The quest to understand Beijing’s views on consumer spending continues.
The latest: On August 13, China’s finance ministry (MoF) said it would bring down borrowing costs for service sector firms by providing them with rebates on their interest payments.
Curiously, authorities framed the measure – which is clearly designed to increase investment – as being an effort to boost consumption.
In this podcast, Trivium Co-founder Andrew Polk and Dinny McMahon, Head of Markets Research, discuss the idiosyncrasies of China’s consumption policies.
They discuss:
Why Beijing sees the path toward greater consumption as reliant on more investment
Why consumption support efforts are increasingly pivoting toward services
And why China’s authorities have opted to dispense rebates on interest payments, rather than just cut interest rates outright
Transcript follows:
Andrew Polk:
Hi, everybody, and welcome to the latest edition of the Trivium China Podcast, a proud member of the Sinica Podcast Network. I’m your host, Trivium Cofounder – Andrew Polk. And I’m joined again today, two weeks in a row, by Trivium’s Head of China Markets Research, Dinny McMahon. Dinny, how are you doing, brother?
Dinny McMahon:
Good, mate. You’ll be getting sick of me soon.
Andrew:
Yeah, not even possible. Not even possible. Good to have you back, man. So, we have Dinny back today because, after last week’s discussion on kind of the overall state of the economy, we wanted to touch a little bit more deeply on what consumption looks like in China right now, and specifically like what authorities are doing to boost consumption. And I think a lot of listeners will know this, but one key reason that we often focus on consumption when it comes to China’s economy is that boosting consumer spending is one key element in so-called rebalancing of China’s economy, which is moving, on a relative basis, away from debt and heavy manufacturing and overcapacity and exports towards more domestic demand, so that China is soaking up more of the products and services that it produces.
This, of course, is highly important for other countries. I mean, just yesterday, I was having a conversation with a U.S. government official, and we were just talking about how so much of the current trade tensions really revolve around the macro imbalances in China’s economy and, to some extent, the U.S. economy as well. But this is really important, not just for kind of how China’s economy evolves and grows, but its relationship, its economic and trade relationship with the rest of the world.
So, that’s one reason we want to get into it. And then additionally, as our readers will know, it’s mid-August, so it’s kind of quiet in China on the policy front. All the senior leaders are out at the beach at Beidaihe — their sort of secretive annual conclave where they get together and presumably talk about high-level policy strategy and things like that. So, not a lot going on. So, I thought it might be a good chance today to just step back and talk about a little bit of a higher-level topic, although we will talk about some of the most recent developments on this front as well. Specifically, we’ll touch on the latest marginal moves that officials have taken to support consumption, and specifically, services consumption.
We’ll talk about why consumption matters in the bigger story of China’s economy, which I already touched on a bit, but we’ll get into it a little bit more. We’ll talk about the latest push to boost services, consumption in particular. And finally, we’ll talk about what we think officials’ the long-term goal is for consumption’s role in the economy. Dinny has touched on this before, but I think he’s got a really smart framework on this, and is worth revisiting quickly at the end of the part. But before we get into all of it, Dinny got to start with the customary vibe check, man. How are you doing.
Dinny:
Well, mate, the kids go back to school next week. So, on the one hand, it’s a relief, but on the other hand, it’s kind of mourning the end of summer. I mean, I know we probably still have a few weeks left in Chicago, at least a pretty hot weather, but still, it does kind of feel that we’re in countdown mode. So, yeah, I’m in mourning, mate. I’m in mourning for the end of week in the summer.
Andrew:
Yeah. That’s fair. My vibe is relaxed. I’m going to be, not off, but out of the lake house next week with some of my wider family — my parents, of course, my immediate family, and my sister and her husband and their baby. So, looking forward to that. And also, it is kind of the last gasp of summer. I will be working, but only the minimum that I can do. And we will have a pod next week. We’re going to record the pod tomorrow. So, it will be another kind of step back, but we will have a pod next week. So, for listeners who hear that I’m going off and start to have heart palpitations, don’t worry. We will be in your feeds next week. So, those are the vibes — relaxed and mourning.
