Economy

Inflation and consumption

By John Ross (chinadaily.com.cn)
Updated: 2011-05-18 11:20

Inflation is the most immediate problem facing China's economy. The author is a great admirer of China's economic policy. But overall correct policy naturally does not mean that every individual issue is tackled correctly. In the case of inflation, insufficient clarity on a key economic objective for China - how to raise consumption -- is complicating the fight against it.

The Financial Times laid out the issue last week when it noted that some policies in China are inevitably increasing inflation: "The policy measures taken by Beijing in its fight against inflation do not reflect the kind of… struggle suggested by comments from the country's leaders. For one thing, Beijing is encouraging double-digit wage increases – of up to 40 percent a year in some places." The Financial Times noted that this scale of wage increases was inevitably inflationary.

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It is important to analyze precise numbers on this. Important factors in present inflationary pressures are outside China's control. Food prices internationally have risen by 60% since their low point in December 2008, and although China is not a large overall food importer, such price pressures inevitably work themselves through to the domestic market. The international oil price has risen to over $100 a barrel – and China is necessarily a large oil importer.

These trends show why analysis of inflationary pressures in China carried out simply through examining its money supply is wrong. Certainly, China's money supply growth was raised during the international financial crisis and needs to be reduced. But other comparable countries are having worse inflationary problems than China. For example, taking the BRIC group of large developing economies, the latest rates of consumer inflation are 6.5 percent in Brazil, 8.8 percent in India and 9.6 percent in Russia – all higher than China's 5.3 percent. Therefore, inflationary pressures in China cannot be explained primarily in terms of domestic factors but have important international drivers.

During inflation it is vital to protect the population's income against price rises. China's inflation rate means that increases in incomes of 5.3% are required to keep living standards stable. In addition, China's economy, and productivity, is growing at about 9 percent a year. Adding these together means that increases in incomes of around 14 percent will increase living standards, will maintain a roughly stable share of incomes in GDP, and therefore will not accelerate domestic inflationary cost pressures - the cost pressures from rising real incomes will be covered by increases in productivity.

But this is a totally different thing to anything approaching the 20-40 percent increases in wages that have been seen. Such rises cannot be financed by increases in productivity, will consequently increase costs, and are therefore necessarily, as the Financial Times rightly pointed out, significantly inflationary – running counter to the goal of bringing down price increases.

Why, therefore, is there pressure for policies to be pursued which increase price rises? One reason is that confusion is being expressed between the goal of the most rapid sustainable rate of increase in consumption and the different question of the percentage of consumption in GDP. A rate of increase of wages which is inflationary is occurring because the goal is being set not of the most rapid possible sustainable increase in consumption, and therefore living standards, which is correct, but instead a target of radically raising the percentage of consumption in GDP.