How Investment-Led Growth Impacts Living Standards in China

Why Investment-Led Growth Lowers Chinese Living Standards

Source: Liberty Street Economics

Overview of China’s Economic Growth

Rapid GDP Growth

• Since the late 1970s, China has achieved significant GDP growth, averaging 8.9% annually.
• China has transitioned to middle-income status, with per capita income increasing drastically.

Lagging Living Standards

• Despite high GDP, per capita household consumption is only around $8,300, significantly below expectations for its income level.
• China ranks at the 45th percentile for consumption relative to other middle-income nations.

Consumption vs. Investment

High Investment Rates

• Investment in China consistently exceeds 40% of GDP, well above the global median of 20-25%.
• This high investment rate is intended to support rapid capital accumulation.

Impact on Living Standards

• The focus on investment over consumption has created a mismatch, with consumption growth lagging behind income growth.
• Many other countries with lower income levels have higher consumption rates than China.

Neoclassical Growth Model Insights

Diminishing Returns to Capital

• As capital becomes abundant, its contribution to economic growth declines.
• Recent estimates show that increases in capital inputs now contribute less than 3% to GDP growth, down from nearly 6% previously.

Projected Scenarios

• Two scenarios were analyzed:
  • High Capex: Sustained high investment rates.
  • Moderate Capex: Gradual reduction to 25% of GDP by 2040, allowing more resources for consumption.
• The Moderate Capex scenario leads to higher per capita consumption over time, despite lower GDP growth.

Policy Implications and Future Prospects

Need for Rebalancing

• The need for China to shift towards consumption is recognized but not sufficiently acted upon.
• Current policies still prioritize industrial growth, potentially stalling progress on improving living standards.

Conclusion

• China risks sacrificing current living standards for future gains that may not materialize.
• A focus on consumption could improve overall well-being and economic stability.