Role of consumption limited

Upgrading manufacturing industries and developing new advantages are crucial to sustaining economic growth

The decrease in developed economies' demand has taken its toll on China. The recent inspection visits across the country by top national leaders signify decision-makers' concerns about economic growth, as well as their resolve to take this opportunity to transform China's economic structure.

There can be no retreat from the transformation. China's economy is confronted by various challenges, such as slowing growth, rising costs and increasing uncertainties at home and abroad. But can the economy rely on consumption to regain its rapid rate of growth? The answer is no.

Past experience indicates the world economic development model, which depends on one single country as the main source of demand, is no longer sustainable, because it necessarily increases the volatility and vulnerability of the world economy, unbalancing the demand structure and growth structure of the global economy.

Investment remains the main driving force for economic development in China, which is still far from the stage where domestic consumption can be the main driver of growth. According to the World Bank, the average annual economic growth in China for the past 30 years has been 9.8 percent, among which 2 to 4 percentage points have been from total factor productivity while the remainder was almost all contributed by investment.

The annual growth of the Chinese economy from 1995 to 2010 was 9.92 percent on average. During this period, the investment in fixed assets in China increased by 20 percent a year on average, and the investment in fixed assets accounted for 41.63 percent of GDP. And investment is still the main driver for China's economic growth now external demand is shrinking.

The high investment growth rate is related to the long-term low utilization of capital, which requires more investment for each unit of output. The incremental capital-output ratio is the index evaluating the marginal efficiency of capital. When it increases, it means more capital is needed to produce the same output increment as before. Over the last five years the incremental capital-output ratio has increased year by year. If the efficiency of investment cannot be improved, only by injecting more money can China sustain its high-speed economic growth. But this practice is no longer sustainable.

I don't think consumption can sustain China's economic growth either. Although China is the world's second largest economy, according to the World Bank, the average per capita GDP is only slightly more than $4,000, the level of a middle to high-income developing country. If we blithely overplay the role of consumption, we may miss the opportunity to upgrade the industrial structure and the chance to encourage enterprises to increase their input into research and development.

As China's demographic dividend is dwindling and labor prices are increasing, the comparative advantages of labor-intensive industries are vanishing, resulting in a stagnant national economy.

China should adjust its supply-and-demand structure and factor structure as early as possible. It needs to make internal supply, rather than consumption at home, its main driving force for economic growth.

The question is where the domestic demand will come. We have ignored the supply side for a long time while emphasizing demand. It is time now to consider a new portfolio of labor, capital, technologies and their efficiency as the main stimulus for sustainable economic growth.

If supply can be adjusted it can drive the overall demand as well as promote the structural transformation of the domestic economy. As the world's manufacturing base, China accounts for 6 percent of the total global manufacturing output. But China's input into manufacturing research and development is only 0.3 percent of the world's total. China's ratio of value added, a comprehensive index evaluating the input-and-output efficiency of an economy, is 22.99 percentage points lower than that of the United States, 22.12 lower than Japan and 11.69 lower than Germany.

Upgrading manufacturing industries and developing new advantages are crucial to realizing the structural transformation of China's economy. They are essential if the economy is to change from the current demand-driven growth model to a new sustainable model that is propelled by both demand and supply.

The author is an economics researcher with the State Information Center.