The 5 economic myths of China
Stephen Dover, Chief Market Strategist of Franklin Templeton analyzes five myths related to China useful to investors (and not only)
For many Westerners, China is an enigma.
Beyond the borders, the country's language, culture and history are still largely mysterious. I was fortunate to have been one of the first Americans to live and study in China in 1982, and have been traveling, working and investing in China for 40 years now. In this paper, I focus on five myths related to China's economy and financial system. By offering more realistic information, I hope to help investors better judge the opportunities and risks of investing in China.
Myth No. 1: The engine of the Chinese economy is exports
Perhaps the most defining myth about China's rapid modernization and the country's economic development is that exports have been the driving force behind its growth. It is an opinion without solid basis, although it is true that all the major successful economies in history, including China, owe much of their economic success to active participation in international trade. Exports and imports provide access to wider markets, knowledge, inexpensive inputs and robust competition, all of which contribute to sustaining economic success.
China's economic transformation, however, is much more due to the successful adoption of a market-based domestic economy and the broad mobilization of savings for investment. Chinese exports represent no more than 19% of the gross domestic product (GDP). This is roughly the same as that of Brazil or India, and only slightly higher than Japan. China's export-to-GDP ratio is ten percentage points lower than countries such as Canada, France, Italy, South Africa, Turkey or the United Kingdom. The share of exports in China's GDP is lower than that of Russia (25%) or the average of the world's low-, middle- or high-income countries.
Only in comparison with the United States, where exports account for just 10% of GDP, could China be labeled as "export-driven". China is the world's largest exporter by value; over $ 2.7 trillion worth of goods were exported last year, surpassing the United States. Considering the goods and services exported around the world, one in 10 come from China.
However, the simple monetary value of China's strong exports only underscores the fundamental point:
China is a large exporting country because it is a large economy, however its domestic economy is a giant compared to its exports. China's road to economic success began in 1978, when Deng Xiaoping introduced market reforms that triggered a broad mobilization of savings for investment financing. Driven by market forces, the Chinese economy began to flourish.
However, the sectors in which China is a true giant are savings and internal investments, which represent more than 40% of GDP respectively, almost double that of the more advanced economies.
Investments in housing, transport and energy infrastructure, together with manufacturing activity, have been the fundamental drivers of China's long path to growth in five decades. In the first three decades of China's rapid development, the accumulation of capital and the rapid increase in productivity have supported a rise in living standards. Over the past dozen years, China's productivity growth has slowed, as has almost every other country in the world. Furthermore, concerns about overinvestment and slowing global trade growth are leading to a review of China's strategic growth plans.
Myth No. 2: China is rich
A second myth is that China is a rich country. There is a thriving middle class in China and many very wealthy families, yet the country is predominantly middle-income. According to data from the World Bank, China's per capita income in 2020 was just over $ 10,000 – a tenfold increase in the past two decades. Nonetheless, per capita income in China is only a quarter of the level of the European Union (EU) and a fifth of the United States. China is often judged as a rich country due to the size of its economy. Adjusted for relative prices (at base parity by purchasing power), China's annual GDP is currently on par with that of the US or the EU.
However, the Chinese population is 4.4 times that of the United States. Furthermore, China's wealth is strongly concentrated in the large cities of the coast, while the western part of the country is much poorer and still lacking in development. The fact that, in terms of per capita income, China is still catching up on advanced economies in terms of living standards, could allow it to continue growing rapidly, moving up the value-added chain to current US levels. Japan or Western Europe. To do this, China will have to constantly adapt and evolve, shifting vast resources from manufacturing and construction to services, and getting closer to the cutting edge of technology.
At the same time, the Chinese leadership has set income parity as an important goal. This will require China to rebalance its economy in ways that support greater growth and at the same time distribute wealth more widely.
Myth No. 3: China is in the process of rebalancing
And this brings us to the third myth: that China is rebalancing its economy by moving from investing in heavy savings and manufacturing to consumption and services. In reality, China is striving for a rebalancing, but has not yet made the necessary progress. To some extent, Chinese policy makers are in a situation where they have to choose between "chicken or egg". They understand that excessive investment, especially in real estate, is not efficient.
