For the past twenty years the Chinese strategy for economic growth has been focused on exports primarily to the United States. In fact domestic consumption in China only accounts for 36% of GDP compared to 54% for India. And until recently this strategy reaped significant benefits which included yearly trade surpluses, a $2 trillion dollar foreign reserve surplus and double digit economic growth. This strategy also had the added benefit of creating millions of low skilled jobs primarily in coastal based low tech manufacturing operations. But by late last year the music stopped and the Chinese export strategy came to a grinding halt as the American economy fell into a deep recession and American consumers stopped consuming!

In reality the US consumption driven economic growth model was a house of cards and ultimately unsustainable. The American consumer was given access to easy credit while concurrently being told that we were becoming a service based economy (welcome to Wal-Mart). For two decades Americans went on a consumption binge borrowing against their houses and their future so that they could buy more stuff, while at the same time savings rates dropped to zero! That fantasy has now ended and the American consumer now finds themselves in a type of financial cold turkey with tightening credit standards, rapidly depreciating housing values and a dismal stock market. So American have stopped consuming and for the first time in over two decades they have begun saving again! This is the beginning of a fundamental restructuring of the US economy that will ultimately be more saving and investment based with far less consumption.

For China it is an economic tsunami as exports have fallen off a cliff. Forget about official Chinese statistics that fact of the matter is that Chinese exports are dropping by double digit numbers and thousands of Chinese manufacturers are simply closing down! China’s economy will slow to approximately seven percent this year and for China that is a full blown recession. The Chinese government has taken some bold measures to address this challenge the most noteworthy of which is the $585 billion dollar economic stimulus package. But for China the day has come in which they must reorient their economy to a consumption based growth model. The problem is that Chinese consumers like to save. In fact they have some of the highest savings rates in the world. Part of this is cultural but primarily it is based on economic and social survival. China’s public healthcare system is virtually non-existent and the social security and retirement systems are more of a fantasy then an actual program. As a result Chinese citizens look after their own family and own welfare by saving and saving a lot!

So what is the way forward for China? An obvious focus must be on creating viable public healthcare systems and a social security net. But less obvious and certainly more controversial would be rural land reform. Over 700 million Chinese are landless peasants beholden to the will of the State and more often than not corrupt local party officials. But if the Chinese government gained the political will to give title to the various plots of land that are now leased by millions of Chinese farmers and laborers it would immediately equate to a massive capital formation for the Chinese economy and at a basic level would create the proverbial nest egg for millions of Chinese families. Many safeguards would have to be put in place to include a 10-20 year nontransferable clause as well as limits on borrowing against land holdings. But the impact on consumption as well as income redistribution would be dramatic. The question of course is will the Chinese government see the way forward?

CNN Media Alert, January 2, 2009