My first impressions of China.
Enter the Dragon
It has been two months since I moved from India to China. As a child, I saw a photobook on China. It presented a calm and agrarian economy. As I grew up, I read a lot about China’s meteoric rise. None of which prepared me for what I was about to see.
For example, Nanjing, the city I live in, is classified as a tier-two city in China. It has roughly the same population as Chennai – around eight million. Both cities have a rich history, but that’s where things start to diverge…
Nanjing is roughly six times larger, which means a much lower population density. Nanjing’s estimated GDP is about half that of Chennai ($100 billion versus $200 billion). But it has a much more developed infrastructure network – roads, highways, bridges, and underground transport are impressive.
I was surprised at the state of infrastructure and the planning that went into the city.
The last 30 years have been a period of very fast growth for China. The GDP of China in the 1980s is estimated to have been $200 billion. It is now $12 trillion, and China is the world’s second-largest economy.
What’s been behind this fast growth? I’ve written earlier about the key components of growth (https://www.equitymaster.com/outsideview/detail.asp?date=10/05/2015&story=3&title=The-Growth-Puzzle-Nitin-Gregory) and the characteristics of catch-up growth (https://www.equitymaster.com/outsideview/detail.asp?date=10/19/2015&story=4&title=Catch-Up-Growth-Snippets-in-History-Nitin-Gregory).
This ‘investment-led’ growth model has been used by other Asian countries, but the size and scale in China is unique. This has increased interest in economic insights related to China. One of the most common discussions is about the need for rebalancing. I will discuss this in two parts.
Internal rebalancing
Historically, domestic consumption as a percentage of GDP has been low in China, averaging close to 36%. Compare that to 68% in developed economies like the US.
This means the growth has been generated through capital deepening, which has come through two channels. One channel comes directly from the government. The other comes from banks that have been lending aggressively to the manufacturing and real estate sector. This has led to overcapacity. The Chinese five-year plan talks about streamlining state-owned enterprises (SOEs) which will result in job losses .
In Avoiding the Fall, Michael Pettis talks about rebalancing between investment and consumption. Part of this will happen through unemployment and public spending. He describes other means such as tax cuts and privatization of state-owned enterprises.
External rebalancing
The last few decades have seen the exports from China to US rise. The trade deficit with China is key issue in the US presidential elections. This represents an imbalance between the two countries. Usually this gets corrected through a change in the currency exchange rates. The exporting country currency revalues upwards, making its exports less competitive.
The depreciation of the renminbi in 2015 was a concern for China’s trading partners. There was a worry that the move was aimed at increasing exports (to offset the anticipated drop in investment).
But it was more likely a function of capital outflows from China. It is estimated that the central bank spent close to $500 billion in foreign reserves trying to defend the currency. The effect of boosting exports through currency depreciation in a weak global demand scenario is minimal. The Chinese premier has indicated that they will not seek to boost exports through currency depreciation.
The future
China has pulled off what seems to be a miracle – about half a billion people have seen a dramatic increase in their standard of living in just two decades.
Many issues still need to be dealt with, and the government and the public seem to understand this. The broad theme of the next few years for China will be rebalancing. The question remains how this will play out – How will the consumption patterns change? Will there be a rise in services? What are the drivers of the housing market? How will currency changes impact the debt levels?
We will explore this further in later discussions. Understanding China is fascinating…and increasingly vital given its rising importance.