A Rebalancing Chinese Economy: Drivers and Challenges

This paper presents macroeconomic evidence that a rebalancing from a lop-sided investment- and export-driven pattern of growth towards more consumption-driven growth is already occurring in China, supported by a declining return to capital and a now-rising labour share of income. We argue that the extraordinary strength of Chinese household consumption in recent years casts doubt on hypotheses that Chinese consumption has been repressed through factor price distortions. Based on evidence from China’s flow-of-funds accounts, we also contend that conventional analysis has understated the role of investment by households in supporting growth of gross fixed capital formation in recent years. While recent discussions stress the need to reform financial markets to foster rebalancing, we argue that rebalancing will probably happen anyway as a natural outcome of dwindling income windfalls from worsening demographics, fading positive productivity shocks and maturing housing markets, all of which helped drive the imbalances in the first place. An analysis of historical ‘rebalancing’ episodes in other economies further suggests that the bulk of adjustment in coming years is likely to occur through slowing investment rather than an increase in the growth rate of consumption.