Based on interviews with 10,000 consumers in 44 cities, a Mckinsey Report of April, 2016 finds that, despite current economic downturn, Chinese consumers remain confident—and in 2015 they continued to substantially increase spending within and outside China. Nevertheless, there is regional divergence, as in Harbin, where consumer confidence faces steep decline.
There are distinctive shifts from products to services, from mass products to premium brands (including loyalty to top international brands), from mere goods to lifestyle, health and well-being, from Online to O2O (Online-to-Offline), from in-store shopping to associated leisure experience on-site such as restaurants and cinemas, and from individual to joint family leisure activities.
China’s Five Year Plan 2016-20 aims to shift to higher value-added and more sustainable development, doubling 2010 national income by 2020. Many China-watchers remain largely unimpressed. Some conclude that China is now stuck between a rock and a hard place. The current model is unsustainable without far-reaching structural reforms while Beijing remains nervous and appears to muddle through with financial stimulus. The way forward seems pointed more to sunset rather than renaissance.
Let’s try to see through the mist.
According to the Premier’s latest Work Report in Beijing, GDP grew by 6.9% to $10.3 trillion in 2015. 13.12 million urban jobs were created, with 7.4% rise in per capita disposable income and a reduction of 14.42 million rural persons below the poverty line. Utilized direct foreign investment amounted to $126.3 billion while outbound foreign direct investment grew to $118 billion. This picture of slowdown does not seem to signal impending paralysis.
Let’s turn to consumption and services.
Consumption seemed to have stalled from 38.3% of GDP in 2006 to 38.2% of GDP in 2015. This comparison, however, ignores the expansion of economy from $2.3 trillion in 2005 to $11.3 trillion in 2015. A similar percentage of a doubled economy equals tremendous growth. Chinese private consumption growth over 2005-14 bested major economies, averaging 8.9% annually compared with 7.3% for India and 1.8% for the United States. Click here
Economic slowdown notwithstanding, evidence points to considerable pent-up demand. China’s “Singles' Day” online shopping in November 2015 splurged $9.3bn in 12 hours. Outbound Chinese tourists number 100 million annually. Galleries Lafayette in Paris continued to report strong sales to Chinese tourists, which accounted for 33.7% of sales in 2013-14. An addition of 260 million affluent Chinese consumers is expected in the next decade. Click here Additionally, McKinsey & Co estimates that China's working and retirees will account for 18% and 10% respectively of global urban consumption growth from 2015-30.
As for services, this sector started to exceed the contribution from industrial production in 2012. Output of services as a share of GDP in 2015 is estimated to total 49.2%, compared to 41.9% for industry. Click here
Much has been made of “supply-side reform”. What this means are de-stocking excess capacity, de-leveraging debt, streamlining bureaucracy, reforming state-owned enterprises, liberalizing currency and interest rate, and providing better social security and a greener economy.
China is drastically reducing excess coal capacity in developing a greener economy. China's coal consumption fell by 2.9 % in 2014 and by 5 % in 2015. As a result, global CO2 emissions may have declined by about 0.6 % in 2015, an astonishing outcome, if confirmed. China reduced its energy consumption per unit GDP by nearly 20% from 2006-2010, and a further 16% reduction by 2015. At this rate, China may achieve her Paris climate commitments well before the 2030 target. Click hereand hereThis Five-Year Plan is the greenest ever yet, aiming to deliver 45% carbon intensity reduction by 2020. Click here
There is likewise much de-stocking in the steel industry, using online trading to help speeding up the process. Click here
It is therefore no longer meaningful to correlate China’s growth with electricity consumption, a source of skepticism with China’s real GDP growth rate. The former “Li Keqiang Index” has become obsolete. Click here
As for state-owned enterprises (SOEs), China wants them to become internationally competitive, playing the transitional role of South Korea’s chaebols. A plan is recently launched to transform 112 SOEs into 40 bigger conglomerates with a view to eliminating duplication, enhancing synergy and streamlining corporate efficiency. The recent merger between stated-owned train-makers CNR and CSR Corporation is also a case in point. More of such mergers can be expected.
