China’s Increasing Focus on Domestic Consumer Demand

China, the world's largest exporter, is transitioning its economy to one where domestic consumer spending plays a larger role.¹

To help facilitate the shift, the government has outlined stimulus plans to boost domestic demand and encourage growth. However, even with these initiatives, transitioning to a more consumer-driven economy may be difficult.

Historically, consumer spending in China has generally taken a backseat to exports.² Indeed, household spending accounts for only about 40% of the country’s gross domestic product (GDP) compared with an average of 60% among the 38 member nations of the Organization for Economic Cooperation and Development (OECD).³

Recent macroeconomic events could also hinder higher domestic demand. More than five years after the initial outbreak of COVID-19, Chinese consumer confidence hasn’t fully recovered from the pandemic. In addition, the country’s real estate market continues to struggle.

Despite these obstacles, Chinese leadership has begun to embrace domestic consumption to counter the risk from U.S. tariffs. China boasts the world’s second-largest consumer market. If the government’s efforts are successful, increasing demand could benefit China’s homegrown companies and foreign businesses that sell everything, from household appliances to luxury goods, to Chinese consumers.

This article discusses the challenges and opportunities we see in this evolving economic environment.

Tariff Threats Encourage a New Focus on Domestic Demand

Following President Donald Trump's imposition of higher tariffs on China, several U.S. companies, including Amazon, canceled orders with Chinese suppliers.⁴ Other firms continue to move production out of China as supply chains shift. Even if the U.S. and China negotiate lower tariffs, we believe trade between the two nations stands to suffer going forward.

For Chinese leadership, the risk of becoming more isolated in trade and geopolitics highlights the need to increase domestic demand for goods and services. Earlier this year, the government announced key initiatives that include:

• More funding for trade-in programs to encourage purchases of select smartphones, appliances and other goods.

• Employment subsidies for local employment and startup assistance programs.

• Strict implementation of paid annual leave, which could encourage spending on recreation and tourism.

• More efforts to stabilize the country’s real estate sector and stock market.

Why Is Domestic Demand Becoming More Important to China?

More Resistance from Trading Partners

For years, China has adhered to a consistent growth strategy: The nation has invested in infrastructure, technology, research and other areas to increase its production capacity.

This approach has helped China dominate global manufacturing. Looking ahead, Chinese authorities are targeting sustainable and higher-quality growth by investing in new and emerging industries. For example, the country has established significant leads in vehicles, new energy, automation and other key industries like artificial intelligence (AI).

However, we think this strategy may be reaching its limits.

China has arguably hit a point of overcapacity. In some industries, factories produce more goods than global markets can easily absorb. Trading partners have accused China of flooding their countries with lower-priced products, undercutting the trading partners’ own companies.

Now, more countries have started taking action against Chinese goods.

Higher U.S. tariffs might be the most obvious example, but Canada, South Africa and other nations have also raised tariffs and duties on Chinese steel and other products. Some trading partners, including the EU, have investigated dumping allegations against China.

Of course, many of these partners also sell to China, so they may be unable or unwilling to push back too firmly.

Setbacks to Other Growth Drivers

Meanwhile, China faces obstacles in other areas that historically helped fuel the country’s economic growth: real estate and infrastructure.

The real estate sector still faces a downturn fueled by overbuilding, especially in smaller cities with slower growth. Property values began to decline sharply in late 2021 and haven’t yet recovered.⁵ This situation poses a direct challenge to consumers, as housing has historically made up a significant portion of Chinese household wealth.⁶

Local governments have amassed sizable debts, leaving them with fewer resources for infrastructure spending and other growth catalysts. The real estate crisis has also hurt a key income source for cities that previously benefited from land sales to developers and related revenues.

A slowdown in real estate and infrastructure spending poses an outsized threat to China because these sectors constitute a notable part of the country’s economy. According to one analysis, they contributed nearly 32% to China’s GDP in 2021, compared to 18% in the U.S.⁷

Benefits of More Consumer Spending

If China can boost domestic demand, it could unlock multiple advantages.

Increased consumer spending could serve as a more sustainable and reliable source of economic growth, similar to what many developed countries experience. Greater domestic demand would help reduce China’s dependence on foreign markets and its exposure to external shocks.

Higher consumer spending would particularly benefit Chinese brands as shoppers shift away from buying foreign brands. For example, both Apple and Tesla have recently seen sales declines in the Chinese market.⁸

Potential Obstacles to Higher Domestic Consumption in China

Ramping up consumer demand may be easier said than done, especially without additional policy support.

Chinese households typically save a high percentage of their incomes, possibly because the country offers a limited social safety net.⁹ If social programs were more robust, it could encourage people to save less and make more income available for consumption.

Promoting consumption might also require higher household incomes and reduced income inequality. However, these changes would likely require government intervention.

Some reforms are moving forward. China’s recent stimulus plans included increases to basic old-age benefits and medical insurance for rural and nonworking urban residents. The government also announced that it will consider offering a childcare subsidy system.

Creating a sustained increase in domestic demand would likely require consistent government spending over an extended period. It remains uncertain whether China’s leadership is committed to this strategy.

Navigating the Risks and Opportunities of China’s Economic Transition

China’s economy faces a thorny set of challenges, but robust domestic consumption can help emerging markets. According to the World Bank, for example, Brazil’s economic growth has held up in recent years largely because of strong private consumption, backed by social spending.¹⁰ Addressing these issues may take time and will largely depend on the Chinese government's readiness to offer more domestic stimulus and accelerate structural reforms. We are monitoring tariff negotiations and domestic factors like consumer confidence surveys and property market trends.

How the situation unfolds could significantly impact returns for Chinese companies and their investors.