to poorer families is unlikely to have a big enough impact in the short term. The only way to be sure of keeping growth high is, once again, to boost investment.

In principle, most accept that weak growth in export markets, coupled with the need to slow domestic property investment, makes the task of seeking more balanced, consumer-led growth more urgent. But in practice, the imbalance is likely to grow. China may ride out the storm of the next few months as a result, but the dangers of overcapacity and bad debt will only intensify.

The author is chief Asia economist at Capital Economics, a London-based independent macroeconomic research consultancy.

(China Daily 12/14/2011 page9)