One of the major debates on the future of China relates to the potential growth with some pundits predicting a sharp and unavoidable fall in Chinese growth throughout 2020.
We have looked into the causes behind China’s slowdown in recent years and it appears that some common concerns about the country’s potential growth are perhaps overdone. If China can continue to push structural reform, the current pace of growth is perhaps near its floor for this multi-year transition.
- First, the concern about the country’s demographics is probably overstated. Admittedly, China’s working-age population has peaked, but employment has continued to grow, though at a slightly slower pace. This is partially due to a steady increase in Chinese lifespans. China has a relatively early retirement age, and allowing people to work longer could help offset some negative impact from demographics in coming years.
- Second, productivity gains reflecting the shift of labor from agriculture to other sectors are ongoing. The agriculture sector is still far less productive than other parts of the economy and other countries, with nearly 30% of employment producing less than 10% of GDP. Increased productivity in agriculture, with more imports of agricultural products, could continue to help release more labors from rural areas. The latest move was that China has officially clarified rural land transfer rights, which should facilitate the growth of modern farmers.
- Third, labor quality is steadily improving. While few Chinese went to college before the 1980s, there are currently around 8 million graduates per year, representing roughly 1% of the labor pool. The gains look to become more meaningful with the economy shifting from low-end manufacturing to higher-end products and services.
- Fourth, China has continued to increase R&D spending, which is already higher than its peers in a similar development stage, such as South Korea and Taiwan. Its R&D spending as a share of GDP has already reached around the average level of EU economies.
Meanwhile, despite decades of relatively fast growth, China’s labour productivity is still only around one-fifth of US levels. If we take US productivity as a standard of the productivity frontier, this implies China has more than enough potential space to catch up.
Sources: Pioneer Investments, CEIC. Data as of December 31, 2016.
Finally, while the above factors are relatively certain elements supporting China’s medium-term growth, a key variable is structural reform, which could help improve system efficiency.
Overall, it appears that it will be a challenge for China to return to 7% or above growth if the recent de-globalization trend lasts, but the 6% growth range remains achievable over the rest of this decade, based on our evaluation matrix on reform progress.
Regarding reform, we believe that most market commentary has either been too subjective or focused on narrow areas. By contrast, we have tried to list all of the reform measures that we thought China should pursue and have been tracking their progress in a systematic way.
Our reform tracker suggests that:
- China has made relatively good progress in financial reform and some fiscal reform over the last 2 to 3 years, while the focus has shifted towards those areas to help shift income and rebalance the economy over the past year.
- Reform measures have been accelerating since the summer, following more convincing signs of the economy stabilizing, while progress was relatively slow in early 2016 when growth was a top concern.
- Important structural measures in 2016 included the opening of interbank bond markets; the launch of the Shenzhen-Hong Kong Stock Connect; a stronger push of the Hukou reforms and the “People-centred” urbanization; a strengthening of financial regulations; some pilots for Stated Owned Enterprise reform; and recent rural land reforms, in addition to ongoing exchange regime transition and measures to speed up overcapacity cuts.
- Regarding recent tightening of capital management in some areas, we think they are largely focused on short-term risk management; targeting short-term and speculative flows, rather than signaling a change of long-term direction.
Source: Pioneer Investments, State Council, NDRC, Xinhua. Data available as of December 20, 2016. SOE means Stated Owned Enterprises. Hokou reform is going to remove distinction between rural and urban population. Red tape refers to a bureaucracy cut.
In our view, the success of the China reform process will be crucial in determining the growth outlook for the next few years.