China’s Big Spender

The hottest debate over the world economy is not on the fate of America; it's on the fate of China. Will it be the worst victim, or the most successful survivor, of the global crisis of 2009? So far the news all points to success, as the Asian giant defies the old assumption that an American recession would trigger a Chinese depression. Long dependent on exports to America, China continues to grow strongly despite a collapse of exports, down 26.4 percent in May alone. The reason is growth at home, with retail sales up 15.2 percent in May, and house and car sales taking off. To some, this is evidence that China has hit a new state of development, emerging as a consumer society wealthy enough to rival America as the world's best customer, and in some ways it has. The problem is that the consumer driving the boom is not the individual, because the Chinese shopper has been in retreat in recent years. The real big spender is the government.

China's economic recovery is real, but it's been bought by the state. No political party in the world can spend quite as freely right now as China's Communist Party, with its nearly $2 trillion in reserves and budget authority unchecked by rival parties or institutions. Beijing's stimulus plan amounts to 4 percent of GDP, double America's 2 percent, and China can deliver this booster shot without resorting to foreign borrowing. Government investment has driven the Chinese boom for a long time, and it is up 30 percent since the beginning of the year, with 75 percent of the money going into infrastructure; spending on rail lines and roads has more than doubled over the past 12 months. New community centers, convention halls, and sports facilities are springing up in major cities and provinces. Central and local governments are raising subsidies to support idle factories, retrain workers, and boost income aid in hard-hit areas. New government lending, as well as government orders to banks to raise lending, is helping to spur a surge in apartment sales. The state is even handing out spending vouchers directly to consumers, particularly in rural areas, good for cars, refrigerators, and other products, many with price restrictions that effectively limit the vouchers to inexpensive Chinese brands. As a top executive at one Chinese state-owned bank puts it, "This is all about the government propping things up."

The hidden hand of the state can obscure the degree to which China still depends on subsidized exports to America. Among the hardest-hit areas are those such as Guangdong province, a southern factory hub that represents an eighth of China's wealth and a quarter of its exports. There five-star hotels built in the boom times stand empty, while job centers for laid-off migrant workers are full. On a recent evening, the Pearl River itself seemed dimmer—many of the garish light displays that usually blaze from waterfront inns and restaurants had been turned off "to save electricity," says Su Caifang, deputy director general of the Guangdong Foreign Affairs Office, who notes that the province has suffered greatly in recent months because of the global downturn. "We're still very export-dependent, especially on America," says Su, who notes that 40 percent of the region's exports go to the U.S.

It's an honest admission that undercuts all the talk about an emerging middle-class Chinese consumer poised to take the place of Wal-Mart moms. Chinese incomes are about one tenth of those in America, and total consumer spending was about $1.7 trillion in 2007, compared with $12 trillion in the U.S. Local officials in the Pearl River Delta say they are now traveling inland to Hunan or Sichuan province to sell to their own countrymen the consumer electronics, jewelry, and shoes they once sent abroad. Yet local sales are a drop in the bucket compared with exports. There's a growing sense that the U.S. market will take years to rebound—while the Chinese market will take a long time to reach critical mass. "Even before the financial crisis, we knew we needed to move beyond the U.S. market," says Allan S.K. Lam, vice general manager of Hua Jian Group, a shoe manufacturer that makes much of what you see in stores like Nine West, Kenneth Cole, and Coach. "But it's going to take at least five years, perhaps even eight years, to develop the Chinese domestic market in an important way."

What's more, Chinese consumers have been playing a less important role in the economy in recent years. Private consumption has been steadily declining for some time, going from more than 60 percent of GDP in 1968 to 36 percent of GDP in 2008, a trend that defies the typical image of China's booming middle class. The biggest reason for this is increasing worry over the country's lack of a social safety net (pensions are rare; medical care means money down at the door). But freedom may play a role: a recent Carnegie Endowment study looking at political freedom and consumption found that countries that became less free over the last 20 years, like China, Iran, and Venezuela, had a significant drop in consumption.

The retreat of the Chinese shopper worries people like Stephen Roach, chairman of Morgan Stanley Asia, who says consumption needs to reach 50 percent of GDP for China to really move beyond the export model. "There's no paradigm shift," says Roach, adding that state investment could rise from 40 percent of GDP to 45 percent by the end of this year, levels "we've never seen." Even when Japan was rebuilding after World War II, its investments reached only 34 percent of GDP. And while Japan was generating double-digit growth with that cash, Chinese leaders admit they will be lucky to hit the 7 to 8 percent target this year. Locals in Guangdong say the view from the ground is less optimistic than the official projections. "I've talked to a number of factory owners in the area, and they tell me if they can't get more orders in six weeks they may go out of business," says Ding Li, director of the Center for Regional and Corporate Competitiveness Research at the Guangdong Academy of Social Sciences.