Debt, however, remains a ticking time bomb. As for household debt, a looming mortgage crisis is not inevitable as gearing remains comparatively low and stringent measures are introduced to curb speculation. Corporate debt is more worrying. China’s central banker Zhou Xiaochuan has alluded to substituting it with equity financing. That cannot be effective without a further opening of China’s capital market, supported by sophisticated regulatory infrastructure. This liberalization will also enhance free capital flow needed to boost the renminbi’s global status, on which China sets great store. Recent reflex actions and immature market expediencies notwithstanding, China’s learning curve must not be conflated with resisting, let alone rolling back financial reform.
With shrinking demographics, overcoming the “middle-income trap” without jumpstarting productivity seems an impossible task. A great deal depends on innovation and quality of the workforce. China’s education spending has grown by 20% annually since 1999. Adding some 7 million university graduates a year, China is poised to have some 200 million graduates by 2030, more than the entire US current workforce. Moreover, China is on track to become the world’s top R & D spender by around 2019. China’s human capital is further enriched by overseas Chinese student returnees. 364,800 students returned to China in 2014, an increase of 3.2% over 2013. Since 1978, a total of 3.5 million Chinese have studied abroad. The total return rate to 2014 stands at 74.5%, thanks in part to an “overseas professional returnees program” with attractive terms. Click here
According to the World Intellectual Property Organization (WIPO), China has been the world’s top filer of patents and trademarks every year since 2012, responsible for a third of all patents filed. While quantity does not equal quality and China still lacks Nobel Laureates, world-class Chinese entrepreneurial disrupters* are beginning to emerge to define the rules of e-commerce. According to a report in the New York Times, Chinese start-ups are poised to take leap in developing a driverless car.
(*China’s Disruptors – How Alibaba, Xiaomi, Tencent, and other companies are changing the rules of business, Edward Tse, Penguin Random House, UK, 2015)
What is more, China has been transiting from a model based on "Make in China", to "Created in China", through to "Owned by China". Recent examples include Wanda's万达集团 acquisition of AMC and Legendary, one of United States' largest cinema chains and film studios; Flagship Entertainment Group 旗舰影业, a new joint venture between China Media Capital (CMC) 华人文化产业投资基金 and Warner Bros Entertainment for global film production and distribution; and the acquisition from KKR by Shandong Ruyi 山东如意纺织集团有限公司, one of China's largest textile producers, for a 70% stake in SMPC, a leading French fashion company.
Yes, China is clamping down on civil society. While charting a potentially turbulent course towards the 2020 goals, stability trumps everything else. Meanwhile, however, a new charity law has just been adopted to promote home-grown philanthropy. According to PEW, an independent public opinion research center based in Washington DC, while corruption, pollution and inequalities remain Chinese people’s top concerns, there is widespread belief that standard of living has improved. In 2008, 66% of Chinese said their personal finances were good. In 2015, 72% hold this view. Warts and all, how the country is managed seems to retain majority support. There is no mileage for regime change.
Do I want to bet on China’s chances of fulfilling the Five Year Plan? Probably not, as the tasks ahead are herculean and many black swans could appear. But considering her track record, I am not convinced that China is now so hamstrung that she can only sleepwalk towards sunset.
China has formally approved the Five Year Plan (2016-20), which aims to double 2010 income levels by 2020, striving to overcome the "Middle Income Trap" towards a moderately well-off economy. Details of the Five Year Plan are contained in the full textof Premier Li Keqiang's Work Report delivered at the 2016 National People's Congress/Chinese People's Political Consultative Conference (NPC/CPPCC) "Two Sessions" on 5 March, 2016.
