Beijing Needs to Junk Its Economic Playbook

Government stimulus and greater exports can’t dig China’s economy out of a deep hole.

A drawing of Zongyuan Zoe Liu
A drawing of Zongyuan Zoe Liu
Zongyuan Zoe Liu
By , a columnist at Foreign Policy and fellow for international political economy at the Council on Foreign Relations.
An employee wears a protective mask as he sits in the showroom of an Apple store in Beijing after it closed on Feb. 1, 2020, during the early days of the COVID-19 outbreak.
An employee wears a protective mask as he sits in the showroom of an Apple store in Beijing after it closed on Feb. 1, 2020, during the early days of the COVID-19 outbreak.
An employee wears a protective mask as he sits in the showroom of an Apple store in Beijing after it closed on Feb. 1, 2020, during the early days of the COVID-19 outbreak. KEVIN FRAYER/GETTY IMAGES

Despite China’s record-breaking exports of $3.59 trillion and 7 percent export growth, the government fell short of its 5.5 percent GDP growth target for 2022. The economy, according to official statistics, only grew by 3 percent, one of the worst performances in nearly half a century—mostly thanks to the uncertainty caused by repeated COVID-19 lockdowns.

Despite China’s record-breaking exports of $3.59 trillion and 7 percent export growth, the government fell short of its 5.5 percent GDP growth target for 2022. The economy, according to official statistics, only grew by 3 percent, one of the worst performances in nearly half a century—mostly thanks to the uncertainty caused by repeated COVID-19 lockdowns.

After abruptly ditching zero-COVID policies, Chinese leaders have recently expressed their commitment to reviving the economy, both through internal post-National Congress of the Chinese Communist Party meetings and public statements at the World Economic Forum in Davos. But to jump-start the economy, Chinese leaders must move beyond the familiar playbook that calls for boosting exports and government investment stimulus. Without first addressing the problems of household underconsumption and sluggish income growth, public pessimism about the future may offset the positive effects of export growth and government stimulus, holding back economic recovery.

Chinese household consumption was a solid growth driver supporting nearly 40 percent of Chinese GDP over the past two decades. China’s rising consumer class was willing to spend more on aspirational goods, confident that their incomes would continue to grow. They were right: The Chinese economy maintained an average of 9 percent annual GDP growth rate for nearly two decades between 2000 and 2019. As a group of Gallup researchers observed using data from a 10-year nationwide survey of the Chinese people, about 3.5 percent of Chinese households had annual incomes of 30,000 yuan (about $3,800) in 1997. This number skyrocketed to more than 12 percent in just five years. Researchers found a continued strong consumer appetite for both must-have items and discretionary fun.

Until roughly 2017, household consumption growth never lost steam. Yet during Chinese President Xi Jinping’s second term, Chinese households experienced the worst slowdown in consumption growth in a generation, dropping from 6.7 percent during Xi’s first term to 4 percent during his second term—considerably slower than GDP growth. Although the nationwide lockdowns and supply chain disruptions have certainly contributed to the downturn in consumption, the Chinese government’s regulatory crackdown on the tech industry combined with China’s worsening external environment have also fueled an unemployment crisis, especially among young people.

The gap between consumption growth on GDP growth has widened since the COVID-19 pandemic hit. Before the pandemic, China’s real per capita consumption grew at an average annual rate of 6.38 percent from 2013 to 2019, 59 basis points below the average annual real GDP growth rate of 6.97 percent. This gap increased to 170 basis points from 2020 to 2022, when GDP growth dipped sharply to 4.5 percent, but consumption plummeted to 2.8 percent, less than half the rate before the pandemic. 2020 saw Chinese household consumption experience the sharpest contraction in growth since the 1990s, even though China was the only major economy to see economic growth that year.

As sharp as the pandemic’s impact was, declining income growth has been the real driver of shrinking consumption during the Xi years. The average nominal annual household disposable income growth rate fell to 8.39 percent from 2013 to 2022 from the average rate of 11.04 percent from 2001 to 2012. Chinese households are experiencing the worst material stress as income growth stagnates and are more insecure about their economic security than at any time since 1990. In November 2022, China’s Consumer Confidence Index plummeted to a record low of 85.5 points.

