Let a Billion Consumers Bloom; Subsidies to encourage consumption distort China’s economy

April 25, 2013, 12:24 p.m. ET

Let a Billion Consumers Bloom

Subsidies to encourage consumption distort China’s economy.

The 7.7% growth rate China clocked for the first three months of the year was lower than economists had expected, and now Beijing is looking to stimulate domestic consumption instead of its usual reliance on manufacturing exports and investment. Uh oh. This wouldn’t be the first time the government has gone down this route. In 2009 it rolled out a range of consumption subsidies, such as the Chinese version of “cash-for-clunkers,” to encourage new-car purchases, handouts for rural households that bought new appliances, and even a subsidy for new motorbikes. This was only part of the broader four trillion yuan ($647 billion) stimulus plan Beijing rammed through that year, but it led to some of the most positive headlines out of China’s economy, especially concerning sales of new cars.

That stimulus was less than it was cracked up to be. Consider the case of automobiles, in which roughly 6.4 billion yuan in government money subsidized the purchased of 459,000 new cars in 2010 alone. Some observers hailed this as a policy success. But subsequent events have shown that—like its American counterpart—the Chinese auto subsidy mainly stole consumption from the future by encouraging car buyers to shift forward purchases they would have made anyway. New car sales fell precipitously as soon as the subsidy program ended.Then there was the program that gave assistance for purchases of household appliances in rural areas. This, too, was trumpeted as a screaming success, with millions of refrigerators, televisions, washing machines and air conditioners sold, many to families that had never owned such conveniences.

Yet this supposed success also came at a long-term cost. Smaller, less efficient manufacturers were kept afloat by the windfall created by the subsidy, and other manufacturers felt less compulsion to invest in research and development since government cash meant customers needed less persuading to buy than they otherwise would have.

Although it’s conventional wisdom to say China needs “more domestic consumption,” that’s only partly true. China’s greatest need is to transform into a more entrepreneurial, free-market economy than the largely state-directed, investment-heavy version of today. Rising domestic consumption—especially consumption of services, which Beijing may try to target if it launches a new round of subsidies—would be one symptom that such a transformation is occurring, but it won’t do China much good on its own.

If Beijing truly wants a rebalanced economy, the focus needs to remain squarely on liberalization, especially in service fields such as telecommunications, transportation and financial services that form the backbone of most consumption-dependent economies. Temporary efforts to boost quarterly consumption data through subsidies or other incentives would be a step backward to the old model of government intervention.