But before we get into the rest of the discussion, of course, got to do the old housekeeping. First, a quick reminder, we’re not just a podcast here. Trivium China is a strategic advisory firm that helps businesses and investors navigate the China policy landscape. That includes policy towards China out of Western capitals like D.C., London, Brussels, and others. So, if you need any help on policy towards China out to the West or policy in China that’s going to impact your business or your fund, please reach out to us at hq@triviumchina.com. We’d love to have a conversation with you about how we can help out. Otherwise, if you’re interested in receiving more Trivium content, check out our website — triviumchina.com. We have a bunch of different subscription products, both free and paid.
You’ll definitely find the China policy intel that you need on the site. We have a bunch of different things geared to different levels of interest, different types of interests, from tech policy to investors and hedge funds to net zero, people interested in the net zero transition. So, go check that out. And then, finally, please do tell your friends and colleagues about Trivium, both about the podcast so we can grow the listenership, and also about the business so we can grow our business, do more cool stuff, put out more free content to all of our listeners and readers on the free side, and do even more interesting stuff for our paid subscribers as well.
With that, let’s get into it, Dinny. I think I do want to start… we’ve talked about consumption a bunch on the pod. I touched on it again at the beginning in the intro, but just talk a little bit about why we focus so much on consumption and why you think consumption is so important to this specific moment in China’s economy, and, more specifically, to how kind of Chinese policymakers are sort of thinking about it? Why are they always talking about consumption?
Dinny:
Well, it’s so important at this particular moment because China needs a new economic model. Well, more specifically, the old economic model is dead. So, for 20 years, the driver of economic growth in China was the housing market, housing construction. And that was supported largely by infrastructure construction. And the following effects of that, well, it required steel factories, glass factories, cement production, excavators, the whole thing. So, you had a model driven by investment and specifically by housing demand, and more broadly by a growing population. That’s kind of what made it year-on-year expansion of housing construction and infrastructure construction viable.
China’s population topped out, I think, in what, 2022, and it’s downhill all the way from here. So, China will never again require as much newly constructed housing as it was building in the 2010s. So, it now needs a new economic model. And if you kind of look at the three major components of any economy, it’s investment, consumption, and exports. And, of course, in this geopolitical environment, it’s a bit of a risk to rely on net exports as a major driver of growth, particularly for a country as big as China, which is already such a huge exporter and already has such a huge economy.
Because to even extract a 1% increase in GDP from exports, net exports, it requires a really significant increase in the rest of the world’s potential, or a willingness to absorb Chinese goods. Of course, investment, there are limits to how much that can drive growth these days because of the end of the housing boom and because local governments are so financially overstretched. Relying on them to keep funding more and more infrastructure is really not a good idea. And so that kind of leads as the third and most important piece, really, consumption.
And it’s so important because consumption has been a relatively weak contributor to Chinese economic activity for more than 30 years. And so, there is this real potential for perception, at least, that, look, if we can just get household spending more, getting them up to levels comparable to other countries of a similar GDP per capita around the world, well, that would help drive growth. It would provide China with a sustainable, relatively stable source of growth to replace housing and infrastructure. So, that’s why Chinese officials talk about it so much at the moment. That’s why it’s so important for China to kind of come up with a way to boost consumption as a way to really provide balance. Balance to an economy that can no longer rely on its former drivers’ approach.
Andrew:
Yeah. So, you’ve talked to the structural piece very eloquently, but can you also just quickly let our listeners know, how does the sort of pandemic and post-pandemic period play into this? There’s kind of this wider need to come up with new structural drivers of growth. But also consumption has not really bounced back to just sort of what we call a normal level trend growth, whatever you want to call it, post-pandemic. How do those dynamics play in?
Dinny:
It’s an interesting point because initially, everyone, and I mean, from foreign observers and economists to the Chinese leadership themselves, everyone assumed that once China got rid of its zero-COVID policies, got rid of the lockdowns, that after a short period of time, consumption spending, household spending would just come roaring back because it really took a hit during the pandemic years, and particularly in 2022 when city of the city was kind of in this revolving lockdown. So, there was a sense of like, okay, China’s public, they massively ramped up their savings. Now things are going back to normal. Not only will spending go back to normal, but we might even get a boost in 2023, as what people were kind of calling revenge spending. We’ve been locked up for a year, which saved a bunch of money.
