China’s ghost middle class

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China’s ghost middle class

At Davos last month, Chinese Premier Li Keqiang told a room full of fretting executives and policymakers not to worry about his country’s slowing economy. China, he argued, had a foolproof means of maintaining rapid growth: an urbanization boom that is creating millions of new consumers.

“China has much room for urban, suburban, and regional development and domestic demand has huge potential,” Li said on Jan. 21. “Domestic demand will keep improving and bring even greater development for the world.”

There’s one problem with this argument, though. China’s massive stimulus efforts since 2009 are indeed enriching new city dwellers, but not necessarily the ones most important to the global economy: the middle class.

In a recent report titled “Will the Middle-Class Consumer Please Stand Up?,” Ernan Cui of Gavekal Dragonomics notes that “the real drivers of consumer spending in China, as elsewhere, are the middle classes - and their income has been slowing.” He warns, “If household income growth follows the business cycle downward in 2015, as it has so far, then China’s consumption will disappoint.”

Since coming to office, Li and Chinese President Xi Jinping have laid great emphasis on rebalancing the economy away from exports and investment and toward services and consumption. Yet since 2009, when Beijing launched a massive stimulus effort to fend off the global financial crisis, per capita consumption is down: It stands at 7.1 percent now, compared to 8.5 percent then. One key reason why is that the bottom 40 percent of households saw incomes rise most during the period - about 70 percent, considerably faster than the middle 40 percent (where incomes are stagnating around $3,320).

Of course, China should welcome the fact that lower-income migrant workers are climbing out of poverty. The gap between extreme rich and poor has narrowed for six straight years - a remarkable accomplishment that is to be applauded. But China also desperately needs the middle class - the ones who buy flat-screen TVs, iPhones and Starbucks lattes rather than cheap rice cookers - to boost consumption; so do multinational companies. Instead, a 19.9 percent year-on-year plunge in January imports may be an omen of things to come.

What gives? Demographics, for one thing. Contrary to conventional wisdom, the increase in the flow of new migrant labor into cities from Beijing to Chongqing has slowed to about 1.3 percent from 5.5 percent in 2010. Labor scarcity - partly because of the one-child policy - means the bottom of the labor market is receiving big wage gains, while the middle 40 percent isn’t. China, it seems, is approaching its so-called Lewis Turning Point - when a nation runs out of cheap labor - sooner than expected. In a 2013 paper, for example, International Monetary Fund economists Mitali Das and Papa N’Diaye figured it wouldn’t arrive until 2020 at the earliest.

Meanwhile, white-collar workers who urbanized earlier, as well as college graduates, face a tough job market. With higher-end jobs harder to find, wages are under downward pressure.

As Beijing’s clampdown on credit and shadow banking hits profits at state-owned enterprises, Cui expects a “clear if not disastrous slowdown in China’s consumption growth in 2015. The hit to consumption growth will come from the more gradual, but very real, slowdown in earnings of the middle-income households.”

China’s reform process also deserves some blame. Since the global crisis, China has spent trillions of dollars (only Beijing knows the true tally) ginning up growth with new six-lane highways, airports, shopping malls and high-speed rail networks. The stimulus boom solidified the primacy of state-owned enterprises in the economy. Their outsized role is stunting the development of the private sector needed to create good-paying services jobs that would benefit the middle class. Xi and Li need to invest less in construction and manufacturing and more on supporting small-to-midsize private companies.

As usual, Li said all the right things at Davos: China “will let the market play a decisive role in resource allocation to foster a new engine of growth”; will “focus on structural reform and encourage mass entrepreneurship and innovation”; and “will successfully overcome the middle-income trap” that ensnares all too many developing nations. That, he declared, will “bring greater opportunities to the world economy.”

First, though, China needs to do better at enriching the middle 40 percent of the population. In November, the IMF’s senior resident representative for China issued a blunt warning. China, Alfred Schipke said, needs better regulation and supervision and faster results on its reform program to keep income growth from stalling. It’s great that China wants to make the world richer. It should start with its own middle class.

*The author is a Bloomberg View columnist based in Tokyo and writes on economics, markets and politics throughout the Asia-Pacific region.

by William Pesek

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