The Plan marks the "opening years" of a make-or-break battle to transit to a different development model. The desired shifts are nothing less than dramatic, from exports towards services and domestic consumption, from labor and energy-intensive manufacturing towards innovative, higher-technology and higher value-added production, and from growth characterized by quantity to quality and ecological sustainability.
Considering China's size and diversity, the transformation is unlikely to happen without upheaval, pain and dislocation, including a relatively slower growth rate. My live TV interview on 16 March 2016 with ABC (Australian Broadcasting Television) highlighted some of the domestic and external challenges facing the Five Year Plan.
Those who focus exclusively on China's economic convulsions and short-term stimulus measures are generally underwhelmed by the new Five Year Plan. Download BBVA - CHINA Five-Year Plan 2016-20Amidst Party-speak characteristic of the "Two Sessions", it is easy to lose sight of some game-changing realities.
Notwithstanding weak global economic conditions, China’s economy has grown from $2.3 trillion in 2005 to $11.3 trillion in 2015.Personal per capita disposable income increased by 7.4% in real terms, overtaking the growth rate of the economy. Premier Li pointed out that one percentage growth now equates in size to 1.5 percent five years ago.
Consumption's share of a much larger economy signifies tremendous growth. According to a reportof the US Congressional Research Service of 21 October, 2015, the growth of Chinese private consumption over 2005-14 was among the fastest of any major economy,averaging 8.9% annually compared with 7.3% for India and 1.8% for the United States (Fig. 25, p.35). Evidence points to continuing surges of private consumption even when the country’s overall growth is slowing down. China is already the world’s top market for “e-tailing”, valued at US$615 in 2015, bigger than Europe and the US markets combined. The “Singles' Day” in November 2015 splurged $9.3 billion in 12 hours on world's biggest online shopping day. Clearly there is much pent-up demand. Under the Five Year Plan, more supportive measures (e.g. lower taxes) will be provided to boost consumption.
China's economic transformation necessitates turning some 100 million rural migrants into working urbanites and consumers.The household registration system (hukou) has been changed to provide them with social security and children education on par with urban citizens. In 2015,7.72 million government-subsidized housing units were completed in urban areas. In 2016, 21 million new job-training opportunities will be provided to assist rural migrants in urban relocation.
According to the Congressional report, in 2015, services as a share of GDP grew to 49.2%, surpassing industry's at 41.9%. This tallies with the Premier's reported increase of services' share to 50.5% of the GDP for the first time. Services will be further promoted in the coming years.
Innovation and private enterprise have registered significant headway. Business startups and innovations flourished, with newly registered businesses rising by 21.6% in 2015, averaging 12,000 new businesses per day. The Made in China 2025 initiative has been introduced to upgrade manufacturing nationwide. By 2020, investment in research and development is expected to reach 2.5% of GDP. The aim is for contribution of scientific and technological advances toward economic growth to reach 60%.
The Premier reiterated the imperative of state-owned-enterprise reform, including "zombie enterprises".SOEs are to have mixed public and private ownership. Some will be transformed into state-owned investment companies (similar to Singapore’s Temasek). Measures are introduced to drastically reduce over-capacity, excessive stock, and over-indebtedness, using instruments such as packaged sale of non-performing loans. At the same time, local government bondsare issued to replace outstanding debt, lessening interest payment burdens. Fiscal, tax, financial, and other key reforms were deepened. Pilot free trade zones were established in Guangdong, Tianjin, and Fujian based on the model of the China (Shanghai) Pilot Free Trade Zone. These are all part of a Supply Side Reformdesigned to achieve a leaner, more streamlined, higher-quality and more competitive economy.