Now, we’re just going to go out and spend to make up for lost time. But that didn’t happen, and neither did the expectation that spending would just go back to normal. So, what was originally presumed to be the direct impact of COVID and the pandemic and the lockdowns, over time, it’s become far more clear that something actually happened during the pandemic years to affect spending as opposed to the pandemic itself being responsible for the long-term sluggishness of household spending.
So, what is it? What exactly happened during those three years? There’s a bunch of potential explanations. Most of them, in one way or the other, come back to the housing market. So, on one level, household wealth is taking a massive hit because houses are just not worth as much as they used to be. So, China’s middle class just does not feel as well off as they used to. On top of that, there’s just not as much construction activity going on anymore. And so, people who used to have, you know, particularly migrant workers who used to have good, well-paying construction jobs, have had to take jobs elsewhere, mostly in the services sector, often in smaller cities where they’re getting paid less.
Then you have kind of the knock on effects of the property sector, which means, well, you know, specifically we’re talking about local government finances here because the local government debt structure, the sustainability of local governments debts and their ability to borrow more and more, and even to maintain their annual budgets, were in large part dependent on local government’s ability to sell land. And that has absolutely collapsed since 2001. And that has had some really interesting consequences. Specifically, I think often people look at China’s local government debt problem and go, “Oh yeah, we’re just waiting for the crash.” That defaults are going to happen one day, and then there’s just going to be knock-on effects, and it’s going to be a big financial mess.
The reality is the problem of Chinese local government debt, the risk here isn’t default, isn’t some massive financial crisis. What it is, is austerity that the local governments, and this isn’t a potential risk. This is exactly what’s happening at the moment. Local governments, rather than defaulting on their debt, have massively paid back their spending in a lot of key areas in order to ensure that they’re able to meet their debt obligations. So, throughout the country, you’ve got a lot of state employees who aren’t getting paid on time, or they’re not receiving their Social Security benefits, or they’re being forced to take pay cuts, or they’re not getting their bonuses. And then, on top of that, you’ve got government suppliers and contractors throughout the entire country are just not getting paid.
So, you have this sort of austerity effect that because it’s a direct knock-on effect that the housing market collapse, which happened 2020/2021, local governments are engaged in austerity policies, which are having a real dampening effect on consumer, on household spending. Additionally to that, you’ve got a whole involution overcapacity problem because even though China’s manufacturers are churning out nearly manufactured goods like it’s nobody’s business, profits are getting squeezed. And so, that means that companies are not providing pay increases like they used to.
Often employees have been forced to take pay cuts. If they haven’t had a pay cut, then they’re probably not getting their bonus. And there’s a huge sort of wave of job insecurity that’s sort of emerged as a result of this sort of a surge in manufacturing that’s resulted in overcapacity pressures. There’s probably a bunch of other things going on as well. I’ve got a short list of stuff that’s affecting consumer sentiment, but they’re probably the three big things that ultimately this stuff falls happened during the pandemic years. And when we came out expecting that things would get back to normal, they weren’t going to get back to normal because some very fundamental structural characteristics of the Chinese economy changed in a way that really has put a real dampener on consumer confidence.
Andrew:
Great explanation. Thanks for that. Despite the fact that, or maybe even on top of the fact that there are these huge both structural and cyclical headwinds to consumption, officials keep talking about the need to get consumption up, but the moves that they’re making to boost consumption or support consumption seem very marginal. We’re going to talk about sort of the most recent moves, marginal though they are, and talk through what we think the implications are and what authorities are trying to achieve. So, this week, the most recent move was that the Ministry of Finance introduced a new policy to reduce borrowing costs for consumers and service sector firms. So, service sector firms are now entitled to a one percentage point rebate on business loan interest payments, covering loans up to 1 million renminbi.
