China's Economic Imbalances and the 2008 Financial Crisis Response

Key Insight

Many observers characterize China's past economic growth as 'imbalanced,' stemming from an over-reliance on investment and exports, alongside insufficient household consumption, which was typically below 40% of demand compared to 60% to 70% in rich nations. The common prescription was to reduce investment and boost consumer spending. However, a declining consumption share of GDP is a normal and often necessary consequence during the capital-intensive phase of industrialization, when significant investment is required to build a modern capital stock. China's consumer spending, in fact, grew rapidly for over a decade, and its falling consumption share mirrored historical patterns seen in Japan and South Korea during their development.

Despite the typical development trajectory, China's reliance on exports before the global financial crisis and investment thereafter became excessive. From 1990 to 2004, China's trade surplus consistently ran around 2% of GDP, but it surged to nearly 9% in 2007, with the broader current account reaching an exceptionally high 10% of GDP. Concurrently, the investment share of GDP, which had fluctuated between 32% and 36% up to 2002, rose to about 41% by 2008, exceeding peak levels of other East Asian economies during their most capital-intensive phases. This surge was partly due to housing privatization and the boon to exports after China's WTO entry in 2001, but also exacerbated by policies such as low interest rates, subsidized energy prices, and an undervalued exchange rate from 2002 to 2007, which effectively subsidized investment and export activities.

The 2008 global financial crisis profoundly impacted China, primarily through a 20% drop in exports, leading to an estimated 23 million workers in export-oriented factories being laid off. In response, China launched an unprecedented infrastructure-focused economic stimulus program, initially announced at Rmb 4 trillion (approximately US$590 billion, or 12% of GDP), with actual spending closer to Rmb 11 trillion over two years. This colossal stimulus, the largest globally, successfully maintained GDP growth above 9.5% from 2009 to 2011. It also marked a strategic shift to reduce reliance on exports, considered a vulnerability, towards domestic demand. Consequently, China's current account surplus decreased from 10% in 2007 to under 2% by 2013. Since boosting consumption is a slow process, the government propelled investment through public infrastructure and private housing, causing investment to surge to an astonishing 46% of GDP by 2010, effectively trading an external 'imbalance' for a domestic one. The crisis also spurred China's decision to internationalize the Renminbi, driven by concerns over the US dollar's global dominance and associated vulnerabilities.