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China's consumers need stimulus checks

April 2, 2012: 5:00 AM ET

To empower the Chinese consumer, Beijing needs to put more money in people's pockets and make them feel comfortable enough to spend it. They can do it by lowering taxes, providing more direct stimulus, and letting wages rise.

By Cyrus Sanati, contributor

china consumer spending

FORTUNE -- China's consumers need to step up and spend if the nation is to avoid an economic hard landing. But in order for that to happen, the Chinese government must institute a number of reforms to give the nation's consumers the confidence to stop saving and go shopping. While the government is taking steps in the right direction, more will be needed to arm Chinese consumers with the necessary buying power to keep the country's economic engine from sputtering out – threatening to derail the already fragile economic recovery in the West.

Last month the Chinese government shocked economists around the globe by announcing that the nation's economic growth target for 2012 would be just 7.5%. While hitting such a growth target would be an amazing feat for a mature economy like the United States, it is scarily low for China. After all, the country grew between 9.2% and 14.2% over the last five years, most of which followed the rumblings of the global financial crisis.

Since the target was lowered, traders and fund managers on Wall Street have become increasingly worried that China might experience a much harder economic correction, which they refer to as an economic "hard landing."  There is no definition as to what would constitute a hard landing versus a less acute soft landing, but the general consensus seems to believe that China would have a hard landing if its economic growth rate for the year was below 4% to 6%. Again, such high growth rates would be welcomed in more mature economies, but for China, it would be a big blow to the nation's economic master plan.

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So how can China prevent a hard landing? The Chinese government believes that it needs to finally reduce its economic growth away from the fickle export market and stimulate more internal economic growth through increased consumer spending. China is a command economy, meaning that its leaders have elaborate plans that steer the nation on a certain economic path. The transition from export powerhouse to a consumer-driven economy wasn't set to occur for another few years in Beijing's long-term growth plans. But the 20% drop in Chinese exports since 2007 has forced the nation's central planners to move up the timeline and focus on the Chinese consumer to fill in the economic gaps left from weakening export growth.

Beijing's plan to fill that gap centers on increased government spending. The Chinese government authorized a 2012 fiscal budget deficit target of 2% of GDP, up from 1% in 2011. The increase in spending will be invested in infrastructure, education, social housing, social security and healthcare.

Deficit spending has its virtues, but the size and scope of the spending here doesn't seem to be adequate to get China's economy going. After all, the special $600 billion economic stimulus package the Chinese government made a couple years back at the height of the global financial crisis has had mixed results. The stimulus, as big as it was, failed to stem the nations declining growth rate. That may be because the scope of the spending was directed to fixed asset investment projects, like building a new port or improving a roadway, and not toward boosting consumer spending. The extra cash the government is slated to invest in social programs may make life better for the average Chinese citizen, but it won't necessarily help boost economic growth – at least not to levels needed to fill the gap from decreased exports. What China needs to do is empower its consumer base and save on the social welfare.

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Consumer spending makes up the bulk of economic activity in mature economies, most notably in the U.S. where it is around 70% of the economy. The much-maligned American consumer society not only held up the U.S. economy for years, but also helped drive China's growth rate by absorbing a large chunk of its exports. But now, U.S. consumers are tapped out, and therefore cannot be counted on to suck up more Chinese goods. Meanwhile, Europe's economic malaise means that it cannot be counted on either to help mop up surplus Chinese goods. That duty now falls to the Chinese consumer, whose spending comprises just 44% of the country's GDP.

To empower the Chinese consumer, Beijing needs to put more money in people's pockets and make them feel comfortable enough to spend it. One way to do this is to make goods cheaper by lowering taxes, like the national 17% VAT tax. VAT taxes have a negative impact on consumer spending as they basically tax people for shopping. Lowering or removing the VAT, along with a number of other state and local consumption taxes, would have a direct and immediate positive impact on consumer spending.

The country should also look for a way to keep Chinese consumers from spending money abroad. Chinese consumers spent nearly $50 billion overseas last year, which was up 66% from 2010, according to China UnionPay, the nation's largest credit card issuer. China's overall retail sales growth was up 17% during the same time, far less than the growth in foreign spending. The Chinese are traveling more than ever before, but one of the primary reasons is because they want to go shopping for goods that they either can't get in China or that are too expensive due to all the heavy taxes and import duties. Prices for luxury goods in China are around 50% higher than in the U.S. and a whopping 72% higher than in France, according to the Chinese Ministry of Commerce. The World Luxury Association estimates that the Chinese consumer made up around 62% of all luxury sales in Europe last year. Ironically, much of what they are buying was originally made in China.

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But it isn't just the well-off Chinese buying Prada purses that should be targeted here. The Chinese consumer market could get a huge boost from just a fraction of growth in spending by the billion or so Chinese who live on meager wages. The Chinese government may consider sending out stimulus checks like the U.S. did during its last recession to give a temporary boost to consumer spending. For a longer term fix, the government should allow wages to slowly rise across the country or possibly institute a minimum wage so that more people can afford to buy the things that they have been making all these years. Of course, these policies should be balanced and introduced gradually to ensure that the gains in consumer spending aren't eaten up by inflation.

Ultimately, the Chinese need to feel comfortable spending to help China move into its next phase of economic growth. Improvements in the nation's social security system would go a long way to make it easier for Chinese people to spend more and save less. The net effect could be a strong increase in economic activity, which could help China avoid any sort of landing, be it hard or soft.

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