China’s economy is set to rebound this spring, after a year dominated by Covid. But by how much, and in what ways? China's top leader Xi Jinping vowed to make consumer spending the "main driving force" of the economy, but the task at hand is daunting.

Beijing's abandonment of its harsh Covid policy is sure to unleash some pent-up consumer spending. But the authorities' precipitous and inept opening of the economy has further tarnished their reputation for economic management and brought uncertainty about the future. 

The loss of confidence is likely to prove a more intractable problem which won't be solved by simply lifting Covid restrictions.

To truly ensure that consumers have the ability and willingness to spend more, China must free up its own internal market, boost household disposable income and tackle the reasons behind consumers’ excessive savings rate.

In a series of articles over the coming weeks, Enodo Economics will assess the likelihood of consumer spending becoming a sustainable growth driver in China. We'll start with Beijing's attempt to create a unified national market.

As a dyed-in-the-wool socialist, Xi's approach to the economy leans heavily on the supply side, focusing more on production and distribution than on demand. It is not surprising, then, that he has focused on the idea of a unified national market to boost consumer spending by making supply and distribution in China more efficient. The idea was first fleshed out in April last year but was then eclipsed by the dramatic and ultimately futile attempt to keep Covid under control.

Beijing to tackle supply-side bottlenecks

For decades, both foreign and domestic firms have been frustrated by formal and informal barriers that hinder cross-regional sales. Meanwhile, the country’s economic and regulatory infrastructure is geared towards facilitating exports. There’s been little focus on cutting the red tape that creates local monopolies and ensures that beer brewed in Shanghai is rarely served in bars in Beijing.

At the second Politburo study session of his new term, Xi spoke about establishing a "long-term mechanism to expand  residents' consumption so that residents can consume with stable incomes, dare to spend without worrying about the future, and have a strong desire to spend in a good consumption environment".

The new plan aims at breaking down domestic market barriers, standardising market access, improving the connectivity of market infrastructure and creating a fair and transparent business environment -- objectives that would result in a more competitive and open domestic market.

Each of these objectives encompasses major supply-side reforms, as shown below. 

The Threat to Vested Interests

Opening China's internal market seems simple, but it is harder than it looks on paper. Effectively, the Chinese national economy is more like a conglomeration of extremely big regional economies. To a large extent, the informal boundaries of these regions align with the regional military administrations set up by the Communists when they first won the Chinese civil war, over 70 years ago.

Each of these regions boasts its own industrial champions (almost all of them state-owned enterprises) that enjoy de facto dominance and great political clout. The fragmentation is sustained by distribution networks, that also hold near-monopoly commercial status in their own territory.  That's why, for instance, there is effectively no national market for consumer commodities like beer. The situation is worse when it comes to entrenched, infrastructure-heavy industries like electricity, steel or automobiles.

To a certain extent, e-commerce breached these traditional but invisible economic divisions, allowing marketing and distribution of consumer goods across regions. E-commerce also allowed more penetration of consumer goods into the countryside, unlocking the untapped consumer spending there. But the explosion of rural spending has now long peaked.

Creating a unified national market will be no mean feat. Reforms to allow greater national access will, by definition, put these regional champions in competition. They will threaten deeply vested interests and potentially trigger the Party’s inherent obsession with controlling the economy.

Provincial officials, intent on protecting their local champions, may resist dismantling barriers to entry. Xi himself is far from your classic economic liberal. He has defended the role of China’s state-owned enterprises as an instrument of party policy and national defense.

Would he be willing to see one of these inefficient behemoths stripped of its regional protective policies and left to compete head-on with foreign rivals or private competitors from elsewhere in China? Probably not. It is more likely that policy will be geared to ensure that the SoE sector emerges as the winner of the market opening.

Conclusion

China has already made some progress in the area of streamlining and opening its domestic market, and the unified national market shows the leadership understands more is needed. 

But these transformations are difficult and, even if successful, unlikely to bear fruit immediately over the next couple of years.

If China manages to improve the production and distribution side of its economy this will invariably boost productivity growth over time. But this can only take it so far in terms of "restoring the structural role of consumption in the economy" as Premier Li Keqiang put it. 

For the short term, if Beijing wants to see consumers spending it will still rely on its tried-and-true tricks of large fiscal transfers, government mandated job creation at SoEs and maybe employment-linked credit to private SMEs to boost consumer spending.

Our next installments in this series will explore Beijing's options, and the constraints it faces, in trying to boost the demand side of the equation. Stay tuned.