And this is for firms operating in catering, accommodation, health care, elder care, childcare, housekeeping, entertainment, tourism, and sports sectors. And then, on top of that, households will, or separate to that, households will enjoy a one percentage point rebate on consumer loans up to 50,000 renminbi. So, the Ministry of Finance will cover 90% of the interest rate subsidies, with provincial governments making up the remainder. And these subsidies will last for 12 months. Dinny, can you talk us through, sort of, so there’s the consumer side and the services side, you know, what’s going on, on the consumption side here first? How does this fit into kind of the policy moves that have been taking place over the past couple of years?
Dinny:
So, on the consumption side, this is what we think is happening. This kind of goes a long way to explaining the timing. In March last year, Beijing rolled out this consumer trading program that if you go but go buy a new dishwasher, if you trade in your old dishwasher, you get some sort of discount. But initially, Beijing didn’t really provide any subsidies. It was only until the second half of the year that it said, “Okay, okay, we’re going to provide 150 billion renminbi’s worth of subsidies to kind of get this thing moving.” And so what we saw in September, that was really the first time that we saw a sort of real expansion in sales of goods that were covered by this trading program.
So, we’re talking white goods, we’re talking to furniture, and we’re talking cars. And so September last year, that’s when this program really started to pick up some steam off the back of government subsidies. So, they had the government subsidies last year. And then they rolled out an additional 300 billion renminbi of subsidies this year. Now, the thing is, though, after a year of subsidies, so like September this year, the government will be in this situation whereby, to sort of boost growth beyond last year’s level, it really has to provide even more subsidies than it did last year. Right? So, this whole program is designed to sort of bring forward demand from future years. In September last year, it brings forward people who wouldn’t have otherwise have bought a dishwasher in 2024.
Instead, maybe they would have done it 2025, 2026, maybe even 2027. They go, “Okay, it’s now sufficiently cheap. I’m going to buy it this year rather than in two years’ time when there aren’t going to be subsidies.” So, fast forward a year. We’re now in a position of people who would have bought at two years, at 2027 or whatever, have already bought that dishwasher. So, the government kind of needs to bring demand forward from even further forward in the future. And so, after a year of this, for the government to maintain growth, they’ve got to stop providing more and more bigger and bigger subsidies.
So, they could do that. But I mean, really, where does it stop? Do they keep doing that year on year for the next many years? So, what they seem to be doing is pivoted a little bit. And this is the interest rate program you just talked about then, Andrew. So, we’ve got the existing subsidies and, in addition to that, we’ve now got this incentive for people to borrow to now be able to buy white goods and pretty much anything they want. And the government will subsidize interest rates to get them to do it. So, that seems to be what’s happening that we’ve had a year of these consumer goods subsidies. The program needs an additional boost rather than just ramping up more government funding in that specific program.
We’ve had a variation, a diversification of the approach. And they’re trying to leverage interest rate subsidies to kind of get a far bigger scale of borrowing and, by extension, yeah, consumer good purchase is growing.
Andrew:
So, before we move to the services piece of this, I mean, what do you think of the pivot to borrowing to incentivizing consumer loans? It strikes me as a somewhat dangerous policy path, and one that has always kind of been out there is a discussion for, I would say, kind of as long as I’ve been covering China. This idea that China needs to get consumption up has been around for a long time. I mean, when I first started my job at The Conference Board in 2011, we were writing about the need to get consumption up. And officials were always kind of like, “Well, we can always get it up, like get consumption up. There’s a high savings rate. We can tap into that. We can always just boost consumer borrowing.”
Now, since that time, so 15 years, 14 years, the level of household debt, not just on the property side, but just consumer debt has risen substantially. So, there’s less kind of room to build up debt. But also the officials always kind of talked about it as you really only get one shot to pull the consumer debt level, because once you leverage up households, you can’t keep leveraging them up. Otherwise, you just end up in a situation like we’ve been in, in the U.S. where households become overleveraged. So yeah, this might support consumption, but it seems like a weird way to go about it to pile on debt or to incentivize the increase of debt in the household sector. What is your thought there?
