Oct 2, 2015

There is no question that the speed of China’s development as an economic power has been staggering. In the past two decades, China’s economic output has swelled from half a trillion dollars a year to over $11 trillion, making it the world’s second largest economy by GDP[1]. However, with the Shanghai Composite Index plummeting a staggering 30% since June and decreasing $3tn in value, many have suggested that the current path is unsustainable and that the cracks are beginning to show. China will need to shift to a more balanced economy, not solely based on exports and state funded infrastructure. Steps underway towards a more consumer-based model for economic growth will lead to a number of challenges and societal shifts. With great change likely to take place over the coming years, a range of promising investment opportunities will in turn arise.

 Why is this model unsustainable?

 Chinese economic growth was driven by two factors. Firstly, China transformed itself into a global manufacturing powerhouse. It now exports 40-50% worth more goods than the United States or Germany[2]. ‘Made in China’ has become synonymous with manufactured goods ranging from clothing/textiles to high-end technology. Secondly, the Chinese landscape has been radically altered by large-scale investment in infrastructure projects[3]. China now boasts 69 thousand miles of motorways and a high-speed rail network that is the envy of many developed states. This provided China with an average growth rate of greater than 10% during the 21st century.

There are a many reasons and theories explaining why the current model for economic development in China is reaching its end. Firstly, the model depends on low wages, which results in low levels of domestic consumption. Should the demand for exports decline, as happened after 2008, then economic growth will decline as domestic consumption is not sufficiently developed to cover the shortfall. Policy makers have been able to ward off the impacts of the decline in export demand by loosening monetary policy; however, this has had its own consequences – cheap financing has fuelled both a housing bubble and industrial overcapacity – which are clearly not sustainable[4].

Secondly, the sheer speed of China’s development, combined with falling export demand, has resulted in excess capacity within the Chinese economy. The availability of cheap financing and a desire to maintain high growth has meant that large infrastructure projects which previously brought substantial economic benefit to a less developed country, are now suffering diminishing returns. This has reduced the rate of growth, limited profits and also prevented new, more innovative competitors entering the market[5].

Thirdly, Chinese workers are earning more and getting older, reducing the supply of cheap labour central to China’s recent development. Increases in the cost of labour will erode the returns previously provided by the investment led model, rendering levels of growth unsustainable[6].

 A new course for a sustainable model?

It has long been recognised that policy makers must act to rebalance the Chinese economy by encouraging domestic consumption. By doing so, it is hoped Chinese manufacturers will find new markets amongst the, as of yet, underdeveloped domestic consumer market, thereby reducing the economy’s exposure to fluctuating demand in the global economy. For most of the last two decades, Chinese household consumption has hovered at ~35% of GDP. When compared with the UK (~64%) and the US (~68%), it is evident that China as a consumer remains underdeveloped[7].

Policy makers will need to persist with efforts to increase household income, further develop social welfare and engender the services sector, private enterprise and competition. This should reduce the extremes of China’s consumption profile and produce a new middle class with genuine purchasing power. Such reform can lead to sustainable growth, even if it means the overall growth rate falls.

If this can be done without provoking a fall in GDP growth below the 7% considered essential to maintain current levels of employment and social stability, then a number of new investment opportunities are likely to arise[8]. Higher wages and a broadening consumer profile will create demand for a wider variety of Western goods and services. Whereas previously brands such as Rolls Royce and Burberry have profited from serving the upper echelons of Chinese society, one should expect those aimed more toward the middle class to find new profit making opportunities. Furthermore, these new consumers will not only require luxury goods, but also ancillary services, such as, healthcare, finance and tourism. All this will not only create demand for expertise in the provision of high-end consumer goods and services but also capital as the Government takes (albeit tentative) step toward encouraging greater FDI (Foreign Direct Investment).These changes are also likely to create opportunities beyond China itself. Expect manufacturing in SE Asia to also experience an upturn as the increasingly expensive Chinese labour market leads manufacturers to seek alternative labour pools allowing them to maintain their profit margins and competitive edge.

Change has become synonymous with China and this looks set to continue. Despite the short term risks, Chinese leaders need to continue to take steps to ensure that the level of growth is not only high, but sustainable. It is through balancing exports and imports; private and public sector infrastructure, services and investment the next wave of opportunity in China will emerge, encouraging growth both at home and abroad.

[1] Andrew Sentence, ‘A slowdown in China’s high-speed economy may be a boost for Britain’, The Daily Telegraph, 9th August 2015.

[2] Ibid.

[3] Ibid.

[4] Tomas Ramanauskas, ‘China – Approaching the end of the export-led growth story?’, Euromonitor International, 16th March 2014.

[5] Ihssane Loudiyi, ‘The past and future of export-led growth’, The World Bank – Growth and Crisis, 24 February 2010.

[6] Paul Krugman, ‘Hitting China’s Wall’, The New York Times, 18 July 2013.

[7] The World Bank, ‘Household final consumption expenditure etc. (% of GDP), http://data.worldbank.org/indicator/NE.CON.PETC.ZS.

[8] Tomas Ramanauskas, ‘China – Approaching the end of the export-led growth story?’, Euromonitor International, 16th March 2014.