The Third Plenum's full 22,000-word resolution cemented our assessment that the vast majority of reforms to be pursued over the next five years were in line with Xi Jinping’s long-held preference for self-reliance in tech-innovation-led growth.

Unlocking the consumer potential of China's vast population, unfortunately, didn't receive the attention China's floundering economy desperately needs.

Beijing's blueprint for how to boost its enfeebled consumers did not get its own section, but several sections contained measures which will have a direct or indirect impact on consumer spending.

But these policies are likely to disappoint as Beijing fails to address adequately the most fundamental obstacle on the path to consumer-led growth: household financial repression.

Household financial repression makes it difficult for people to build and grow their wealth, prepare for retirement, or protect themselves against economic uncertainties. As if on cue, the surprise cut in short-term and long-term benchmark interest rates by China's central bank on Monday and Thursday, followed by banks trimming their lending and deposit rates, reinforced our assessment that Beijing continues to misunderstand both the nature of the economic dynamics and the direction of causation at play here.

Beijing's misguided redistribution efforts

Chinese households net interest-bearing wealth is close to one third of GDP, and interest-bearing deposits are over half of total financial assets and over one and a half times household disposable income. Hence, in China, cutting interest rates, which is one way to redistribute national income, reduces household disposable income.

Beijing is hoping that lower deposit rates would not only help bank margins but also incentivise households to save less in bank deposits, either buying goods, services or other assets. But as Chinese household wealth is dammed up at home and better trustworthy investment options are limited, the direction of causation has been the other way around -- low interest rates lead households to save more, not less.

Beijing needs to redistribute national income from corporates to households to kick-start the economy in the context of excessive corporate debt and meagre investment returns. But instead it has chosen to use the interest rate level to boost corporate income and spending.

The top leadership is intent on a different form of redistribution. The Plenum resolution says:

We will work to raise the share of personal income in the distribution of national income and give more weight to work remuneration in primary distribution."

But from an economic structure point of view, the primary flow of income towards households in the form of compensation of employees as a share of GDP is on par or exceeding that of developed economies. China's cheap labour force fuelled the initial phase of its industrialisation, but its shrinking migrant and then overall labour force gave labour bargaining power, helping boost the share of wages in GDP over the past decade.

From an international comparison standpoint, there isn't much scope for Beijing to focus solely on giving "more weight to work remuneration in primary distribution".

Instead, the authorities need to focus on boosting the income households derive from their wealth. Here, China is decidedly a laggard when compared with consumption-oriented developed economies, such as the US, although much less so when compared with mercantilist Germany.

But if China is to create its own sphere of geopolitical influence and not rely on the US consumer to supply the genuine final demand, then the only other entity which has the heft to do the job is its own consumer.

Not all ideas are in the wrong direction

Beijing may be squandering the opportunity to boost household incomes from assets cyclically by raising interest rates. But it seems to have the right idea about the need to increase its share in GDP over the long run.

We will keep the income distribution and the means of accumulating wealth well-regulated, open more avenues for urban and rural residents to increase their property incomes, and put in place systems to effectively boost the incomes of low-income earners, steadily expand the size of the middle-income group, and properly regulate excessive incomes."

The phrase "property income" used in the context of income distribution refers to all income from assets, rather than just income from owning properties. The authorities have initiated an important structural transformation which should, if successful, help decrease household financial repression -- capital market reform. 

We will improve the functions of the capital market to give balanced weight to investment and financing."

Beijing wants to change its equity market fundamentally by shifting its focus from serving the 'financing' needs of listed companies to helping investors manage their wealth. Up to now, its inherent speculative and short-term nature has made it akin to a casino where retail punters try their luck for a quick gain.

Instead, the authorities want a stable market which can provide adequate long-term returns to households.

We will facilitate the entry of long-term capital into the market...We will optimise dividend incentive...and improve the mechanisms for protecting investors."

Boosting dividend income is a positive move in both the short-term and long-term, but at present equities represent just over a tenth of household financial assets and just under a third of household disposable income. So while, if successful, professionalising China's capital markets and raising the share of equities in household wealth will pay off over the long term, it's not going to provide a lot of short-term bang for its buck.

Missed opportunities

A short-term lever the authorities could have used to unleash pent-up household money balances was the mooted equity stabilisation fund. Households were more likely to start buying equities if they saw a sustained increase, even if state-led, than a decline in the return on their bank deposits. 

But the idea for a substantial state-led boost to the equity market does not seem to have made the cut, while the growth in the supply of money has slowed to worrying levels, prompting us to end our positive tactical call on Chinese equities in late May. 

Another missed opportunity is the unwillingness to unleash market forces in the rental market. Property accounts for the bulk of household total wealth in China, but also earns paltry returns as the rental market is underdeveloped. Beijing made a direct reference to supporting housing rentals in the resolution, but in relation to affordable housing not rental income.

We will move faster to establish a housing system that supports both housing rentals and purchases, and foster a new development model for the real estate sector."

Several deeply engrained factors have held back the development of the rental market in China. When Xi Jinping first stated that "houses are for living in, not for speculation" in the spring of 2018, we argued that developing the rental market would be a good thing, and "if successful, it will give a sizeable boost to household incomes" but "the likely negative wealth effect from a stagnation in house prices will be a headwind".