Vigorous measures are introduced to combat air pollution, cherishing a "beautiful" China Dream of "green hills, clear waters, and blue skies". According to a Roadmap of Chinese Academy of Sciences, fossil energy’s share of the nation’s total energy consumed is expected to decline from 92.7% in 2007 to 45% by 2050, while renewable energy is expected to rise from 6.5% to 45% and nuclear energy from 0.8% to 10% over the same period. (Science and Technology in China: A Roadmap to 2050, Strategic General Report of the Chinese Academy of Sciences, Science Press Beijing, Springer Heidelberg Dordrecht London New York, 2010). As reported by the Brookings Institution, President Xi Jinping, at a high-level meeting in June 2014, called for a sweeping energy revolution in China in five areas: demand, production, technology, institutional governance, and global markets. Among the objectives are energy efficiency, reduced energy intensity, energy sustainability, and reduction of emissions. Over the period 2016-20, water consumption, energy consumption, and carbon dioxide emissions per unit of GDP are to be cut by 23%, 15%, and 18%, respectively, while forest coverage is to reach 23.04%.
By way of Intended Nationally Determined Contribution (INDC) under the COP21 Paris Climate Agreement, China committed, with reference to 2005 levels - (a) to achieve peak carbon dioxide emissions around 2030; (b) to lower emission intensity per unit of GDP by 60-65%; (c) to increase the share of non-fossil fuels in primary energy consumption to around 20%; and (d) to increase forest stock by around 4.5 billion cubic meters. A 20-billion-yuan (about US$3 billion) China South-South Climate Cooperation Fund will be set up to support other developing countries in combating climate change. China's INDC aims to double wind capacity to 200 gigawatts and to more than triple solar capacity to 100 gigawatts by 2020 from 2014 levels. This expansion is supported by the dramatic growth of non-fossil generation capacity over 2010-2014. Solar capacity jumped by 3,161.6% to 28.05 gigawatts, wind capacity by 225.8% to 96.37 gigawatts, nuclear by 83.7% to 19.88 gigawatts, biomass by 72.4% to 9.48 gigawatts, hydro by 39.7% to 301.83 gigawatts, and geothermal by 7.1% to 0.03 gigawatts. Overall, the increase had been 73.3% to 455.64 gigawatts in just four years.
In order to reduce emissions by 40-45% by 2020 relative to 2005, coal consumption is being tightened. A strenuous battle against air pollution and coal usage started a few years back. In September 2013, six ministries jointly launched the Air Pollution Prevention and Control Action Plan in the Beijing-Tianjin-Hebei Region. This requires PM2.5, or “fine particle,” concentrations in the Region to be reduced by 25% from 2012 level. The Region’s total coal consumption is to be reduced by 83 million tons by 2017.
An Environmental Protection Law was enacted effective 1st January 2015, including accumulative fines with no ceiling, provision for law suits by environmental NGOs, and sharpening accountability of local governments. An Environmental Impact Assessment system will be embedded in relevant legislation. A new Air Pollution Prevention and Control Law came into force on 1st January, 2016. Laggard cities are required to publish detailed plans to achieve emission reduction targets with public input and regular updates. Party secretaries are held to account for their green credentials in judging their promotion prospects.
At the 2013 Communist Party’s 18th Central Committee Third Plenum, China decided for markets to play a decisive role in allocating resources. Environmental market instruments include price reforms, subsidies and taxes, and emissions trading schemes (ETS). Seven pilot ETS have been launched over 2013-2014: Shenzhen, Shanghai, Beijing, Guangdong, Tianjin, Hubei, and Chongqing. They apply to energy-intensive sectors covering 35-60% of the total emissions of the respective region and 10% nationwide. These pilots combined make up the second-largest ETS in the world after Europe. They translate into 650 million to 700 million tons of CO2 in 2014, compared with 2.1 billion tons in Europe, 382 million tons in Australia and 165 million tons in California. A national emission trading system (ETS) is expected to be launched in 2017 covering key industry sectors such as iron and steel, power generation, chemicals, building materials, paper-making, and non-ferrous metals.
