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End of An Era: 30 Years of Double-Digit Chinese Growth
Saturna Capital
By Bryce Fegley
January 17, 2013


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Slumping exports, lackluster domestic consumption, and slowing urban migration contribute to lower growth expectations for China.

January 2013

With Chinese manufacturing capacity now saturated relative to global demand, and developed economies facing the consequences of over-indebtedness, external tailwinds to China's growth have passed.

China has completed a remarkable transformation over the past three decades, rising to become a global power and the world's second largest economy. From 1981 to 2011, China's real GDP rose at an annual rate of 10.2%.1 This growth began from a low base and was not without hiccups. But in the last decade, the GDP had grown to such a scale that it began to have a profound impact on the rest of the world, particularly with respect to China's demand for materials.

Although China remains poor in terms of per capita income, its scale, demographic profile, and accumulated political and economic imbalances suggest future growth may not match the pace of previous decades. A growth slowdown would likely have its biggest impact on the economies of countries such as Australia, Brazil, Canada, and Indonesia that have large trade exposure to China and/or commodities. Of course, lower commodity prices could be a boon to the U.S., Europe, Japan, and much of the developing world.

Why China's growth has peaked

In 2000, the Chinese government recapitalized the country's faltering banking system and bolstered pro-growth economic policies. Improving political relations combined with the sheer scale of the country's low-cost manufacturing potential and abundant cheap labor opened the door to rapid export growth.

The human capital needed to support China's export boom and ancillary economic activity was provided by migration of younger rural workers to the southern and eastern port cities. In 2000, 36% of Chinese were classified as urban, a number that grew to 50% by 2010.2 Many workers remained migrants and lacked access to permanent urban housing. As the housing shortage accelerated, and the congestion of the major port cities capped any further benefit of increasing scale, the government responded by promoting the development of "2nd tier" cities. This phase of urban development accelerated sharply after the onset of the global financial crisis, with the unveiling of a massive stimulus plan to support economic growth in the face of slumping export demand. Much of this stimulus went toward public works β€” roads, rail, airports, and municipal infrastructure β€” while bank lending quotas fed real estate development.

China's Rural to Urban Migration

We estimate the annual growth rate of the working-age urban population from 2001 to 2011 was 4.4%, but that it will slow to 2.5% annually in the coming decade. The lower rate of migration suggests China's economic growth should decline about 2%, assuming no change to the growth rate in productivity per worker. However, urban migration and worker productivity are closely linked because workers become much more productive when they move from a no-tech farm to a high-tech factory.

China's export boom accelerated after its 2001 acceptance into the World Trade Organization (WTO), with a large scale outsourced manufacturing transition that tapped its deep labor market. That transition is largely complete and may be reversing as Chinese labor costs have escalated. With Chinese manufacturing capacity now saturated relative to global demand, and developed economies facing the consequences of over-indebtedness, external tailwinds to China's growth have passed.

 

China's Inflation and Money Rates

2001-2011

Annual inflation*

4.25%

Average deposit rate

2.61%

Average lending rate

5.88%

* Saturna's estimate of China's GDP deflator

Source: Bloomberg

China's growth over the last decade was also financed by high household savings rates and the negative real interest rates on bank deposits that financed cheap loans to state-owned enterprises. China's high savings rate has been a natural consequence of the low fertility rate caused by China's one-child policy and the lack of a social safety net in a Confucian society where working-age children are expected to support their older parents. When faced with the limit of only one child to meet that burden, urban families need to save a significant portion of their income instead of relying on offspring or nonexistent state pension systems.

Still, the absolute level of savings would not be so high were savers able to earn a real return on their deposits. But the central government has subsidized investment by holding deposit rates below the level of inflation. There have been few alternatives for most Chinese savers to protect the purchasing power of their savings other than simple bank deposits. The high savings rate provided ammunition for the central government to achieve its growth targets through quotas for lending by state-owned banks to other state-owned companies.

The high level of state-directed investment during the past decade caused capital investments as a share of Chinese GDP to rise from 35% to 46%. The household consumption share of GDP, however, plunged from 45% to 35%. Wages of Chinese workers grew slower than GDP, while inflation eroded the value of their savings, both of which limited the appetite for consumption.

Optimistic observers of Chinese growth point out that the accumulated stock of capital and infrastructure remains low compared to the developed world on a per capita basis. The biggest flaw with this perspective is that the extraordinary scale and pace of capital accumulation over the last decade eventually overwhelmed production of raw materials, driving their prices sharply higher. The multi-year timeframe of large scale investments and the momentum of investment spending is likely to have resulted in numerous projects that will not generate economic returns above their escalating costs. The specter of ghost cities such as Ordos in Inner Mongolia is a visual manifestation of this phenomenon, but the full scale is tricky to nail down. Economic intuition strongly counsels, however, that subsidized investment with rapidly escalating input costs will result in negative return projects, and a decreasing pool of attractive projects from which to choose.

China Growth Forecast: 2012-2022

China's economic fate in the coming years may resemble countries such as Korea and Japan that also experienced investment-led booms through a combination of high savings rates and repressed consumption. Their economies did not immediately rebound as their investment booms waned, and China, too, may find it difficult to maneuver to raise consumption growth. We suggest a baseline case for China's GDP growth over the coming decade could be 4-6%, which is at least 2-4% below consensus forecasts of economists. Slower economic growth combined with much slower growth in demand for materials via capital investment may pose trouble for countries and industries with large exposures to China's raw material demand.

Footnotes

1 Source: World Bank

2 Census shows China's population hits 1.339b. China Daily, April 28, 2011. http://www.chinadaily.com.cn/imqq/china/2011-04/28/content_12412491.htm

Copyright 2013 Saturna Capital Corporation and/or its affiliates. All rights reserved. Vol. 7 Β· No. 1

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