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China's consuming problem

ChinaFinanceConsumersEconomic IndicatorGross Domestic ProductXi Jinping

Last month, alarm bells were nearly ringing in business and political circles because China's latest gross domestic product figure came in lower than expected — at 7.5 percent. Some rather eminent people immediately came out to proclaim the need for China to do something, lest the world come to an end. Slow down, Charlie.

Over the past 20 years, as a professional and an academic, I have read more articles, monographs, research reports and books about China than I care to recount. Whether lengthy treatises or short op-eds, whether written for a general readership or an academic one, and whether written in the mid-1990s or last week, they're all about the same. I can spare you a great deal of reading by summarizing them as follows: They recognize the successes and/or opportunities that China has, but they highlight the risks to further gains if China doesn't reform something critical.

Reform, reform, reform. I suggest that future Sinologists get very used to that word, because they'll need it a great deal throughout their careers. But consider this: Is that really any great insight? Isn't it the job of any country's leadership to be reforming something? The word reform simply means to change for the better. If aspiring world leaders don't have ideas about changing their country for the better, they could hardly ascend to leadership. Just ask President Barack Obama. Just ask Japanese Prime Minister Shinzo Abe. Just ask German Chancellor Angela Merkel. Just ask whoever's in charge in Italy at the moment. They would all tell you many things that need reforming about their country.

And China is no different. It's no different because in the human world, things can always be made better. The entire world could use reforming. The suggestion to reform is so universal and so inarguable that it has little value by itself.

With that acknowledged, let's consider two further inarguable truths about China's economy:

•China's growth was bound to slow down at some point, because no country can grow at a double-digit pace forever; and

•The low-hanging fruit of export-led growth driven by cheap labor isn't quite so plentiful anymore.

Given these two facts, there is a rather simple conclusion that presents itself to Chinese President Xi Jinping. In place of declining growth in exports, China must beef up domestic consumption.

But not just any old consumption will do. China requires the actual fulfillment of Chinese consumers' needs, wants and desires. China emphatically does not need any more creation of real estate monstrosities that no end user ever demanded in the first place. Asia has seen far too often the tragic result of such non-market-driven building.

Over my years of teaching international finance, there is one idea that has been the single most difficult to get students to appreciate, especially since they hear almost the opposite from other professors. It is not anything mathematical. It is merely an understanding that although exports do indeed benefit a country's GDP, they do so to the detriment of that country's standard of living.

Students inevitably comment that GDP growth and standard of living surely must correlate. I need to tell them that this is not necessarily the case. Consider a bakery that produces 10 cookies. The bakery can sell them in the neighborhood or "export" them to sell to the next neighborhood. If the bakery exports them (probably at a higher price than could be obtained locally, or else there usually would be no point), the baker will get richer. This will be reflected in the neighborhood's GDP. But is the neighborhood's standard of living higher? At least initially, haven't the neighbors actually been deprived of goods? I admit that in the longer term, the baker's "export wealth" might get "repatriated" — but that won't necessarily be so, or soon.

In this example, it is the neighborhood people (the Chinese population) who have not benefited from the baker's wealth (China's export earnings). The solution is something that the United States knows very well. To replace China's declining exports, China needs to increase domestic consumption. In other words, China needs more of what America has too much of. That's good old-fashioned, American-style consumer spending.

America may indeed have overdone it, but there's no question that American spending has provided more than adequate incentive for local and foreign producers to continue to invest here to serve the market. That is precisely the dynamic that China needs much more of now.

Chinese demand for goods is definitely there. And finally, after centuries, even the ability of the people to pay for them is largely there. But much like in Japan in the 1970s and 1980s, the consumer demand isn't being met because so much of the country's means of production and supply of goods have been dedicated to the export markets. That's made the country richer but has deprived the Chinese consumer.

If China were to appoint me Lord High Counselor to President Xi (and I'm quite open to this), I wouldn't waste any time urging him to reform the financial sector. He's surely heard that enough. Instead, I'd encourage him to move toward satisfying consumer demand. I'm pretty sure he doesn't hear that nearly enough.

Michael Justin Lee is a lecturer in the University of Maryland's Department of Finance, a veteran chartered financial analyst, and a former Financial Markets Expert-in-Residence in the U.S. Department of Labor (2003 to 2005). He is the author of "The Chinese Way to Wealth and Prosperity." His email is leem@umd.edu.

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