Dinny:
Yeah, I think you’re right. But I’m also really interested to see just how successful this is because in this environment, for all those reasons I explained before why people aren’t spending, in that environment, are people really willing to take on more debt for consumer goods just because the cost of borrowing went down? I think this has always been a bit of a question hanging over China’s interest rate policy at the moment is, is the PBoC pushing on a string? If it cuts interest rates more aggressively, just how much more of a stimulatory effect will it have on the economy?
Usually, we talk about what it means for corporations and the industrial sector, but I think the question is equally pertinent to consumers. In this environment of like consumer confidence, where people are worried about their incomes and jobs, do lower interest rates, because, effectively, that’s the sort of the net effect of these interest rebates are going to have. Are lower interest rates going to result in people willingly borrowing more to buy consumer goods? I mean, clearly, the authorities think it’s a great idea and it’s going to happen. But I think we have to wait and see to see how people are wired,
Andrew:
And also not a sustainable way to boost consumption by any means. If people have to borrow to consume, they can’t just keep borrowing and borrowing and borrowing. So, I don’t know, I’m not the biggest fan of this policy, but we’ll kind of see how it rolls out. This is the way they’re going for now. But there’s a second part of this policy, which is towards the subsidies on interest rate payments for service sector businesses. Talk us through that, what you think’s going on on that side.
Dinny:
That’s interesting because the authorities are framing this effort to encourage service sector businesses to borrow and invest as a proportion consumption measure. So, it’s all about consumption, even though the direct impact of these measures is to encourage investment, which seems a little bit crazy, but it kind of gets to the heart of something that’s very central to the Party’s thinking. And listeners to the podcast world have heard me talk about this concept of latent demand before. And this has really been at the heart of Beijing’s efforts to promote consumption, really, since the end of the pandemic. They have this idea that there is this huge amount of the latent demand among the Chinese public, and that the Chinese public would be willing to spend far more than that currently spending, not if they had more money, but if they only had access to the sorts of things that they’d really want to spend money on but they don’t have access to.
And I appreciate that’s kind of a strange idea, and I know I’ve talked about this before, but it bears repeating — That the way I really got my head about it is when I saw what they were trying to do with electric vehicles a couple of years ago. There was a sense, probably in around 2003, that high electric vehicle sales in the cities had been really going well. But when government subsidies peter out, will we be able to maintain growth? What we really need is an additional market. And the question was, how do we get rural areas, people in rural parts of the country to embrace electric vehicles in the same way that cities have? And the idea was like, well, maybe they’re a, well, not maybe, but clearly there are some barriers standing in the way of people in rural areas using an electric vehicle.
In city areas, there are charging centers, charging piles all over the place. It’s relatively easy to ensure that you can recharge your vehicle, but in rural areas, it’s a little bit more risky. That infrastructure doesn’t exist. And so, Beijing’s approach was, okay, to unlock this latent demand for electric vehicles in rural areas, what we have to do is remove the institutional barriers that stand in the way of people who want an EV from actually buying an EV, and those barriers were the lack of infrastructure. And so, I think, starting in 2023, I think it was a real campaign by the government to push the construction and installation of EV recharging infrastructure outside of China’s cities.
So, whether that was a success or not, it’s kind of beside the point. My understanding is that rural areas have mostly embraced hybrids rather than really getting on board with pure EVs, but that’s kind of beside the point. It’s a really telling example for understanding what this idea of latent demand is. That there’s a bunch of stuff in China that people would buy, but there’s some sort of barrier standing in the way. Sometimes it might be infrastructure like charging piles or people in rural areas not being able to fully enjoy the benefits of e-commerce because there aren’t adequate settlement centers outside of the cities. Or it might be because of a trust issue. So, Chinese people often don’t trust foods and supplements and whatnot that are made in China. And so, the government’s trying to deal with that by improving, monitoring, and supervision, sort of things like this.
