For China to become a country that is wealthy and not just big, spending needs to shift from the state to consumers. But as the Chinese economy grows ever-larger, analysis by Enodo Economics shows that Chinese households are still under-spending, and one reason is that family income generation has come short.

Economists have argued for years that consumer spending in China should rise to balance the economy better. Enabling that shift has been an economic policy goal over the past decade, even as the political drivers of the economy have become notably more top-down under the rule of Xi Jinping. The verdict? For now, statist policy is winning out, and Xi's economic vision has yet to benefit households.

Enodo Economics' most recent analysis shows that China's households continue to earn very little income from their assets and wages have stopped their relative rise. Meanwhile, large but unexplained transfers from the state to households raise the question of whether underlying household income is actually even weaker than it seems.

This is the second report in Enodo's ongoing series on household consumption. In the first, "China Attempts to Unlock its own Internal Market", we argued that China would rely for the short-term on tried-and-tested tricks of large fiscal transfers and employment incentives, while pursuing a longer-term supply-side vision of a "unified national market" that -- in theory -- will reduce barriers to internal commerce.

From a demand perspective, the recipe for what China should do is clear: It should encourage rental markets, and professionalise capital markets to boost households' paltry income from assets. It should end household financial repression by allowing the free movement of the deposit rate. 

At the moment, however, the political atmosphere in China supports heavy-handed allocation by the state over sustainable free market reform. We don't anticipate that will change in the foreseeable future.

Home is where the heart is -- but not the income

Household disposable income in China is much lower as a share of GDP than in the US. The main reason for this is that Chinese get very little income from their assets.

The main asset for middle class Chinese families is property. In cities, families hold apartments for capital gains, not rental income as the rental market is underdeveloped. Often they don’t even kit out the investment properties they buy, which sit unoccupied. In the countryside and in provincial towns, rural migrants build homes that they may never end up using, since household registration restrictions limit their ability to settle in the megacities where they work.

As a result, China’s housing boom has not been associated with an increase in the consumption share of GDP, making it unlike most other major economies.

The obvious solution is to encourage the rental market. In 2018 when we wrote "Consumers to Benefit from Xi’s Maxim “To Hoard Is Bad, to Rent Is Good” we were hopeful that a push to develop rentals could underpin a boost to household income. 

But Beijing's response ended up being at cross-purposes:  the focus since 2015 was on providing affordable rental housing (often state-owned) rather than boosting households’ rental incomes. Around the same time, the government made it harder for migrants to live in the biggest cities, pushing the population towards provincial centers which suffered from a housing glut.

In the autumn of 2021 the government moved to cap the cost of renting a home in cities. As a result, we don't expect rental income to rise much as a share of GDP in the near future. (In Enodo's next report, on household savings, we will address the wealth effect from higher house prices.)

As for other types of assets, Chinese families' financial assets are mainly cash and bank deposits (36% of total) and direct equity holdings and investment funds (58%). Bank deposits earn close to nothing in real terms because of the authorities maintaining deposit rates artificially low to boost investment and keep the banks profitable.

Chinese households have subsidized China’s industrialisation, especially investments by the state. The share of Chinese deposits in total financial assets is also way too high relative to the US; but given underdeveloped capital markets savers feel secure in bank deposits and must endure "financial repression" as long as the state mandates artificially low deposit rates.

The  surge of shadow banking since 2011 -- like WMPs and P2P lending -- was a way for households to get higher yields, but the authorities became worried by the explosion as banks' off-balance sheet assets which households perceived to be as safe as bank deposits. Beijing's efforts to de-risk that sector have killed some of these instruments completely – P2P – and lowered yields for others. 

As Beijing tries to boost household spending and growth after the disastrous 2022, it is misguidedly -- households are large net savers -- yet again guiding banks to lower deposit rates. 

Direct equity holdings (52% of household financial assets) have not been a great investment either. Chinese stock markets are often likened to casinos: very tempting for short-term speculative profit, but the wild fluctuations and no correlation to real GDP growth make it hard for individual investors to achieve consistent returns. 