China is also considering carbon taxes. At the China-U.S. Strategic and Economic Dialogue in July 2013, Finance Minister Lou Jiwei confirmed that China would expand environmental taxes to include carbon in due course.
The share of non-fossil fuels in primary energy consumption is mandated to expand to 15% by 2020 and 20% by 2030. To achieve these targets, a "green dispatch system" is to be implemented in favour of renewable sources in electricity distribution, supported by rapidly growing solar and wind capacities. Clean coal measures, coal caps and coal-free zones are to be introduced while vehicle fuel quality standards are to be enhanced.
Half of China’s energy use today is subject to mandatory efficiency standards. With a national emissions trading scheme expected in 2017, the Chinese economy is on the way towards 85% less energy-intensity compared to the past 25 years. With large-scale deployment of wind, solar, hydro and nuclear power, China’s CO2 emission growth is expected to flatten, to peak around 2030.
To realize the above goals, half a trillion RMB (UD$ 77 billion) has been earmarked to invest in housing, agriculture, rail network in inner provinces, technological upgrading, innovative industries, energy conservation, ecological re-construction, education, healthcare, culture, sports and poverty relief. Some of this investment are prone to misinterpretation as short-term stimulus. Click here However, it is evident that the progress outlined above has not come about as a result of opening the spigots.
On civil society, a new law is introduced to formally recognize and regulate non-government and charitable organizations. Emphasis is also being placed on the Rule of Law and accountable governance. All of the above, along with the anti-corruption campaign, are imperatives to reboot the legitimacy of the Communist Party.
Last year alone, 13.12 million new urban jobs were created amidst difficult economic conditions worldwide. The 13th Five Year Plan (2016-20) calls for a total of 50 million-plus new urban jobs over the next five years. The targets in the new Five Year Plan do not appear over-ambitious compared with those in the preceding Plan (2010-15), which has been successfully achieved. Indeed, successive Five-Year Plans have a consistent record of successful realization.
Implications of the 13th Five Year Plan (2016-20) for the rest of the world would include the following -
Demand from China for resources is set to slow down further, including steel and other minerals.
More labor-intensive operations are likely to move offshore.
Increased demand can be expected for branded consumer goodsfor China's rising middle-class.
More capital will be going out to seek investments, under the One Belt, One Road initiative, in countries including Europe with UK poised to be a prime target ( McKinsey & Co - China 2016 )
More demand for joint ventures in high-technology and green businesses.
Reforming the Militaryis part and parcel of President Xi Jinping's "China Dream" of national renaissance by restoring the nation's historic world prominence.While China's military modernization and expenditure have been advancing significantly over the years, the 2016 Military Budgetregisters the first single-digit rise (7.8%) since 2010, much smaller than originally expected by the rest of the world. The People's Liberation Army is to shed 300,000 soldiers. The whole military command system and configuration have been totally streamlined and revamped. The Central Military Commission is put in overall command with military regions transforming into all-dimension combat-ready bodies, including integration of the army, navy and air force and "rocket (missile defense) units".
As I said at the TV interview, China's growing military capabilities to defend her territorial claims and integrity are bound to rattle relationships with her neighbors and with the world's current superpower, the United States. No doubt, the relationship between China and the United States is set to define the world order in the 21st century.
All in all, China's Rise is set to present epochal challenges as well as opportunities. In short, it needs to be better understood and carefully managed by all nations.
My live TV interview on 16 March 2016 with ABC (Australian Broadcasting Television) highlighted some of the domestic and external challenges facing the Five Year Plan (2016-20), which is no less than a historic watershed for China's changed socioeconomic trajectory.
In his Brookings blog of 9 March, Bernanke opines that "China faces the classic policy "trilemma" of international economics, that a country cannot simultaneously have more than two of the following three: (1) a fixed exchange rate; (2) independent monetary policy; and (3) free international capital flows. Accordingly, China’s ability to manage its exchange rate may depend, among other factors, on its willingness and ability to adjust on other policy margins".
