What could China possibly learn from Brazil, economically? After all, real GDP growth in Brazil averaged 2.75% annually over the past three decades, compared to 10% in China. Moreover, Brazil’s consumption-oriented growth model is about to exhaust itself, while China’s investment-focussed strategy continues to generate high, if somewhat diminished economic growth. Factor in the social, environmental and political consequences and it becomes clear that China’s growth model needs to change as well. Therefore: Brazil would be well-advised to become more “Chinese” in terms of savings and investment behaviour, while China would benefit from becoming more “Brazilian” in terms of consuming more (saving less).
Brazil’s economic growth has disappointed in the past couple of years. After increasing more than 7% in 2010, real GDP growth decelerated to 2.7% and 0.9% in 2011 and 2012, respectively. Even if real GDP growth recovers to slightly more than 3% this year, it will be below the 4% growth level Brazil got accustomed to over the past decade. While economic growth has disappointed, household consumption has remained resilient due to rising incomes, tight labour markets and the greater availability of household credit. Investment growth, by contrast, has been very weak, especially in the manufacturing sector. This is largely due to rising labour costs, a strong currency and a lack of productivity-enhancing structural reform. Brazil may be showing symptoms of Dutch disease.
The combination of strong consumption and relatively weak investment growth will sooner rather than later force the authorities to choose between higher inflation and lower growth – if this has not already happened. For now, the president continues to benefit from high approval ratings, recent protests notwithstanding, against the backdrop of a strong labour market, rising household incomes and expanding consumption. But the government seems to have realised that greater investment is necessary to keep employment and income growth going over the medium term. The government has been seeking to expand lending by public-sector banks, accelerate public-sector investment, reduce labour and production costs through tax cuts and exemptions and create and/or offer more favourable conditions for/to private investment in infrastructure projects (e.g. sales of infrastructure concessions). Unfortunately, this has thus far failed to trigger a rise in domestic investment.
Chinese GDP growth has slowed down from more than 10% a year to a still high 8% or so. Nonetheless, capital-intensive growth is having an increasingly adverse ecological impact. Investment-led combined with export-oriented growth makes the economy more vulnerable to exogenous shocks and creates incentives to engage in potentially risky quasi-fiscal stimulus policies (2008-09). Last but not least, more service-sector and consumption-oriented growth would be more employment intensive. As such, the political incentives to modify the growth strategy certainly exist, and they are growing larger.
Admittedly, Chinese household consumption is growing rapidly, but so is GDP, while household income remains very small as a share of GDP. Savings remain high across the government, corporate and household sector. Household savings are high in part due to an under-developed social security regime, creating significant incentives to accumulate precautionary savings. Household incomes are weighed down by extra-low returns on household assets due to financial repression. By contrast, corporate savings and investment are high due to a favourable tax and dividend regime as well as an undervalued exchange rate and cheap credit, favouring investment in the export-oriented, capital-intensive manufacturing sector. China has taken measures to raise domestic consumption, mainly by expanding social welfare coverage, providing tax incentives and gradually appreciating the exchange rate. Plans to liberalise interest rates, thus boosting household incomes and raising the cost of capital, and to raise corporate dividend pay-outs are also in the works, amongst others.
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| Source: IMF |
The structural differences between Brazil and China have thus remained very striking. In Brazil, the household sector has limited incentives to generate precautionary savings. An extensive social security and pension regime incentivises households to consume rather than save. In China, the household sector faces the opposite problem: the social welfare regime is not very extensive. In Brazil, the corporate sector is facing very high borrowing costs (in part due to low domestic savings), which limits profitability. In China, the corporate sector has access to very cheap funding due to high savings and financial repression. In Brazil, the exchange rate is overvalued, limiting the incentives to invest in export-oriented industries, while in China the exchange rate - at least until recently - had been undervalued, favouring investment in the export-oriented manufacturing sector. The list goes on.
Policy-makers in both countries have acknowledged the need to adjust their economic strategies; and the political incentives to adapt their respective models do exist, too. Both governments have taken a number of measures in the past few years, but respective consumption/ savings patterns have changed only little in the past few years. Chinese savings have declined a little, but investment is actually higher today than it was before 2008-09. (While the combination of higher investment and somewhat lower savings/ higher consumption has helped narrow the politically-contentious external surplus, it has made the economy even more dependent on investment.) Admittedly, neither Brazil nor China has taken overly aggressive measures to achieve their respective objectives. But savings, consumption and investment patterns perhaps only change slowly.
Perhaps fundamental factors such as demographic trends and cultural or historically-inherited attitudes (e.g. hyper-inflation) are also at work. This does not mean that government policies will not have any effects – only that they need to be pursued more forcefully if Brazil and China are to shift their economic growth models towards greater investment and greater consumption, respectively.