Increasing the proportion of China's economy that is consumption may take longer than expected
Much has been made about the intention of China to move the emphasis of its economy away from growing Fixed Capital Investment towards growth in Consumer expenditure. While obviously the relative contribution of these two items to overall GDP growth will change in the direction desired, the amount of change may be less than expected because of structural issues.
This month’s insight looks at the factors influencing the extent to which consumer spending (the consumption aspect of the economy) can be increased. It shows that it is reasonable to expect consumption expenditure to grow at a faster rate than total real GDP over the next decade, but the impact of this on the proportion of GDP that is consumption is relatively small.
How Can Consumption Expenditure be Increased
The reality is that additional consumption (over historic levels) would boost the economy. So in what circumstances and by how much can consumption be increased? There are two major options available to the Chinese Government:
- Increasing the share of production that is paid in wages. As shown below, China is rather poor on this respect with the average worker in 2015 getting 62% of the value they produced. In the rest of the world wages are typically over 85% including other developing economies such as India.
- By increasing the proportion of the household income (and wages) that is spent – either by reducing taxes or more usefully, savings. Again, as widely known, savings rates in China are high – can that come down?
Each of these options will be examined in the context of China in the two sections that follow.
Increasing the share of Productivity that is paid in wages
Figure 1 below shows the relationship between GDP per worker (a gross but reasonably reliable measure of productivity) and the average wage of workers (Note this is both urban and rural workers). As shown, it declined from 58% to 52% between 2005 and 2007 and did not start to increase until 2010 such that by 2015 it had reached 62%. So while the overall economy has grown consistently over the last decade, the worker’s share of that growth declined to 2007, grew in line with GDP to 2010 and grew faster than GDP through to 2014.
Figure 1: Historic Trends in Average Wage, Productivity per worker and wage as share of productivity: 2005 to 2015
However, at 62%, it is still low by international norms. Indonesia, Malaysia and Thailand are in the 73% to 77% range, India is 85% and Affluent Asia average 85% as does Western Europe. So clearly wages can be increased and with that, household incomes.
As evidenced in Figure 1, from 2010 wages have been increasing as a share of productivity and with that the absolute real wages paid. But, there is a constraint. Once it approaches 73% China starts to lose some of its competitiveness as a place in which to manufacture. (be it local or foreign investment). Especially if it is taking place in an environment where future wage increases seem likely – which is the case in China but probably not in Indonesia and Mexico for example.
Global Demographic Ltd.’s view is that it will increase to around 74% by 2025 as a consequence of Government policy, tightening labour supply (slower growth of labour in the urban market) and increased skill levels of the labour force. If this is the case, then there will be significant growth in wages and salaries (total GDP per worker is expected to be increasing as well – so it is an increasing share of a growing economy).
But it is considered to be unlikely to go much past the 74% level in real 2015 terms because of the implication for competitiveness of its manufacturing and services environment. Indonesia, Mexico, Czech Republic etc. are not going to be far away as a source of competition in the medium term at 70% plus.
Assuming that it does increase to 74% by 2025 and that total real GDP grows at 5.1% per annum for the decade 2015 to 2025 (growing from Rmb 67.8 Bn to Rmb 111.9 Bn), then the average wage per worker is projected to increase from the current estimated value of Rmb 55,735 pa to Rmb 119,897 pa. This represents an annual real growth rate of 8.0% per annum for the decade which is clearly very good for the worker (and households). Especially when compared with a total real GDP growth rate of 5.1% per annum for the same period.
Wages will increase – but will spending?
There are two issues that intervene between the changes in wages of the employee and the total spending of the household. These are:
- The trend in the number of workers per household and
- The impact of tax and saving on propensity of the household to spend
Workers per household
While the number of employed persons is projected to continue to increase over the next decade, this will be at a much slower pace than for previous decade. As discussed in an earlier ‘Insight’ the growth rate of the working age population of China is slowing and with increased affluence the proportion of the workforce that is of working age and working is also projected to decline. As such the total workforce of China is projected to decline (from 753 million to 695 million). However, it is important to appreciate that this decline is totally a function of the decline in the rural labour force. The urban labour force is projected to continue to grow as a result of the size of the rural to urban migration and its younger age profile. But, do note that it is projected to grow at a much slower pace than before.