Bernanke sets up and disparages three straw men: (a) One-off massive devaluation (b) Tightened control to prevent capital outflows (c) Wait for growth to return. Instead, he advocates a better solution via proactive fiscal policies. These are designed to facilitate China's transition towards a more liberal and sustainable economic model e.g. improving social security, re-training, tax-cuts or tax-credits for innovative small-and-medium-sized enterprises, and meaningful reform of monopolistic but inefficient State-Owned Enterprises.
Says Bernanke, "There are recent indications China might be moving this direction. On Saturday, Premier Li Keqiang noted the budget deficit target for 2016 would be 3.0%, an increase from 2.3% in 2015. Mr. Li also spoke about using “mergers, reorganizations, debt restructuring and bankruptcy liquidations” to deal with “zombie enterprises”—failing state-owned enterprises supported by government assistance—and added that the government will spend $15.3 billion to help those laid off as a result. Further fiscal reform measures were announced on Monday".
Bernanke's blog appeared in the middle of the "Two Sessions" in Beijing where 3,000 provincial administrators, top businessmen and Chinese Communist Party (CCP) bigwigs met as China formally unveiled the nations's next Five Year Plan (2016-20).
At the start of the Two Sessions, Premier Li's Work Report included new fiscal policies including some along the lines mentioned in Bernanke's blog. Let's not forget that such an important national policy document is not the outcome of a last-minute drop of a hat. For months and even years before, the main thrusts of the Premier's draft Report had been extensively discussed and debated both internally and internationally with national and foreign experts.
Indeed, at the height of the global financial crisis, China's economic re-structuring in the context of her exchange rate policy had been hotly dissected and debated among leading policy formulators, thinkers, central bankers and financiers across the globe. (See Debating China's Exchange Rate Policy, Morris Goldstein and Nicholas Lardy, (ed.), Petersen Institute for International Economics, 2008, pp. 100-108 - "The Open Economy Trilemma: An alternative view from China's perspective", Jin Zhongxia,(now Deputy Director-General of the People's Bank of China, the nation's central bank).
Regardless of the origin of these fiscal insights, China-watchers should perhaps wake up from the notion that China is now "walled-in" between a rock and a hard place where the only game in town seems more and more stimulus and devaluation of the RMB. Or the notion that China's short-term growth measures are sacrificing the opportunity for the imperative of structural reform. (See China NPC Reaction: Targets point towards new focus on growth and financial stability, a research note dated 8 March, 2016 of BBVA, a global Spanish bank) Download BBVA China Flash on NPC2.
The Heading belongs to a Brookings Institution Foreign Policy Program "Order from Chaos Project" Asian Working Group Paper No. 2 (February, 2016), authored by Jeffrey A Bader, Brookings Senior Fellow affiliated with the John L. Thornton China Center.
The Project sets out to examine dynamics that uphold or challenge the world order, define US interests in re-vitalizing a rule-based liberal international order, and suggest policy recommendations in time for the next US Presidency. The Working Paper explains President Xi's world view and his perceived more assertive stance in the global order partly as a product of China's development trajectory since the founding of the People's Republic of China.
Under Chairman Mao, the West-dominated world order was rejected as imperialist, oppressive of the weak and hence illegitimate. China was bent on exporting Communism but otherwise preferred to be left alone in "splendid isolation" to pursue her own development under Communist ideology.
Under Deng Xiaoping, China opened up to and joined the world system and its institutions, including the United Nations, the World Trade Organization, and the Asia Pacific Economic Cooperation (APEC) Forum. Even the US-led North Atlantic Treaty Organization (NATO) was accepted as a beneficial balancer against an aggressive Soviet Union. In international relations, however, Deng's mantra was "tao guang yang hui" 韬光养晦, which translates into "“develop capabilities while keeping a low profile".
