Market Insights: A China reality check

Amid the breathless reporting on the Chinese economy last week a widely quoted fact was that growth “had slowed last year to the weakest pace in 25-years”. This note places China’s recent growth performance in an historical perspective. As we will see, Chinese economic growth has been quite cyclical in the past. Across these cycles, moreover, growth has been structurally slowing for some time – and it should continue to slow. That said, China’s contribution to global GDP growth remains quite substantial, and it should be well into the future.

China’s growth has been slowing for a while

According to the Chinese authorities, China’s economy grew by 6.9% in 2015. Of course, most western commentators were quick to dismiss these GDP numbers, particularly as they are released within only a few weeks of year-end – a statistical feat few other countries can manage. In Australia, for example, the December quarter national accounts won’t be released until 2 March. In the United States, the “advance’ measure of GDP for the December quarter will be released on 29 January.

All that said, taking the numbers at face value, growth of 6.9% is still not that bad – and broadly in line with the Government’s target and even a touch higher than the 6.8% forecast by the International Monetary Fund in October last year. Indeed, although the IMF downgraded its global growth outlook in its January Update released last week, this largely reflected weakness in Latin America – China’s growth outlook was not downgraded.

As seen in the chart below, moreover, it’s clear that Chinese economic growth has been slowing for some time. Chinese economic growth last peaked at 14.2% in 2007, it then dipped during the financial crisis and recovered in 2010. But since this recovery, the economy has been progressively slowing down ever since.

What’s also apparent from the chart above is that China’s economy has exhibited quite notable cycles in the past – which is at odds with the view that Chinese officials “massage” the economic statistics to portray relative stability. Strong Chinese economic growth was interrupted by both the early 1980s and early 1990s recessions. There was also a notable slowdown in the early 1990s, before a strong recovery that peaked in 2007.

China’s growth will continue to slow

Not only will China continue to have economic cycles, but its underlying trend growth may be expected to slow. The IMF, for example, forecasts the Chinese economy will grow by only 6.3% this year and only 6.0% in 2017. China’s latest economic plan targets average annual growth of 6.5% over the next five years – which is still ambitious, but less than the 7.8% average annual growth over the 5 years to 2015.

China’s ongoing structural slowdown reflects the influence of two factors: population ageing and rising living standards. For starters, as seen in the chart below, China’s working-age population is set to slow after rising strongly in recent decades. United Nations population projections show China’s working-age population (15-64 years) grew by 1.5% p.a. in the decade to 2005, then by only 0.6% p.a. in the decade to 2015. Over the next 10 years, this population cohort is projected to contract by 0.2% pa.

Chinese Population Projections

Source: UN

The fact that China is getting richer also means growth should slow as there’s less scope for “productivity catch-up” with developed nations. As seen in the chart below, a slowdown in GDP growth per capita is quite normal as nations get richer: when and if China’s GDP per capita ever reaches the current levels of Korea, Japan and the United States, history suggest per capita growth should slow to around 2 to 3% p.a.

That said, given China’s GDP per capita is still only around $US 13,000 (PPP basis, 2014 prices) there still seems scope for at least 5 to 6% p.a. growth over the next few years if the example of Korea is anything to go by. In 1990, for example, Korea’s GDP per capita stood at $US12,800 and per capita GDP was able to grow by 6.8% p.a. over the following 5 years. But even in Korea, per capita growth has since slowed to around 2.5% p.a. in more recent years.

China’s contribution to global growth remains strong

Another point to note with regard to China is that despite the slowing in growth in recent years, it’s overall pace of growth has still been quite high by global standards. Together with its relatively large and growing share of the global economy, this means its overall contribution to global growth remains strong. It has been widely quoted, for example, that Chinese growth in 2015 was the weakest in 25 years – given the economy grew by only 3.8% back in 1990. As seen in the charts below, however, back in 1990 China’s share of the global economy was only 3.7% – today China accounts for around 17.5% of world GDP – or 4.5 more. In 2015, based on IMF data, China contributed just over one third – or 1.1 percentage points – to the 3.1% growth in the global economy. That compares with a contribution of only 0.1 pp in 1990.

Structural Change can be confusing

Last but not least, a lot of commentary has focused on the impact of China’s slowdown on world trade and its industrial and manufacturing sectors. Some suggest, for example, that the notable slowdown in Chinese exports and imports – together with industrial production – suggest the true state of the economy is far worse that the GDP numbers alone portray. While that may be so, relative weakness in trade and industrial production (compared to GDP) is also consistent with structural change toward more service orientated and domestic demand led growth.

Anecdotal evidence suggests the consumer side of the Chinese economy is strengthening. Given this, the continued focus on “traditional” industrial production based measures of activity may be providing a negatively biased picture of the overall economy. At the same time, the slump in Chinese equities continues a long tradition of boom-bust cycles in this volatile market which has traditionally borne little relationship to the wider economy.

No Reason to Panic

All up, so far at least there is little to suggest China’s economic slowdown remains anything other than orderly. China’s economic growth has slowed and should continue to slow – as is normal for a successfully developing economy. Its economic transition also means traditional economic indicators need to be interpreted with care. Despite China’s slowdown, moreover, its overall contribution to global economic growth is – and will continue to remain – far more substantial than in earlier years when it was growing much faster.

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