China must stimulate domestic consumption to drive the economy as its Western export markets shrink

Profound and complicated changes in the world economy have further demonstrated the close relationship between China's economic transformation and the prospects for global economic growth. Consumption-driven economic restructuring will be the determinant of China's sustainable development in the coming one or even two decades, and will greatly influence the rebalancing and recovery of the world economy.

Why is China making domestic consumption the strategy for its economic transformation? Why is increasing residents' consumption rate the government's binding objective? It is because the complicated situation enveloping the world economy will have a significant influence on China's economic transition. On the one hand, conflicts resulting from the European sovereign debt crisis have become more serious, and there are now concerns that the crisis will lead to a European banking crisis. This is a profound and complicated issue that will require more than the short-term policies that Europe is adopting to mitigate the effects of the sovereign debt crisis.

On the other hand, the US' economic growth is influenced by both the huge financial deficit and the upcoming presidential election. Analysis shows that the US has to realize 5-percent growth to solve its deficit problem, which is actually a vain hope. This international background will influence China's inflation and economic growth, and more importantly have a big impact on China's transformation, because, China will not be able to rely on exports for its economic growth. Therefore, China will have to adopt a consumption-driven growth strategy.

So the profound changes that are taking place in the world economy have compelled China to propel a consumption-oriented economic transition.

In the coming three to five years, China's consumption rate is expected to rise from the current 48 percent to 50 percent or more by the end of the 12th Five-Year Plan (2011-2015), forming the initial shape of the fundamental pattern of consumption-stimulated growth.

The key factor for attaining consumption-stimulated growth will be the service industry. As Premier Wen Jiabao said at the recent Davos Forum held in Dalian, Liaoning province: "China will accelerate its pace to open up the service industry at home and abroad, create a friendly environment and favorable policies for the development of this industry and increase its proportion in the national economy."

The service industry will likely grow from 43 percent to 47 percent by the end of 2015.

Meanwhile, China's urbanization will be the means of promoting development of the service industry and stimulating consumption. In the next five years, the urbanization rate in China is expected to increase from the current 47 percent to about 52 percent.

However, more compatible institutional reforms are needed for China to realize its consumption-driven economic transformation. Considering the proposed development pattern during the 12th Five-Year Plan, whether or not China's opening-up and reform will succeed is dependent on whether or not major reforms related to domestic consumption can be substantially fulfilled.

First, reform of the income distribution system will need to be realized to increase the expectations of both urban and rural residents for income increases and improve their appetite for consuming. Second, though there have been some adjustments in personal income tax, reform of the fiscal and taxation system has severely lagged behind the requirements for economic restructuring. The current relationship between central and local governments guided by GDP is rooted in the existing fiscal and taxation system.

Third, it will be hard to achieve any substantial progress in transforming the economy if the government fails to make any breakthrough in relevant and necessary reforms to promote the sustainable use of resources and environmental protection, cultivate market vigor and make public service the focus of the government.

The author is president of China Institute for Reform and Development.