This mantra was continued during the administrations of Deng's successors - President Jiang Zemin and President Hu Jintao. The US-led international system was largely embraced by China which benefited from it hugely. Where certain norms were perceived to be in conflict with China's own perspectives, China was vocal but lacked the comprehensive power to project her own global interests and ideas effectively.
President Xi inherited a China much more powerful economically, financially and militarily. He "emerged from the experiences of privilege and suffering with a firm faith in the necessity of a strong Communist Party to govern China, an aversion to chaos and social instability, a commitment to China’s economic growth based on acceptance of the role of markets, and demand for respect for China internationally". "The new ideas of the Xi era reflect massive changes in China’s place in the international system, its economic, political, and military strength, and China’s expectation that the international system would and should accommodate this transformed China." Xi's vision is for the nation's global renaissance encapsulated in his "China Dream."
The author makes the point that it would be surprising if a transformed global power doesn't seek a larger role in the world system of which it forms such an integral part. Indeed, there is broad consensus that China should now be allowed a larger role as "responsible stakeholder" both as "operator" and as a "rule-writer".
The author recognizes that at the same time, China is facing a mountain of unprecedented challenges at home and abroad. This necessitated a transformed and powerful Party to navigate and push through critical reforms with a full command of the domestic leverages of power. This echoes the theme of an earlier prescient report of the European Council for Foreign Relations (ECFR) (Mark Leonard, ed., November, 2012). This argued that China is trapped in its own success and needs to enter into a transformative era. Click here
The author's conclusion is that China under Xi and beyond is likely to remain committed to the existing market and rule-based international system, yet prepared to challenge, modify, or deviate from it whenever it doesn't suit China's own development imperatives. He debunks popular suspicions that China is prone to imposing a Monroe Doctrine trying to exclude US influence from the Asia-Pacific or exercising coercion on China's weaker neighbors in support of a classically-Chinese tributary system. Both concepts, according to the author, are outdated and unsuited to an inter-dependent and inter-connected world in the 21st century. Nor would they support China's long-term development goals.
In short, according to the author, China is not, at least for now, a revisionist power. Nevertheless, he opines that the jury is still out on how China treats her weaker neighbors as her global power expands over time.
A January 2016 Goldman Sachs Investment Strategy Group Insight Report Walled In: China's Great Dilemmaexpects China to grow between 5.8% and 6.8% and avoid a hard landing in 2016.
However, its outlook for 2016–20, which spans China’s 13th Five-Year Plan, is more pessimistic. It envisages a low probability of China achieving 6.5% growth rates while rebalancing the economy. Moreover, it considers that China is unlikely to escape the “middle-income trap” and will not be able to challenge US preeminence over the next several decades, and possibly beyond. In fact, according to the report, China is more likely to follow the path of Japan, where unfavorable demographics and excessive debt have led to slower growth and bouts of deflation.
The report’s prognosis is based on the following consideration -
"1. China’s growth will inevitably slow to substantially lower rates over the next decade. 2. The path China will follow is highly uncertain as growth slows. 3. China will incur greater risks as it attempts to implement reforms while maintaining control of the financial markets and the economy. 4. China’s debt will continue to grow, making any eventual deleveraging process as painful as it has been in the US and the peripheral countries in the Eurozone. 5. China’s financial markets will be much more volatile without any increase in expected returns. 6. China’s profile today has many parallels to Japan in 1990”.
The report puts forth two scenarios for the next five years (2016-20):
The Likely Path (Base Case Scenario): China’s 6.5% minimum growth target is achieved for say, two to three years, through rapid investment and increased debt. Thereafter, GDP growth rates decline steadily.
An Alternative Path: China’s leadership forgoes the 6.5% target and, instead, focuses on implementing reforms and slowing the pace of credit growth.
Both scenarios do not see that the target growth rate of 6.5% can be maintained with economic restructuring, pointing to the possibility of China being trapped in Japanese-styled “lost decades”.