There are things that sort of stand in the way of people buying and consuming more, and China has to deal with it. Now, up until probably the end of last year, I would have said the focus on unlocking latent demand was very much on goods. Getting Chinese people to buy more stuff. But, certainly, this year there’s been a real pivot, and it’s no longer about unlocking the latent demand for people to buy cars and things on e-commerce platforms and supplements or whatever. Focus has very much shifted towards services, and that’s what this policy is aimed at doing. The idea is that you reduce the cost of borrowing for service companies so that they can invest in providing of services that the Chinese public want. And once they’re in place, then you’ll boost consumption because people will finally be able to spend money on the things that they now finally have access to.
Andrew:
Thanks for laying that out. And now it also strikes me that this pivot towards services makes sense on the back of what they’ve done with the consumer goods trade-in program recently, which is, you know, they started it very limited. It was focused, I think, like you said, on white goods and autos, but they expanded it in particular to electronics, you know, tablets, cell phones, mobile phones. So, they started in one area, and once that started to run its course and people had bought the things they wanted to buy, they expanded it to other consumer goods. And then the next sort of logical step is, okay, everybody’s bought all the goods they want, now let’s incentivize them to buy services. And the “nice thing,” I guess, about services is that you do replicate the spending over and over.
It is a little bit more, I don’t know if sustainable is the right word, but it’s replicable, right? Like, you might just buy one toaster or one dishwasher or one car in a two or three or four or five-year time frame, but you’re going to go out to a restaurant multiple times. You may go get your haircut, join a club, go golfing, whatever it is, right? Those are replicable expenses. You think that’s playing in here at all?
Dinny:
Yeah, I think so. But I think the reason that they’re really coming at this is they kind of look at other countries and they find that look, as countries get richer, they just spend the bigger and bigger share of their incomes on services. I mean, the breakdown of the economies starts to become more heavily weighted towards services. So, I think China’s economy at the moment, or at least in 2004, now, what? 56%, 57% of GDP was generated by value-added services.
Andrew:
2024. right?
Dinny:
2024, pardon me. And that’s pretty comfortable for a country of China’s per capita GDP. But if you look at richer countries: Japan, Singapore, the United States, it’s up to about 70%. France and Germany, somewhere in the mid-60s. So, there’s certainly a real trend towards, as a country gets richer, the roll of services just takes on a greater role in the economy. And, certainly, there’s been a bunch of academic research in China at the moment, just trying to make a point that, look, China’s households really aren’t going to spend much more on physical goods already. There’s been this argument that even though China consumes the relative proportion of goods and services in the household spending in China is kind of comparable to other countries with a similar GDP.
In fact, China probably is, Chinese households are probably consuming far more goods relative to those other places because goods in China are just so much cheaper because everything is made in China. And so, people have a goods consumption-level bar higher than what the data would actually suggest. And so, that there is this real potential for a rebalancing towards services.
And so, I think that’s kind of where they are at the moment. They’re like, look, there is some real tension here, both as the economy grows and becomes richer. And even at this level of income, we can probably shift to services in a far greater way and really meet people’s demands that aren’t being met.
Andrew:
You’ve written a little bit about how sort of the five-year planning cycle fits into all of this. In terms of 2016 to 2020, there is a focus on services and value-added services. Talk us through that. And then there’s sort of a shift back to manufacturing. Talk us through that and what to expect, now that we’ve got the next five-year plan, you know, period coming up on us in October, how will all that fit together?
Dinny:
Yeah, it’s interesting. In the five-year plan for 2016 to 2020, the government actually set an explicit target for the share of services as a part of the economy. They wanted to say it increased by, I think, it was three or four percentage points. So, very explicitly wanted to see services grow faster than manufacturing and industrial production. So, it was like, okay, this is going to be a driver of growth. We see the real value here. And then for the next five-year plan, which is just wrapping up now, so 2021 to 2025, no one mentioned of guarding services at all. Instead, there was a real pivot back to manufacturing and sort of a very explicit statement that, at the bare minimum, we have to maintain manufacturing at the current level of GDP.
I mean, implicit to that was like no more services growth. Now, given the way that officials are starting to talk about services and unlocking demand and whatnot, I think when the next five-year plan comes out next year, we’re going to see a shift back. There’ll be a recognition that we can’t continue just to rely on more and more manufacturing. There has to be a reorientation towards services because there is real potential there.
