From time to time, Morningstar publishes articles from third party contributors under our "Perspectives" banner. Here, Ian Harwood, Chief Economist at Evolution Securities, discusses what he calls the "key business, investment and policy issues for the world" today -- China's continuous growth. If you are interested in Morningstar featuring your content, please provide your details and/or submit your article here.
The key business, investment and policy issue for the world in general is the future health, or otherwise, of the Chinese economy. Now the world’s second largest economy, and the most populous (with even more people than India), China is currently experiencing the most extensive industrialisation, urbanisation and construction project in history. Crucially, no end to this process is yet in sight.
During the course of the past three decades - following Deng’s pro-market reforms of the late 1970s - China has been the world’s fastest growing economy, its GDP expanding by an average of almost 10% per annum. Growth at such a pace means that the absolute size of the economy has doubled every 7-8 years. And, significantly, in 2010 China’s GDP overtook that of Japan, making China the world’s second largest economy in current dollar terms (it had surpassed Japan in PPP-adjusted GDP terms quite a few years previously). A favourite guessing game is speculating how soon the size of China’s economy will exceed that of the US. Indeed, The Economist magazine recently launched a website model which allows people to input their own GDP and CPI projections to obtain an answer (www.economist.com/chinavusa: the magazine’s own guess is 2019).
The 20th century was America’s to dominate economically and financially (just as Britain had in the 19th) and it’s often said that it will be China’s turn during the 21st century. Indeed, viewed from the perspective of the past two millennia, China’s current catching-up constitutes no more than a reversion to the status quo ex ante. As the late Angus Maddison’s extensive and painstaking work has demonstrated, China and India accounted for over half of global economic activity prior to 1820, before being progressively eclipsed by the West as the latter’s industrial revolution got underway (see his magnum opus Contours of the World Economy, 1-2030 AD: Essays in Macroeconomic History, 2007).
Not that anybody expects China’s economy to keep expanding as rapidly in the future as it has in the past. The World Bank, for instance, in a “growth accounting” study published last summer projected that China’s GDP growth would slow to 7% over the next decade, the result of diminished availability of labour and slowing productivity. And, significantly, the Chinese government’s provisional 2011-15 five-year plan - to be confirmed at March’s National People’s Congress - targets no more than a 7% annual growth rate.
Some commentators are far more bearish, arguing that China is likely shortly to suffer an asset price and economic bust similar to that suffered by that previous high-flying economy Japan. During the late 1980s Japan was also confidently (and hubristically) projected to be on track to be the world’s Number One economy - prior to the onset of its 1992-2001 “lost decade”. We should emphasise that we’re not persuaded in the slightest by this argument – particularly as China’s policy makers are clearly very aware of the mistakes other countries have made in the past and are intent, therefore, upon not repeating them.
This said, China faces considerable medium-term challenges: changing its growth model to one in which household consumption will play a much larger role at the expense of the “traditional“ export and fixed asset investment drivers; re-balancing economic growth away from the coastal areas towards the interior; fostering “green” technologies and investment, in order to minimise energy consumption and pollution. Ever since China’s “animal spirits” were first unleashed by the late-1970s reforms one of China’s primary growth engines has been exports - the result of low labour costs and massive FDI inflows (the latter greatly encouraged by China’s 2001 WTO entry). Looking ahead, however, there are clearly limits to how fast exports can expand in future. From playing a pretty insignificant role in the world economy thirty years ago, China overtook Germany in 2009 to become the world’s biggest exporter and currently accounts for 10% of world trade.
Fixed asset investment - outlays on industrial capacity, infrastructure and property - has been the other major engine of China’s growth, and has accounted for a far higher share of GDP generation than was the case. In Japan or Korea at their similar stages of industrialisation. As with exports, investment spending is unlikely to be able to provide the same heavy lifting for China’s economy in the medium-term.
For the Chinese consumer to play a leading role in promoting domestic growth, however, not only will the employment outlook have to keep improving but, in addition, households’ high propensity to save will have to fall. Economists are agreed that the best way of reducing precautionary saving is by enhancing China’s (currently limited) social security net via enhanced spending on healthcare, pensions and education. Importantly, the government is moving in the right direction in all these key regards. Consequently, there is good reason to be sanguine about consumer spending which could, indeed, expand strongly in coming years.
It has been said for many decades (ever since the cataclysmic early 1930s, in fact) that “when America sneezes, the rest of the world gets a cold”. Recently, however, world markets have begun to behave as if the same is true of China, with a recent IMF study adding credence to this response by suggesting that a 1% reduction in China’s GDP will reduce the rest of the world’s GDP by almost 0.5%. According to the most recent WTO annual report, China is now the world’s second largest importer after the US. Such a ranking, though, understates its importance to commodity demand, where its massive appetite for energy and industrial metals makes it the dominant influence upon many commodity prices. This global ranking also understates China’s regional importance, insofar as it has supplanted the US as the biggest purchaser of the rest of Asia’s exports.
Certainly, the health - or otherwise - of China’s economy is increasingly scrutinised, with the Chinese monthly data flow now followed in the trading rooms and board rooms around the world almost as closely as that emanating from the US. Many of China’s official statistics, of course, are treated with scepticism (though the statistics bureau is making great efforts to improve its products), and consequently observers lay great emphasis upon alternative data sources, with China watching - data interpretation, commentary and forecasting - constituting a major growth industry. Certainly, the health - or otherwise - of China’s economy is increasingly scrutinised, with the Chinese monthly data flow now followed in the trading rooms and board rooms around the world almost as closely as that emanating from the US. Many of China’s official statistics, of course, are treated with scepticism (though the statistics bureau is making great efforts to improve its products), and consequently observers lay great emphasis upon alternative data sources, with China watching - data interpretation, commentary and forecasting - constituting a major growth industry.
The business cycle is alive and well in China - just as it is in other major economies (despite periodic efforts to deny that a business cycle exists, most recently during the 2003-07 global upswing). Indeed, the OECD’s statisticians have identified seven separate Chinese cycles since the late 1970s, with the contraction of the late 1980s and, subsequently, that of 2007/08 having been the most acute. At present, though, talk of a Chinese hard landing - whether brought about by an export slump or by domestic excesses (most notably, a purported property market bubble or rising consumer price inflation) - seems very wide of the mark. On the external front, the US and major European economies are in a sustained upswing, and the threat of protectionism has significantly receded. Meanwhile, on the domestic front, property price inflation is being curbed by the adoption of direct measures to curb “speculation”, while it seems unlikely that the current surge in food price inflation will be transformed into a generalised overheating.
See a timeline for China's GDP growth.
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