Nonetheless, the share of household wealth managed by professional investors has increased, which is a positive development and is likely to continue. Lots of other reforms are underway to professionalise capital markets, including offering more diversified investment portfolio choices. All well and good, but the authorities under Xi Jinping have roped in Chinese firms to serve state priorities. Healthy firms buy up unhealthy ones and obey government plans for redistributing income and investment; and  investment abroad is still very limited.

As long as these state priorities trump genuine free market reforms, we expect at best household investment income to rise only marginally as a share of GDP.

The end of catch-up for labour compensation

Historically in China, one of the structural obstacles to consumer spending in the past was too much income flowing to businesses and too little to labour. Employee compensation consistently declined as a share of GDP, from China's entry into the WTO through 2011, as cushy jobs at state-run factories were phased out and the enormous rural migration kept wages low.

That changed in 2011, when the migrant labour force started to decline, workers got more bargaining power and labour compensation rose as a share of GDP. But this rebalancing is now near complete.

Since 2016 the rate of increase has levelled off, and the share of labour compensation is now comparable to that of the US. In other words, China has more or less exhausted the scope of catch up when it comes to labour compensation.

Mystery transfers

China to date has focused on increased transfers to households as a way of raising household income, and therefore, spending. These have had a positive effect on boosting consumer incomes, but are not an efficient way of distributing resources. Structural reforms have proven harder to accomplish.

That's why we've been so intrigued by an anomaly that has turned up in the data from 2018-2020. Enodo is one of the few analytic houses that pay close attention to sectoral financial balances. This time, we spotted a major discrepancy in the data. Further investigation showed these adjustments were made after the 2018 census data was published and are not as yet reflected in any of the Chinese data providers' numbers.

Enodo can reveal that substantial amounts of household income was added through government transfers in 2018-2020.The sums involved are quite large: equivalent to 6% of GDP in 2018 and 2019 and rising to 7% in 2020.

That's no small number!

Enodo does not yet have any further details about these transfers. Just getting to the right numbers took us a few weeks of detective work! But one intriguing explanation is also very troubling, in terms of what it reveals about the structural health of the Chinese economy under Xi. The years 2018-2020 were the peak of Xi's signature anti-poverty drive, in which cadres and SoEs were ordered to eliminate absolute poverty in China.

Communities (almost all of them in ethnic minority areas) were moved to new housing, factories created and any number of creative measures deployed, to give the appearance that poverty had been "solved". In some cases, companies and government officials simply resorted to cash subsidies to get every family in their district above the mandated income line. 

That the campaign was enormous and, also, economically highly inefficient was obvious from afar. But if these data reflect that campaign -- and we admit, it's a speculative "if" -- they provide the first look at the economic cost, and the difficulty, going forward, of maintaining the "progress" that was achieved.

Unfortunately, the household income and asset data necessary to evaluate these trends is always quite out of date for China. We are still working off 2020 figures for household income and sectoral financial balances, and 2019 figures for household assets.

But even so it is vital to analyse this data to evaluate whether the recent improvement in retail sales is the start of a sustained period of consumer spending growth or not. Worryingly, these mystery transfers are an early sign that politically-driven redistribution is the only game in town and the jury is out on whether this will lead to a higher share of consumption in output or not.

Conclusion

Xi Jinping's platform of "common prosperity", is, in some ways, Marxism-lite. As his third term in office unrolls, we expect to see government transfers as a share of income to continue to increase, and more redistribution of income from the wealthy to the less wealthy.

This redistribution will only succeed, in economic terms, if the boost to income and spending of the poor outweighs the hit to income and spending of the rich. In other words -- will it trigger a virtuous cycle of spending and healthy economic activity, or will it mire the state deeper in inefficient spending that detracts from public services like education, health and an organically vibrant economy. 

This is the big gamble that Xi has made.

Our verdict: it is too early to tell if "common prosperity" brings true common prosperity, in the form of stable and sustainable household consumption. We suspect not.