China’s exports have boomed, but that hasn’t helped ordinary households. This suggests China cannot export its way out of an economic slowdown or stimulate its way toward an economic boom. Boosting export growth is important, but its marginal effects at this point are limited. China became the world’s largest exporter in 2009, and in 2020, China’s share of global goods exports reached 14.7 percent, more than the shares of the United States and Japan combined. China’s exports-to-GDP ratio peaked in 2006 at 36 percent and has since declined below 20 percent between 2016 and 2020. Even if China could increase its service exports while maintaining its dominance in goods exports, there is only a narrow space for the exports-to-GDP ratio to rise as China’s GDP grows and supply chains relocate out of China. A report by New York University’s Stern School of Business and DHL projects China’s export growth rate to decline from 6.6 percent from 2016 to 2021 to 3.4 percent from 2021 to 2026.

The usual government solution to hard economic times has been major stimulus packages—but over the past 14 years, these have exacerbated local government indebtedness, chained financial stability to an unstable and often corrupt property market, shrunk fiscal space, and raised the amount of credit necessary to stimulate growth for future crisis response.

China’s two major economic stimulus packages offered a temporary boost but had long-lasting negative consequences. In the wake of the 2008 financial crisis, the Chinese government deployed 4 trillion-yuan stimulus ($586 billion) between November 2008 and December 2010. This stimulus boosted growth to 8.7 percent in 2009 and 10.4 percent in 2010, and it gave China the final push to overtake Japan and become the world’s second-largest economy in 2010. However, this short-term growth came at the cost of ballooning local government debts and rampant expansion of local government financing vehicles (LGFVs). These are investment companies owned and provided with capital by local governments for the purpose of issuing debt in bond markets and financing property development and other local infrastructure projects. Because the primary lenders to LGFVs have been banks, a large-scale default of LGFVs could trigger contagion in the banking sector. Additionally, debts raised by LGFVs can be more susceptible to corruption because they are kept off local governments’ balance sheets. The 2015 to 2016 credit expansion to save the stock market crash amid a housing market slowdown was estimated to have cost at least 5 trillion yuan ($805.2 billion). Despite costing more, the effect of this was weaker than the first round of stimulus—and aggravated the legacy problems of the previous 4 trillion yuan in spending. International Monetary Fund (IMF) research showed that the price to generate the same amount of nominal growth from 2015 to 2016 more than tripled the cost in 2008.

During the pandemic, the Chinese government strongly encouraged local governments to take advantage of the special purpose bonds program—introduced in 2015 as a form of off-budget financing that local governments use to issue bonds and raise capital to finance a particular policy or address a certain problem—to front-load the economy with more infrastructure investments and public projects. Bloomberg estimated that China’s stimulus through various financial and monetary support amounted to around 35.7 trillion yuan ($5.3 trillion) by the end of May 2022 in addition to the 30 trillion yuan stimulus in 2021 and 37.5 trillion yuan stimulus in 2020. In August 2022, the State Council added another 300 billion yuan in credit support using its policy banks.

All of these credit expansions with record-breaking exports only generated 3 percent growth in 2022 but at a mounting cost. The result of a proactive fiscal policy for over a decade since 2008 is that about a quarter of Chinese provinces will spend more than half of their fiscal revenue on debt repayment by 2025, as former Chinese Finance Minister Lou Jiwei warned. Previous credit expansion schemes also aimed to support major corporations, not to boost private consumption or provide household support. As a result, Chinese household income growth and consumption growth fell behind GDP growth. Although the U.S. government’s pandemic relief measures were also primarily targeted at corporations rather than households, many American households received greatly increased unemployment insurance as a cushion. However, this option was unavailable for the hardest-hit millions of unemployed migrant workers and recent college graduates in China.

In this context, Chinese leaders’ recent shift over the last year to prioritize private consumption for economic recovery is the right policy move. The government issued two critical documents about consumption. In April 2022, the State Council released the “Opinions on Unleashing Consumption Potential and Promoting Sustained Consumption Recovery.” The report mentioned 20 measures in five areas to promote consumption, providing implementation guidelines for local governments. In December 2022, the day before the Central Economic Work Conference (CEWC), the National Development and Reform Commission published the “Strategic Planning Outline for Expansion of Domestic Demand (2022-2035),” which laid out 38 measures to boost domestic consumption in 11 areas over a 12-year horizon. While acknowledging the critical role of investment, the outline put “expanding household consumption” before “effective investment” as a long-term strategy for the first time. At the December 2022 CEWC, policymakers reaffirmed their intention to prioritize supporting household consumption over investment and export.