However, as a result of reducing number of persons per household (more, older, empty nester households) the number of households is projected to grow at a faster rate than the workforce. As a consequence, the number of workers per household is projected to decline from 1.45 to 1.26 for urban households between 2015 and 2025 and for rural from 1.89 to 1.75. This means the average household (urban and rural) declines from 1.65 workers to 1.44 workers and means that the increase in household income is much less than that of wages. Specifically, the average household income is projected to grow from Rmb 91,081 to Rmb 169,399 – an annual real growth rate of 6.4% per annum. This compares with a projected wage increase of 8.0% per annum and total real GDP growth of 5.1% per annum for the same period.
The Propensity to Spend
The second intervening factor between increased wages and consumer spending is the propensity to spend that money. Two factors influence that, taxes and propensity to save. In China wages are subject to a progressive tax rate (i.e. the percentage of gross income that is taken in tax increases with income). As such, the more a household earns the greater is both the amount and proportion that is taken in tax. Overall the rate of increase is not steep – and it not likely to change from the past in the short term (although governments have been known to increase tax rates, we cannot forecast that). However, with increased affluence it does mean that on average the proportion of gross household income that is available to be spent declines and conversely the amount available to spend increases at a slower rate than gross income.
The other factor influencing the amount spent is the propensity to save. In China (relative to other countries) the propensity of households to save is high, especially for urban households. On average a higher income household (Rmb 200,000 and above) spends just 55% of its gross income. The other 45% goes in tax and savings. So as affluence increases (particularly amongst urban households) so does the average proportion and amount saved – with a consequent negative impact on the proportion spent.
The impact of the higher proportion of households in higher tax/savings rate income segments means that the average household’s expenditure is projected to grow from Rmb 56,765 in 2015 to Rmb 93,108 in 2025. This represents an annual average real growth rate of 5.2% per annum. When multiplied by the increasing number of households this results in total consumer spending going from Rmb 26,157 Bn in 2015 to Rmb 45,824 Bn in 2035 (in real 2015 values). This is a projected growth rate in total consumption expenditure by household of 5.8% per annum. This compares with the projected total real GDP growth rate of 5.1%. This relatively small difference in growth rates indicates that the consumption aspect may not give GDP the lift expected – the combined impact of fewer workers per household and increased propensity to save (and pay taxes) means that the expected increase in wages is perhaps insufficient to achieve a significant rebalancing of the economy towards domestic consumption.
Table 1: Projected Growth in total real (2015) household expenditure: 2015 to 2025
SO WHAT IS THE IMPLICATION FOR COMPANIES AND INVESTORS?
The key issue here is the savings rate. It is high, as households are saving for property investment, and, more importantly, retirement and health care. The reader is reminded that the majority of the population is now over 40 years of age and retirement and health care increase in importance to this segment. These concerns are not going to go away unless the Government can increase pensions and availability of adequate free healthcare in the intervening time period.
But the good news is that while consumer spending will not significantly outpace the total GDP growth rate, it is nonetheless positive and a consumer market growing at 5.8% per annum is not easy to ignore. Especially as the spend per household/person is increasing thereby offering better margins.
It is considered very unlikely that wages will increase at a faster rate because of implications for competitiveness on the Global Market although currency devaluation may reduce that constraint.
Find Out More
A more detailed analysis of the changing demographic profile of China, and its implications for the future consumer profile, labour Force, household number and structure, GDP, household incomes and expenditure, and consumer age/income segments through to 2035 is available in our latest publication:
China’s Demographic Future
This provides a no nonsense analysis of the underlying demographic trends in China. By reading it you will be prepared for the China of the Future, rather than surprised by it! Click here for a detailed Chapter description and purchase options.
NOTE: This will be updated taking into account the changes in the One Child Policy over the next 2 weeks and will be automatically updated for all purchasers.