In the event, the rental market reform failed to gain momentum, while the retrenchment in the real estate market, exacerbated by the pandemic, depressed house prices and delivered a sizable blow to consumer confidence. Household current wealth and wealth expectations plunged, increasing their desire to save out of income and curbing their spending. 

We have argued that Beijing's chosen Singapore model solution to China's housing market woes could work in the long run, and that the latest slew of property sector measures mark the bottom of the housing market. But China is far from a V-shaped recovery even though removing housing purchase restrictions in Tier 1 and 2 cities where there is no oversupply will help lift house prices in those areas. Working through the excesses in Tier 3 and 4 cities will take several years. 

The authorities continue to cap rental yields and view the development of the rental market in the context of providing affordable housing, and we do not expect this to change. 

Tax reform in support of consumption

Beijing feels more comfortable using the fiscal lever to redistribute income and its Plenum pledge is:

We will improve the redistribution mechanisms such as taxation, social security, and transfer payments."

But as we discussed in May last year, "large, unexplained government transfers to households in 2018-2020 explain all the increase in household income as a share of GDP". We now have the 2021 data, and the sums involved remain quite large: equivalent to 6% of GDP on average in 2018-21.

We also said that "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 remains the case. 

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.

Sure enough, the Party-state also pledges in the resolution to "explore avenues for gradually expanding the coverage of free education", "improve basic public services for childbirth and paediatric medical care, and further raise the childcare-related deduction for personal income tax" and contains provisions to support elderly care further.

The Plenum had one solution for how to pay for all this -- increase the retirement age. But realistically, government debt will need to rise. 

China's central planning department also disclosed this week that it is earmarking Rmb300bn this year for its "trade-in" initiatives, with about half the funds, amounting to about 0.1% of GDP, going to local governments to enact various incentives for consumers to trade in products like cars and white goods. 

The central government will use funds raised by selling ultra-long special sovereign bonds to fund this, and when the authorities unveiled this new type of bond in March this year, they said they expected to be issuing these continuously in coming years.

One other tax measure unveiled in the resolution also seeks to boost consumer spending. 

Local governments will be permitted to keep a larger share of consumption tax, thereby incentivising them to focus their policy efforts towards boosting  household consumption.

We will take steps to move excise tax collection further down the production-to-consumption chain, with the power of collection steadily being passed to local governments.”

This reform is an important signal to local governments that would work to align their incentives with Beijing's priorities. 

Lowering the household savings rate

As expected, the Plenum also focused on the perennial issue of the distortions that China's household registration system had created. 

We will push to see that eligible people who have moved to cities from rural areas enjoy the same rights as registered local residents with regard to social insurance, housing support, and access to compulsory education for their children living with them.”

and

We will see to it that all restrictions preventing people from accessing social security in the places where they live but do not hold permanent residency are lifted and that policies for transferring social security accounts are improved.”

Recent years have seen a progressive relaxation of the system, with one eye on its long-term abolition. The reforms are driven by an increasing official consensus that the system is a block on consumption. Xi seems to have come around to the idea. At the 2022 Central Agricultural Work Conference, he stated that the full entrance into ‘modernisation’ of the country’s several hundred million officially rural citizens will “unlock enormous creative energy and consumptive potential.”  

Providing all urban residents with equal access to public services will undoubtedly lower their precautionary savings and boost consumption. 

Employment security and a better return on their wealth, however, remain key cyclical and structural factors underpinning China's high household savings rate. 

On the employment front the resolution contained the usual commitments. But Beijing's efforts to 'de-bottleneck' the supply-side of the economy and its push for digitalisation and smart industry and logistics have come at the expense of creating substantial frictional unemployment. 

The leadership is gambling on the idea that 'de-bottlenecking' and pouring money into advanced manufacturing will revitalize the economy enough to absorb that displaced workforce and any bad debts that pile up on top of China's already excessive overall debt burden as uncompetitive firms fail.

Conclusion

In the opening section of the resolution on "Building a High-Standard Socialist Market Economy", the Party commits to fundamental reform rather than quick fixes to boost consumption.

“We will refine long-term mechanisms for expanding consumption.”

But how long can the serious debt deflation plaguing China continue before it starts to destroy the fabric of the economy and society?

China needs a strategy to inject short-term optimism like a defibrillator for its long-term reforms to to succeed, but it is currently missing. Worse still, its blueprint doesn't tackle household financial repression -- the key barrier to consumer-led growth. The central bank’s surprise interest rate cuts further exemplified Beijing's misinterpretation of economic dynamics, as lower rates ironically drive households to save more, exacerbating financial repression.

As Beijing is engaged in an all-out great power competition with America, the need for a new path of economic development has never been more urgent. 

Xi believes China’s scarce resources must be channeled into industries that enable it to resist and ultimately transcend U.S. attempts to suppress its rise. 

In Enodo's view, the success of Beijing's supply-side reforms will not be enough to place the economy on a sustainable growth path without the structural changes needed to create genuine consumer demand. 

The Plenum's resolution had some good policies supportive of the consumer, but as a whole disappointed.