Published 18 March 2025
China is reaching the limits of its investment-led growth model. Not even the Chinese leadership disagrees with the breadth of economic analysis that show the limits of the declining returns on China’s investment, sustained at the expense of the economy’s abnormally low consumer spending. For years, Beijing has vowed to rectify imbalances in its economy. But it can’t do so without heavy political cost.
In a “people-centric” economy, as opposed to a “state-centric” one, economic activity uses market forces to maximize and balance the utility of consumers and producers. Investment and saving represent postponed consumption. Households save to facilitate greater consumption in the future or be able to maintain consumption when they can no longer work.
Through the prism of classical economics, China’s economic rise has been far more abnormal than any other economy bred by market forces. This is because household consumption has significantly lagged the growth in the economy over the past 50 years and secondly, because the vast savings pool that households have accumulated is not generating the sort of economic returns that will facilitate rapid growth in the overall economy.
In 2023, Chinese households’ total consumption was US$6.96 trillion, which amounted to 39% of gross domestic product (GDP). By way of comparison, household consumption in the United States was US$18.82 trillion (68% of GDP), almost three times that of China. On a per capita basis, US households consume 12 times the nominal dollar amount of their Chinese counterparts on average. Even purchasing power adjustments leave per capita consumption by the household sector in the US at about seven times the China equivalent.
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Nor is it just relative to the United States that Chinese household consumption lags dramatically. In Hong Kong, with similar cultural traits to mainland China, household consumption is currently 70% of GDP. In Japan, with many similar macroeconomic attributes, household consumption at its lowest was 46% in the early 1970s but had risen to 50% when Japan’s asset bubble burst in the late 1980s and has risen steadily to average about 55% in the past decade. At 39%, China is a significant and persistent outlier, the more so for how large its economy has grown.
Several factors contribute to China's high savings rate and low consumption. One key element is the undervalued exchange rate, which encourages exports over domestic consumption. Additionally, China's economic planning system prioritizes state objectives over market signals, further skewing production towards capital goods rather than consumer goods. Despite a significant pool of household savings, which should theoretically support consumption, Chinese households continue to save rather than consume. At the same time, state-directed interest rates on household savings are kept low to support state-backed banks, resulting in poor returns on savings and discouraging consumption.
No less than a deep restructuring of the way capital is allocated in China would be required to reform the economy. But the political obstacles to implementing such a deep set of reforms are very large. A market-driven allocation of capital, where the state’s role is diminished, requires the free flow of information and price signals from the market. This remains at odds with the desire to allocate capital toward the Party’s economic priorities.
China is well placed to implement reform, if it chooses to do so. For example, the government sector could reduce its investment spending and increase social transfers in kind through government expenditure on healthcare and education. This would have the immediate impact of reducing overall investment and putting more money into the hands of consumers. In addition, the government could reduce the taxation of consumption and correspondingly reduce industrial subsidies. More contentious and over the longer term, a structural overhaul of China’s fiscal system to make the aggregate taxation system more progressive would increase the propensity to consume. The reluctance to drive such reform calls into question whether the challenge is simply a matter of changing policy makers’ “mindset,” as Chinese Premier Li Qiang has recently suggested, or whether the Party-State can withstand the inevitable consequences.
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Stewart Paterson is a Senior Research Fellow at the Hinrich Foundation who spent 25 years in capital markets as an equity researcher, strategist and fund manager, working for Credit Suisse, CLSA and most recently, as a Partner and Portfolio Manager of Tiburon Partners LLP.
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