China’s New Worry: Timid Spenders

Drowning in a glut of consumer products that threatens to plunge its economy into recession, China has started extending credit to its citizens in hopes that they will charge their way out of it.

But as policymakers are learning, it takes more than cheap money and a flood of credit cards and mortgages to change Chinese people’s frugal habits ingrained by centuries of scarcity.

Not even repeated cuts in interest rates by the central bank--seven times in three years, including a move earlier this month to a minuscule 2.25%--have pried open people’s wallets.

Chinese still use cash for more than 90% of their consumer transactions. One recent survey of Beijing and Shanghai residents found that nearly a third of respondents had no idea what consumer credit was, while about 70% said they knew what it was but didn’t want it.

That might seem a sensible attitude, but it doesn’t do much to help China through a critical moment in its economic evolution. The nation is saddled with hundreds of billions of dollars’ worth of excess industrial inventory that threatens to send the economy into a deflationary spiral.

The glut of goods--from rice to color televisions--is just another economic imbalance left by decades of China’s rapid, uneven development.

Before market reforms in 1979, China’s factories and farms were so inefficient they couldn’t turn out enough TVs or grains to meet the nation’s needs. In the 1980s, the bottleneck was a lack of railways and roads to get the products to the people. Today China’s economy is finally able to deliver the goods. It is the consumers who can’t keep up.

While China has so far escaped the currency and stock market collapses suffered by its Asian neighbors, experts say the real threat to China lies in the consequences of this glut.

In a classic deflationary spiral, oversupplied goods’ prices drop, cutting firms’ profits and employees’ incomes. As a result, citizens spend and invest less, causing inventories to rise and firms to cut prices even further in a self-perpetuating economic recession.

“Serious deflation has become the biggest enemy affecting China’s sustained, fast and healthy economic development,” writes influential government economist Hu Angang.

Hu warns that “if the central bank is overly cautious, unclear in its aims or slow to react, China may fall into a deflationary spiral” similar to today’s Japan or 1930s America.

Stores Cut Prices, Offer Loans to Lure Buyers

Retail prices in China have been falling steadily since October 1997. Roughly a third of all state-owned retailers are operating in the red, with many of the rest just breaking even.

Of some 600 consumer products monitored by the Domestic Trade Bureau, more than 60% are considered in oversupply, nearly double the figure for 1997.

This is a heavy blow to the perennially profitable retail sector. Until recently, the state owned most stores and rationed or set price controls on scarce goods. Store clerks made more money than university professors.

Desperate to lure customers, the upscale Parkson department store on Beijing’s West Side recently slashed prices up to 50%. Now, in conjunction with a local bank, the Parkson has become the first department store in the capital to offer credit for household appliance purchases.

In the electronics department, Jia Guangqun, a middle-aged salesman for a food factory, is considering taking out a loan for a new television.

“It’s not a nice feeling to see something you want and be unable to afford it,” Jia says, looking hard at the 29-inch screen of a new Sony model, priced at the equivalent of $730.

In addition to a 40% down payment on the TV, Jia would have to provide proof of income and, in some cases, put up other property as collateral. Parkson staff say the cumbersome application procedures have scared off many potential loan applicants.

After all, for most Chinese consumers, this is new territory.

In the past, Chinese banks existed to loan money to state enterprises and construction projects. Regardless of the fact that the banks’ assets were built on the nest eggs of thrifty savers, the banks were unwilling to loan money to consumers out of fear of non-repayment and inflation. During the Maoist era, consumerism was considered decadent and bourgeois.

At present, consumer loans account for a small fraction of bank business, and only 5% of China’s urban residents have taken out personal bank loans. While China has more than 35 million credit cards, all but a few thousand are debit cards, most of which sit unused by consumers.

Now that buying stuff has become respectable--if not essential to economic survival--Beijing is trying to pull the right economic levers, but it is getting the wrong results.

The central bank’s succession of interest rate reductions since May 1996 has cut returns from 9.18% to 2.25%. Yet despite the paltry returns, consumers have been socking money away rather than spending it: Savings have more than doubled, from $300 billion to more than $700 billion through April.

In April, the central bank handed down orders to increase consumer credit. Banks have responded by lowering to 20% the down payments required for house and car loans, while introducing loans for everything from education to travel. Some localities are trying to encourage home buyers with the promise of tax breaks.

Big-Ticket Items Out of Reach for Many

But not everyone is jumping at the opportunities.

Ultimately, economists observe, Chinese incomes--annually averaging $665 for each urbanite--are too low to afford loans for the big-ticket purchases that would really spark economic growth.

By day, many urban residents look as affluent as those of any first-world country with their designer clothes, cell phones and pagers. But at night, many ride their bicycles home to crumbling, crowded housing without central heating and hot water.

The market for consumer items under $1,000 is largely saturated. Everyone has televisions, washing machines and enough clothes to last for years. But the price gap between those items and the tens of thousands of dollars needed to buy cars and homes is too great for average citizens.

“I thought about getting a mortgage to buy my own home,” says one young college English teacher with a wife and son. “But when I realized it would take our entire family’s income just to pay the interest on the loan, I scrapped the idea.”

The consumer psychology that is keeping purse strings tight is a mix of tradition and pragmatism.

For most citizens, rising unemployment tops the list of residents’ worries in numerous surveys. And citizens predict that an increasing portion of their income will go to pay for sweeping reforms in health, education, housing and care of the elderly that are redistributing the burden of welfare and social services among government, companies and employees.

All this contributes to a general uncertainty about the future. Until a real social security system takes shape, consumers will probably keep squirreling away money to cope with unforeseen difficulties.

Traditionally, Chinese are used to borrowing money for weddings, funerals and other events that mark their place in society. But for personal consumption, as the saying goes here, “What you have is what you spend.” Purchasing power is measured by cash in hand, not potential earning power.

Some economists argue that the solution to China’s glut of goods lies in developing its rural areas, not in persuading urban dwellers to buy things they can’t afford.

“If China is to resolve its problem of over-capacity, if it’s going to jump-start its markets, the main hope is in the countryside,” which is home to more than 70% of the country’s 1.3 billion people, argues Justin Yifu Lin, director of the China Center for Economic Research at Beijing University.

So far, government infrastructure spending to spur economic growth has centered on cities. Many rural areas, meanwhile, lack the roads, power and water that would enable them to distribute and use televisions and washing machines. Only about 20% of the rural population own basic consumer durables.

Yet rural per-capita incomes have reached 1991 urban levels, Lin says, and appliance prices have dropped by half.

“So based on their purchasing power, the number who own appliances could at least double” with minimal infrastructure investment, he says.