Boosting China’s Domestic Consumption: Tax cuts or government spending?

Since the onset of the current downturn, there have been constant mentions of the need to boost domestic consumption to compensate for the drop in world consumption, particularly so for countries that are heavily reliant on exports to drive their economy. It is a good suggestion although I have to qualify that any country considering it must meet one obvious prerequisite: a large domestic market.

With its population size of 1.3 billion people, the Chinese leaders can confidently proclaim that China meets this prerequisite without any difficulty. The next step? Urge its population to spend x yuan more than their initial intended consumption (x being the drop in the world’s demand for Chinese goods) and voila, the economy is still clocking its double-digit growth. Is it that simple? Unfortunately, not really.

China’s dependency on exports consequently means large proportion of its population is employed by both local and foreign companies that cater to international demand. A slump in international demand means fewer revenues or even losses to these companies and hence, cost-cutting measures such as retrenchments which inadvertently lower the spending power of the population.

To cut a long story short, there is a positive correlation between world’s demand for Chinese goods and spending power of the Chinese population. When the world’s economy shrinks, so does the pocket of the Chinese man walking down the street. And that is excluding the fact that Chinese are savers by nature, even when times are good. Great speeches without government intervention, it appears, will unlikely create the desired effect. Do the Chinese leaders have any plans on hand?

As a matter of fact, they have 2 options and they seem to be exploring both, though I am not sure if comparing their level of contributions to domestic consumption is part of the plan. Firstly, announcing tax cuts which essentially put more money in the pockets of the people in addition to reducing the total price of certain goods. Secondly, increasing government spending whose multiplier effect may also spur more spending by the people. To me, it is more of a question of trust. The first option means trusting its people to spend and the second option means otherwise.

At the moment, both seem to have some impact. China sees record car sales in March, exceeding that of US for third month in a row due to taxes on purchases of small cars being halved. As for notable government spending, China announces that it is pumping 850 billion yuan over 3 years to reform its health care system which includes giving each village a clinic.

However, which of the 2 options will make greater contribution to domestic consumption remains to be seen. My money is on government spending because when government spends, it really spends but tax cuts may end up in savings accounts or hidden biscuit tins. But then again, it maybe because I am a Chinese infused with Confucius teachings.