Although policymakers have some big levers to pull, including possible expansionary monetary and fiscal policy, that may underpin real economic activity for some time, China’s long-term real GDP growth prospects have dimmed.
By Arthur Kamp, Investment Economist at Sanlam Investments.
Slowdown not unexpected
In 2011, Barry Eichengreen, Donghyun Park and Kwanho Shin, in a joint paper1, warned of the pending slowdown in China’s growth. They identified a number of growth drivers, but the broad thrust of their argument is that economies can grow fast for a period by shifting labour from the primary sector to the secondary industry, while ‘importing’ and applying technology from abroad. These developments typically boost productivity and GDP growth, but not indefinitely.
Ultimately, they observe, once an economy reaches a particular stage of development, a growth slowdown typically occurs as economies struggle to continue extracting robust productivity gains from these drivers. Characteristics of this ‘stage of development’ include a median GDP per capita level of just over US$15 000 in 2005 constant international prices and manufacturing employment of around 23% of total employment. Roughly, China is approaching this point.
Viewed from this perspective, the slowdown in China’s growth rate is therefore no surprise. But the question is just how prolonged and deep the slowdown will be.
Will throwing more capital at the problem help?
There is reason for concern. China’s fixed investment expenditure has been exceptionally strong for decades. Accordingly, the level of capital stock has increased sharply relative to both GDP and labour input.
During the first decade of this century China’s investment ratio climbed from around 30% of GDP to close to 50% of GDP, while the real capital stock increased, on average, by more than 10% per annum. This is exceptionally high and cannot continue indefinitely.
For a time, strong investment spending drives productivity and GDP growth. But as the capital stock continues to expand for a given level of GDP and labour, it becomes more difficult to sustain growth as an increasing share of investment goes towards replacing ageing plant and machinery.
An increasingly smaller portion of investment is in new machinery and equipment. Although productivity is boosted at first when workers are equipped with new machinery, the marginal product of capital (the increase in output per additional unit of capital input) decreases as more and more capital is added for a given level of the workforce.
Investment in property has already declined markedly, but overall fixed investment spending continues to outpace growth in GDP, while the ratio of investment in output has remained high at close to 50%. It seems unlikely that this can continue.
China’s demographic trends are not favourable. Indeed, the country’s working-age population is going into decline. GDP growth is a function of employment and productivity. Given a declining labour force, long-term growth is dependent on productivity growth. But, considering the above, productivity growth is likely to slow significantly.
Looking ahead, China’s economic growth seems set to disappoint materially, while a defining feature of further moderation in China’s growth is likely to be a falling share of investment in GDP.
What does this mean for investors?
China is currently the world’s second-largest economy and a net importer of commodities, which means commodities countries like South Africa will be affected. Investors will need to taper their expectations regarding equity returns over the next few years.