For stock investors, analyst research reports offer authoritative, professional, timely and comprehensive insights to help uncover potential thematic opportunities. Recently, a viewpoint has been widely shared and debated on WeChat Moments: "There is no such thing as consumption-driven economic growth." With plenty of desk work on hand, I originally did not intend to comment, but in a brief moment of leisure, I could not resist saying a few more words.

Consumption is the ultimate purpose of growth

Before arguing whether economic growth is driven by consumption, one point must first be made clear: consumption is the ultimate purpose of economic growth, and everything else, including investment, is merely a means to that end. As early as 1776, in The Wealth of Nations, Adam Smith explained this point: "Consumption is the sole end and purpose of all production; and the interest of the producer ought to be attended to only so far as it may be necessary for promoting that of the consumer." Adam Smith then indignantly added: "But in the mercantile system, the interest of the consumer is almost constantly sacrificed to that of the producer... It cannot be very difficult to determine who have been the contrivers of this whole mercantile system... it has been the producers, whose interest has been so carefully attended to." In modern economic growth theory, the idea that consumption is the ultimate purpose is expressed even more clearly. Whether in the neoclassical growth model or endogenous growth theory, the ultimate goal is to solve the consumer's utility (U) maximization problem under an income budget constraint: maximize the utility function U=U(C), subject to the budget constraint that C in each present and future period equals income in each present and future period. In the utility function U, there is no investment or any other variable, only one thing: consumption C. The above maximization problem can ultimately be transformed into a consumption function that depends on income. Of course, income includes today's income, tomorrow's income, and so on. Without income, consumption cannot even be discussed. Then where does income come from? From the supply side, income comes from economic growth determined by the production function; from the demand side, income comes from expenditure.

Consumption determines investment efficiency

In modern economic growth theory, regardless of academic school, growth depends on three factors: technology, capital and labor. In addition to technological progress and increases in the quantity and quality of labor, capital accumulation through investment is a key factor in growth. If the discussion stopped here, then indeed, there would be no consumption-driven economic growth. But if we continue to work through the growth model, we will see that consumption determines investment efficiency, and therefore determines whether the economy can accumulate capital through investment. The economic term for investment efficiency is the "marginal product of capital," abbreviated as MPK. In the simplest neoclassical growth model (readers unfamiliar with this can consult any undergraduate macroeconomics textbook or my own book, Man Makes the Matter: A General Theory of Population, Finance and Capital), the determinants of MPK are: MPK = capital's share of contribution to output / capital-output ratio. The capital-output ratio = capital / output = investment rate / (labor force growth rate + technological progress rate + depreciation rate). When the labor force growth rate, technological progress rate and depreciation rate are held constant, the investment rate determines the capital-output ratio and therefore MPK. The higher the investment rate, the higher the capital-output ratio and the lower the MPK. The opposite of a high investment rate is a low consumption rate, because: investment rate = investment / output = 1 - consumption / output = 1 - consumption rate. The fact that a high investment rate leads to declining investment efficiency is also intuitively easy to understand. Suppose there are two countries, A and C, both with GDP of 100, where Country A has an investment rate of 20% and Country C has an investment rate of 40%. This means that in Country A, 20 yuan of investment creates 100 yuan of GDP, while the same GDP creation in Country C requires 40 yuan of investment. I once measured MPK across 79 to 91 countries worldwide (see "The Mystery of China's Low Per Capita Capital Stock and Low Marginal Product of Capital: The Impact of Population Issues," Financial Review, Issue 1, 2023), and found that China's MPK has been declining continuously since 2010 to the very bottom among many countries. Apart from population factors (declining or even negative growth in population and labor force), the main factor causing the decline in China's MPK is that China's investment rate is too high — or conversely, that China's consumption rate is too low. Taking the average for 2012-2021 as an example (see the previous article on this public account, "Why Don't Chinese People Consume"), China's consumption rate is 20 to 30 percentage points lower than the global average and that of other countries, while its investment rate is correspondingly about 20 percentage points higher.

Consumption determines the investment multiplier

Growth theories generally assume that the economy is at full employment, so economic growth can reach the maximum possible boundary determined by technology, capital and labor on the supply side. But in the real operation of a market economy, insufficient aggregate demand is the norm, and economic growth often fails to reach the maximum possible boundary. When aggregate demand is insufficient and involuntary unemployment exists, economic discussion falls into the Keynesian framework. In the Keynesian framework centered on the problem of insufficient demand, expenditure creates income and thereby drives the economic cycle: investment expenditure by the corporate sector creates wage income for the household sector, and consumption expenditure by the household sector creates sales revenue for the corporate sector. If any sector stops spending, other sectors lose income, and the economic cycle will come to a halt. Regarding the mechanism by which expenditure creates income and thereby drives the economic cycle, Keynes offered a vivid metaphor in The General Theory. The gist is that if I decide today to save money and not eat a hearty meal at a restaurant, then the restaurant owner and employees will lose a portion of income, and therefore they may also decide to save money and buy one less piece of clothing... and so on. Through the multiplier effect, the money I save is amplified into a reduction in overall economic income several times larger. The impact of household consumption expenditure and corporate investment expenditure on total economic income can be condensed into the following formula: newly added income in the economy = investment × multiplier = investment / (1 - propensity to consume). This formula shows that additional (or reduced) investment by the corporate sector brings about a multiplied increase (or decrease) in income through the multiplier, and the multiplier depends on the household sector's propensity to consume — the share of household income that people are willing to spend on consumption. The higher the propensity to consume, the larger the investment multiplier, and the greater the increase in overall income brought by each unit of investment. The propensity to consume of Chinese residents is 63%, while that of American residents is 92% (see the previous article on this public account, "Why Don't Chinese People Consume"). This means that to increase income by 100 yuan, Chinese corporate investment generally needs to be about four times that of American firms — which is in fact also a manifestation of low investment efficiency. In fact, Keynes was equally concerned with the problem of investment efficiency. At the end of The General Theory, after lengthy argumentation on the problem of insufficient demand, Keynes finally realized: "It is precisely because the marginal efficiency of capital collapses that the depressed state is so difficult to govern... the marginal efficiency of capital has collapsed to such a complete extent that a decline in the rate of interest to a level practically possible is of no avail." Then what factor causes investment efficiency to decline so completely? Excess capital resulting from excessive investment. Keynes said: "Capital must be kept scarce enough in the long run to make its marginal efficiency at least equal to the rate of interest over the life of the capital." But Keynes cited the United States and Britain at the time as examples: "The accumulated wealth has reached such a magnitude that the decline in their marginal efficiency of capital is faster than the decline in the rate of interest." To sum up, consumption is the ultimate purpose of economic growth. From the supply side, consumption determines investment efficiency through the production function; from the demand side, consumption determines the investment multiplier through the cycle in which expenditure creates income. How can one say that there is no consumption-driven economic growth? A brief rest, a short essay — just some idle talk.