Andrew:
When we talk about services, it’s a very broad term. What do you think specifically authorities will be focused on trying to grow? What specific types of services?
Dinny:
It’s pretty much almost anything you can think of, but I think just to refer back to the special action plan on boosting consumption, which the government rolled out, I think in, or I’m going to say April, they have a lot of very specific areas in that. And so, tourism — huge part of it. Everything from boosting the sale of RVs, recreational vehicles and motor homes. I mean, that seems like a good purchase, and on one level it is. But the vision is that this is a type of tourism. You get people to buy the thing, you know, encourage tourism. They go around spending money in the country, as I said, sort of, do road trips. Another big area — cruises, what they call the snow and ice economy, which is about getting people out to ski resorts. Wanting to develop a rental car industry, again, kind of people having more of the sort of self-managed holiday. Sports, another big area. Entertainment, they want more things like music festivals.
And, of course, the other really big thing is what I call the silver economy. So, all the additional services that people are going to acquire as China’s population ages. So, that’s everything from aged care facilities, health care, when people say things like housekeeping aged care, that’s elderly people living long life and their children, buy dogs and cats, and even education and entertainment. So, it really is everything you can think of. But that kind of gives you an idea of some of the specific things that the government has actually talked about.
Andrew:
Yeah, that’s a great point. And on the silver economy piece, I also just wanted to bring in one other thing, which is incremental, but also pretty tangible, and also, I think, may help this issue of unlocking some latent demand, which is on August 6th, the State Council released an implementation plan to roll out free preschool education, which it’s been talking about for a few months. And this just suddenly, like, really started to steamroll ahead. So, the government introduced the initiative in March in the Government Work Report. And then, in late July, the State Council promised to kickstart the program, but they just released the details in early August. So, the details are, starting in September, fees for school children in their final year of public kindergarten will be abolished.
Those attending private kindergartens will receive equivalent of these subsidies. The scope of the program will be expanded in the future, though no timeline was given, and the central government will cough up the majority of subsidies, providing 80% of funding for poorer western provinces, 60% for provinces in central and northeastern China, and 50% for the remaining provinces. These are just some tiny numbers here.
So, preschool education fees vary widely, of course, across provinces. But based on an average monthly cost of RMB 500 and roughly 10 million children in their final year of kindergarten, this initiative can save households 600 billion renminbi annually to spend, which they can spend on other goods and services. The little weird thing that they’re initially targeting children in their final year of kindergarten because it will have sort of a negligible impact on birth rates and would have a much smaller impact than could otherwise be on new consumption on services and goods. Do you see this as part of all the piece with what we’re talking about so far, Dinny?.
Dinny:
Yeah, a little bit, because we’ve gone back to this, the latent demand idea, there clearly is lighten demand. People desperately want a whole bunch of services, and they want it to be affordable and high quality. So, childcare, kindergartens, that’s one of it. Probably another great example. They want affordable, high-quality aged care facilities for their parents. As China gets older, people desperately need somewhere where they can be insured or they can take care of their parents health and well-being. The thing is those sorts of facilities don’t exist at a standard, at a price point in a volume that is really required. And so, they need to be built. So, there is a real rationale behind giving service companies the financial resources to be able to build stuff so that you unlock latent demand.
But the thing is the stuff that people really want more of, which is health care, aged care, and what you were talking about, the kids’ education, so much of that is too expensive to pay out of pocket, right? So, people desperately want more childcare. But the thing is what they really need is it’s less of they need more supply, and what they really need is they need the financial help to be able to pay for it. And once they have the financial resources to be able to pay for it, hopefully with government backing, then the supply will come to meet the demand because the demand is only really going to emerge once people feel as though they’ve got the financial resources to be able to pay for it.
So, I think that’s really capable to get people at least in mind. When it comes to latent demand, it’s not just about availability, it is about people’s ability to afford it. So, in other words, it’s not just a supply issue, but it’s a wealth redistribution issue. So, all the other stuff I was talking about, you know, skiing, holidays, cruises, pet care, and music festivals, these are things that people would like to have, but they’re not going to spend on this sort of stuff as long as consumer confidence is low.
