China's Great Rebalancing Continues

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As we've explained in previous issues of Trends, China will be forced to radically transform itself if it hopes to become more affluent. The problem is that household consumption accounts for only around 38 percent of China's gross domestic product.1

To put this in perspective; Chinese household consumption as a share of GDP is barely half that of the United States, where it typically accounts for about 70 percent of economic activity. It's also well below the prevailing rate of roughly 60 percent for other large economies in recent years, such as Brazil, France, Germany, and India.

An economy can only grow so big and so affluent by relying on exports and capital investments. Now that the country's investment-led model is reaching its limits, consumers have to begin picking up the economy's slack, if China is to sustain its economic growth.

China's solar panel industry — referenced in the What Happed to All of Those Green Jobs? Trend — is a classic example of massive investment outstripping demand. In barely a decade, the industry went from nowhere to a position of dominance: The 10 largest Chinese photovoltaic manufacturers today account for more than 60 percent of global solar panel production.2

The problem is that this growth was almost entirely export driven: In 2010, 96 percent of solar panels made in China were exported, and in 2011, that number was 88 percent.3 Banks showered these private-sector companies with loans as part of a post-2009 stimulus program, and that led to oversupply and sharply lower margins.

Similarly, China has accumulated massive capacity in state-owned heavy industries, only to discover repeatedly that such an investment-heavy strategy is both economically and environmentally unsustainable. Environmental crises are increasingly common, income inequality is widening, and the use of cheap credit and state-driven subsidies has sharply accelerated the country's debt levels, leading to fears of potential financial distress.

As the government acknowledges, China's economy must rebalance by reducing its reliance on investment and increasing consumption. Doing so while maintaining growth and stability requires both economic and political changes. Firms and executives must consider the likelihood of changes on both fronts when crafting China strategies for the next decade. That means understanding the likely promise — and peril — of China's great rebalancing.

As highlighted in a recent article by McKinsey and Company, the country's leadership has already taken some tentative steps toward shifting China to an economy centered on household consumption...

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