More precisely, econometrics shows investment accounts for over 50 percent of economic growth. China's economy can grow fast only because it has a high investment level. Significantly reducing this by redirecting resources into consumption would make China grow less rapidly. As economic growth is the main driver of rising consumption, reducing investment, over anything except the short term, would therefore make China's living standards rise more slowly.

The basic arithmetic is that over the last five years China had to invest 4 percent of GDP for its economy to grow by 1 percent. This is very efficient by major economy standards -- even before the financial crisis, the U.S. had to invest 7 percent of GDP to grow by 1 percent, and its position has subsequently deteriorated. Consequently for every 4 percent of GDP China's percentage of investment in GDP is reduced, its economy will slow by 1 percent. Given economic growth is the main driver of consumption increase, this slower GDP growth will soon cancels out an initial boost to consumption by transferring resources from investment. Therefore, after an initial increase, cutting investment leads to consumption being lower than it would have been otherwise.

To illustrate this, consider if 4 percent or 8 percent of China's GDP is shifted from investment to consumption. In the first case, China's GDP growth would slow by 1 percent a year and in the second by 2 percent a year. The initial boost to consumption from the transfer of resources after 10 years is overtaken by the effect of slower economic growth. After that consumption would actually be lower than if the shift had not taken place. In the case where 8 percent of GDP is shifted to consumption, after 20 years China's consumption would be 20 percent lower than if the shift from investment to consumption had not occurred. What happens is shown in the chart below.

Some U.S. neo-cons understand that cutting China's investment level would slow its economy -- therefore they advocate cutbacks in order to maintain U.S. superiority. But some Chinese economists mistakenly fell into the confusion of calling for a major cut in investment, and increase in the percentage of consumption in China's GDP in an attempt to increase living standards. In technical economic terms, maximizing consumption's growth rate, which is key to determining how fast living standards rise, was confused with raising the percentage of consumption in GDP. Actually this error, for reasons outlined, would create the opposite effect and China's consumption would be reduced.

Fortunately such confusions are being sorted out. One of China's most famous economists, Lin Yifu, the former chief economist and vice president of the World Bank, has stressed investment based programs are more effective than those based on consumption. Zhang Jun of Fudan University and Zhu Tian of the China Europe International Business School recently wrote a notable article for the Financial Times noting: "Low consumption means high savings levels, which makes high investment possible… these are among the most important factors behind China's rapid economic growth. From 1990 to 2010, GDP grew at an average of almost 10.5 percent a year, while consumption grew at 8.6 percent… when the world average was less than 3 percent." They rightly concluded: "It may sound paradoxical, but China's relatively low consumption rate is one reason the growth in the rate of its consumption has been so high."

This column has previously looked at why this apparently theoretical economic issue has huge practical implications for China's economic growth and living standards. It is therefore encouraging for the medium and long term strength of China's economy that the recent practical speeding up of economic growth is being accompanied by more clarity on key strategic issues.

The author is a columnist with China.org.cn. For more information please visit:

http://www.h5a3.com/opinion/johnross.htm

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