So, it’s not a question of supply. It’s not a question of the government building all this stuff and unlocking latent demand. It’s really a question of confidence. But I think Beijing knows this. And so, this whole effort to unlock latent demand, what I think it’s really about is it’s about increasing investment now in the expectation that it will create economic activity, which will create jobs, it’ll boost confidence, and thereby it will create the demand that doesn’t currently exist. So, it’s not purely about unlocking like demand. It is about creating the conditions under which people are willing to spend by generating economic activity through investment now. And the thing is, this is really just a variation of the same economic model they’ve been using for 30, 40 years. They used to build housing, infrastructure, manufacturing, and they’re pretty explicit about it.
Andrew:
Build it and they will come, kind of, thing
Dinny:
Exactly. Literally, that if you build it, they will come. Because the idea is if you build it, you are going to create jobs and perhaps you’ll create pay raises and bonuses, and you’ll create all this economic activity that will create the boost in confidence, the environment in which people are willing to spend. And when they are willing to spend, lo and behold, you’re going to have a bigger range of services than were available before. And people will then be willing to purchase it. So, I think that’s kind of what’s going on. Of course, it’s a little bit tricky, makes a lot of sense doing this sort of stuff with housing and infrastructure and manufacturing because there’s a lot of state involvement in these areas.
So, you can kind of push credit into those companies, and they will invest. And if the loans go bad, then there’s a whole lot of ways to kind of smooth things over. But with services, firms are mainly small and they’re mainly private sector. So, the question is, can you really get them investing in new markets that are untested during a period of weak consumer confidence in the hope that they will help kind of get the economy going again? And I think it’s a bit of a long shot.
Andrew:
Well, thanks for that. This all seems like a very kind of convoluted, roundabout way to get consumption up both of goods and services. We’ll see how it pans out. I just have one final question for you before we wrap up, which is, why is the Ministry of Finance providing these interest rate subsidies? Why not just cut interest rates to boost borrowing among service companies and consumers?
Dinny:
No, it’s a great point, right? Because when you’re giving somebody a one percentage point rebate on their interest payments, you’re effectively cutting their borrowing costs by a percentage point. So why not just cut out the middleman and cut interest rates? And I think the reason is the PBoC, at the moment, feels like it’s trying to manage a two-speed economy. On one level, it is dealing with involution and overcapacity. And it’s dealing with the property crisis and whatnot. And it doesn’t want to exacerbate those problems, encourage additional construction, encouraging further investment in the manufacturing sector by cutting interest rates. If anything, I think it sees that as being a benefit in having interest rates at a higher level in the hope that will kind of exert a pressure on the economy and help weed out some of that excess capacity.
It’s not necessarily working that way. But, certainly, cutting interest rates would make it more difficult to get rid of that sort of excess capacity. And so cutting rates would be great for the consumer sector, and it would be a great way to encourage investment in sort of the service quality. But it’s wary of doing that, while cutting interest rates while boosting those parts of the economy will also help support those other parts of the economy that it doesn’t want to provide a leg up to. So, I think that’s what it’s trying to do here. It’s managing a two-speed economy, and it’s doing it the best it can.
Andrew:
Yeah. Well, as we said last week, the economy is performing much better, I think, than officials kind of thought maybe at the beginning of the year, definitely than I think a lot of people outside of China thought it would happen. But, as you say, that at the very least, it’s a two-speed, if not a four-speed economy. So, just because it’s performing better than expected doesn’t mean there are pockets of weaknesses and challenges. And so, this is an ongoing, as we’ve seen for several years now, issue that they will look to be addressing — this being consumption generally and service sector consumption in particular. But we’ll see how these moves impact the macro economy going forward.
We’ll continue to stay on top of it, analyze it as developments take place throughout the rest of the year. But for now, Dinny, thanks for the great discussion. Really appreciate you being back two weeks in a row, man.
Dinny:
No worries, Andrew. It’s been great to be back.
Andrew:
Yeah, thank you very much. And thanks everybody for listening. We’ll see you next time. Bye, everybody.
Share this post