One way to interpret these policy announcements is that they collectively signal that Chinese policymakers have recognized the urgency of correcting China’s underconsumption problem. If this is true, then this year could be a watershed moment as the government pivots toward prioritizing household consumption over exports, which was China’s canonical growth strategy since 1978.

But changing the course of government priorities in China, especially ones deeply mixed with local government finances, can be a slow and tangled process at best. And even if Chinese leaders genuinely attempt to prioritize consumption, then they face two primary challenges: financial repression and household balance sheet deterioration.

Since Deng Xiaoping, three generations of Chinese leaders have established a system of financial repression that suppresses consumption, forces savings, and prioritizes export and state-led investments. At the operational center of China’s repressive financial system is state-owned commercial banks, whose primary customers are state-owned enterprises and have little experience promoting relationship banking. Take the episode in 2022, when Chinese banks offered loans to companies and then allowed them to deposit funds at the same interest rate, or the time when Chinese banks inflated their loan numbers by swapping bills with one another to meet regulatory requirements for corporate lending. Both are sad evidence that the only type of lending that Chinese banks know how to do—and are allowed to do in the current system—is lending to enterprises, and when demand from enterprise is weak, Chinese banks are incapable of channeling credit to anyone else, especially consumers.

The balance sheet of the average Chinese household has gotten increasingly dire over the last 15 years. Household net asset growth has decelerated since 2010, a problem that worsened during the pandemic. A report by Zhongtai Securities, a Chinese securities service firm, estimated that between 2011 and 2019, Chinese household net asset growth rates dropped to around 13 percent from close to 20 percent before 2008. During the pandemic, household net asset growth sunk below 10 percent.

Most of this wealth is concentrated in the country’s increasingly shaky property sector. An urban household balance sheet survey conducted by the People’s Bank of China in 2019 showed that housing was roughly 70 percent of household assets, with mortgage loans accounting for 75.9 percent of total household debt. This level of indebtedness was comparable to the United States in the run-up to the 2008 subprime crisis and the burst of the real estate and stock market bubble in Japan in the 1980s.

Between December 2008 and December 2022, the Chinese household debt-to-GDP ratio increased from 17.9 percent to 61.9 percent, equivalent to an annual increase of 17.6 percentage points. Chinese household debt reached an all-time high of 62.4 percent of GDP in September 2021 and has since maintained above 62 percent of GDP. IMF research showed that higher household indebtedness boosts consumption growth in the same year but reduces it after two years—and acts as a severe drag on consumption even when incomes grow.

Household debt has also risen faster than income growth. Between January 2007 and December 2022, Chinese household debt increased from $517.66 billion to $10.86 trillion, amounting to an annual compound growth rate of nearly 22.5 percent. During Xi’s first two terms, household disposable income grew at an average annual real rate of 6.25 percent. In contrast, the household debt-to-income ratio increased from 68.7 percent in 2013 to 161.5 percent as of September 2022, higher than the U.S. ratio of 119.8 percent. From 2011 to 2021, driven by fast-growing mortgages, the Chinese household leverage ratio increased by 33.8 percentage points, the fastest increase in the world. Between 2012 and 2021, household debt increased at an annual rate of 18.3 percent, whereas income rose only by 10 percent annually.

Fast-growing household debt combined with pandemic lockdowns, salary reductions, layoffs, and major policy swings has exacerbated Chinese households’ financial insecurity. The most unfamiliar—and most challenging—problem for Chinese policymakers is not decoupling or weakened exports. The real test comes at home: how to incentivize and persuade disheartened Chinese families to contribute to economic growth by expanding household consumption. The government has previously mobilized households to boycott foreign goods or travel, but can it mobilize Chinese people to spend more when many have become increasingly insecure about their economic future?

This article appears in the Spring 2023 print issue of Foreign Policy magazine. Subscribe now to support our journalism.

Zongyuan Zoe Liu is a columnist at Foreign Policy and fellow for international political economy at the Council on Foreign Relations. 

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