However, they also aim to achieve strong GDP and employment growth, duly provided by investment and construction. China is unwilling to sacrifice strong growth and job creation, even temporarily, which makes it difficult to move from the current fundamentals of the economy. Undoubtedly, the program is not very brilliant. China needs to boost consumption as a share of GDP, while reducing savings and investment.
An increase in consumption, however, is no easy feat. In the absence of education subsidies, pensions and other social safety nets common in advanced economies, Chinese household budgets are heavily focused on savings.
Furthermore, China's declared dual circulation objective, which is to boost consumption and exports to offset less investment, has its own challenges. An increase in consumption presupposes increases in wages and a larger share of workers' income in GDP, however this very result would erode the competitiveness of Chinese exports and profitability in the sectors of traded goods. In short, as China aims to rebalance its economy, the time it takes to do so could be considerably longer than many expect.
Myth No. 4: Foreign companies are moving out of China
The fourth myth is that foreign companies are leaving the country in droves, driven by trade wars, rising geopolitical tensions, and pandemic-induced problems in global supply chains. Reality is different.
The vulnerabilities of global supply chains have come into the open, but there are no ready alternatives. Indeed, with the global economy recovering over the past year, demand for Chinese-made goods has increased rapidly, and Chinese exports in 2021 have rebounded nearly 30%. Indeed, shipping delays caused by the pandemic have been a much more widespread problem for the United States, while arrivals and departures in Chinese ports in the past year have been minimal. There has been some change, however, with the closure of Shanghai and its ports to prevent the spread of COVID-19.
China also continues to be a magnet for foreign direct investment (FDI), which reached its highest levels on record last year. 2021 was the best year ever for FDI inflows to China, which rose more than 40% from pre-pandemic levels. Last year, one in five dollars of global direct investment was earned by China.
Foreign interest in China is also reflected in the polls. According to a survey carried out by a Chamber of Commerce in mid-2021, 60% of US and European companies were planning to increase their investments in China. Out of 300 US companies surveyed, none had repatriated their business from China to the US.
Less than 10% of European companies were planning to reduce their business in China, the lowest percentage ever recorded.
Myth No. 5: China cuts domestic investment
The latest myth is that China avoids overseas investment in its economy. This myth has emerged in part due to tensions between the United States (or European countries) and Chinese regulators regarding disclosures related to the listing of Chinese companies on foreign stock markets.
It also reflects concerns about possible Chinese industrial espionage, or intellectual rights violations.
In reality, capital market segmentation is more one-sided; the US and Europe are making their capital markets less attractive to Chinese companies, while China is not adopting a similar strategy regarding domestic investment. A selective liberalization of foreign ownership regulations in China has been a factor in retaining and attracting new FDI. In recent years, China has reduced the number of restricted sectors, industries and foreign companies eligible for investment and ownership, and the most recent reductions were announced last month. Last year, for example, large US investment banks were authorized by the Chinese authorities to open deposit services and own 100% of their onshore investment banking operations.
In addition, the China Securities Regulatory Commission (CSRC) recently introduced guidelines to accelerate the development of the mutual fund industry.
A key aspect in this regard is supporting foreign financial institutions in establishing new fund management companies in China, or increasing their ownership stake in local joint ventures. One of the goals is the development of suitable products and strategies for investing in Chinese pension funds, which implies the aspiration to a long-term commitment of foreign partners. These movements send a strong signal beyond finance, sending a message that China is both open to inward investment and interested in providing competitive financial services to residents in the country.
China continues to be misunderstood by the West
China's economy is in a transition phase, facing the challenges of moving from growth based on unsustainable levels of investment (especially in real estate) to something different. The focus may be on the long run, but it seems unable to sustain too many constraints on the economy in the short term, a factor that hinders this transition and could affect its success over time.
It should also be remembered that China is not turning its back on the rest of the world. In geopolitical terms, its ambitions may conflict with those of the West, as evidenced by recent support for Russia. However, China remains economically, financially and politically committed to global involvement, as evidenced by its recent economic performance and policy initiatives.
China will therefore remain both an enigma and an important economic powerhouse and destination for investments, which can hardly be defined on the basis of simple myths.
And finally: the origin of fortune cookies is not Chinese, while that of 'lucky money' is.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/i-5-miti-economici-della-cina/ on Sun, 05 Jun 2022 05:19:36 +0000.