Economy: Consumption and Investment are Both Important to Current Chinese economy: Are the Suggestions by Krugman and Yellen Proper?
July 2024
Author: He Haifeng, Chief Economist and Executive Director of the China Financial Policy Report Project
On April 4, U.S. Treasury Secretary Janet Yellen visited China and pointed out China’s “overcapacity” problem, attributing it to a series of “production-supporting” industrial policies that the Chinese government has long implemented. Coincidentally, on May 24, American economist Paul Krugman wrote in the New York Times :” published an article saying that the world today is suffering from the “second China shock” and claiming that “the most obvious solution to the current difficulties of the Chinese economy is to shift from the production end to the consumption end.”
As a Nobel Prize winner, Krugman is undoubtedly a big-name economist. Yellen, who serves as Treasury Secretary, was also a professor of economics at many universities. But the prescriptions they prescribe for the Chinese economy are questionable. The author believes that simply “turning to consumption” implies the judgment that “consumption, rather than investment, is more important to the current Chinese economy”, which directly separates and even opposes consumption and investment. In addition, the views of these two representative figures are based on the actual needs of topics such as the operation of the US economy, policy choices and even the general election. This article will analyze from three aspects: theory, history and policy to illustrate that consumption and investment are equally important in the current Chinese economy.
Theoretical Debate
Basic economic concepts such as consumption and investment are important economic categories in both Marxist political economics and Western economics. To avoid falling into a contextual dispute, we use the most consistent system, the National Accounts System (SNA) widely used by market economies, and start with the statistical indicators under the national economic accounting system that are not controversial.
From the perspective of expenditure accounting, economic growth is the sum of three demands: consumption, investment, and net exports. Therefore, economic researchers often compare final consumption expenditure, total capital formation, and net exports of goods and services to the “three horses” that drive economic growth. Final consumption is divided into two categories: household consumption and government consumption, which refers to the value of goods and services used to meet the personal needs of residents and the public needs of social members in the current period. The most commonly used indicator for measuring household consumption is the total retail sales of consumer goods (social retail), which includes goods used by individuals for daily consumption and goods used by social groups for non-production and non-operation.
Capital formation refers to the final product used for asset accumulation. From the accumulation results, capital formation corresponds to the net change in production assets caused by economic transactions in the current period, that is, investment expenditure spent on the accumulation of production assets. Production assets include fixed assets, inventory, and valuables. The purpose of capital formation is to increase future production capacity, but it also faces effectiveness issues. Not all capital formation reflects the active accumulation of various economic units.
Capital formation may be passive holding of goods and services. In this case, capital formation is invalid, that is, there is a difference between effective investment and ineffective investment. Currently, China’s investment is divided into two categories: government investment and corporate investment. The former mainly involves infrastructure construction, public services, green environmental protection and other fields, while the latter is corporate investment in production, R&D and other fields.
However, when using the two concepts (indicators) of consumption and investment, there is an important distinction, namely the time limit. A common saying in economic analysis is to look at operations in the short term and growth in the long term; further, even in the short term, it is necessary to distinguish between normal operation under normal conditions and emergency management under crisis conditions.
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