“Anyone who speaks with great certainty [about China] needs their head examined,” the report warns. I totally agree, as China is such a vast and rapid work-in-progress. So due account has to be taken of both sides of the picture from different perspectives if a more balanced view is to be gained.
While the 74-page report has a great deal to commend itself and its prognosis may well be spot-on, the following perspectives need to be kept in mind.
Economic re-structuring towards higher consumption
China’s slowdown has resulted in a great deal of doom and gloom around the world. Much blame has been attached to China’s perceived economic and financial mismanagement. Pessimism about the 6.5% target is largely due to insufficient domestic consumption in relation to capital investment. Discouragingly on the surface, consumption accounted for 38.3% of China’s GDP in 2006 and 38.2% of GDP at the end of 2015. However, this comparison ignores the fact that China’s economy has grown from $2.3 trillion in 2005 to $11.3 trillion in 2015. So consumption at 38.2% of a much larger economy signifies tremendous growth.
Indeed, according to a report of the US Congressional Research Service of 21 October, 2015, the growth of Chinese private consumption over 2005-14 was among the fastest of any major economy, averaging 8.9% annually compared with 7.3% for India and 1.8% for the United States (Fig. 25, p.35).
Evidence points to continuing surges of private consumption even when the country’s overall growth is slowing down. China is already the world’s top market for “e-tailing”. China’s “Singles' Day” in November 2015 splurged $9.3bn in 12 hours on world's biggest online shopping day. The Goldman Sachs report also quotes impressive sales figures of multinationals and local restaurants, retail outlets and cinemas (p.19).
The economy also begins to show convincing signs of shifting away from investment and industrial output. Services started to exceed the contribution from industrial production in 2012. The EIU estimated that in 2015, output of services in China as a share of GDP would total 49.2%, compared to 41.9% for industry, according to the Congressional report (p.32).
As labor and resource intensive industries are giving way to new industrial processes and services, a massive number of jobs have been shed. Those retrenched often end up in the small or informal business sector in small towns and villages. As the service sector picks up, the labor market generally remains reasonably tight. According to data in the Goldman Sachs report (Exhibit 49), the unemployment rate remained flat, if not declining, in a respectable range between 4% to 4.4%.
Market and state-owned enterprises
The Third Plenum in November 2013 affirmed a “decisive role of the market”. It seems to contradict the Plenum's opening statement that “public ownership” would remain the “main body of China’s economy”. While some of China’s giant state-owned enterprises (SOEs) have risen to the world’s top league by market capitalization, their productivity and global competitiveness leave a lot to be desired. As noted in the Financial Times (19 November 2013), state-owned enterprises’ monopolistic privileges will be gradually “chipped away”.
Some of these changes are beginning to be implemented. For a start, SOE’s tribute to the state will be increased from 15% to 30% by 2020. According to a report in the South China Morning Post, guidelines jointly issued by the Party's Central Committee and the State Council mandated that SOEs are to have mixed public and private ownership. Some will be transformed into state-owned investment companies (similar to Singapore’s Temasek). Private banks are to be introduced. Concrete results are wanted by 2020.
According to a report of Voice of America(26 March, 2015), China recently launched a plan to take 112 of its massive SOEs and merge them into 40 even bigger companies in the hope that they can become more competitive internationally. The merger between stated-owned train-makers CNR and CSR Corporation is to create a new entity capable of challenging foreign players like Siemens and Bombardier. More of such mergers are expected.
However, it’s true that certain proposals to enhance SOE governance have been shelved, at least for the time being. Among them are the appointment of general managers by the board instead of the party and the removal of civil service ranks and perks for state-owned enterprise executives to make corporate profits their only concern. As SOEs are by definition assets of the state, it is understandable that national interests cannot be entirely be precluded from business considerations where strategic assets are involved.
China sets great store on the RMB playing a more influential role in the world. A milestone, even if symbolic, was reached when it was accepted as the third weighty world currency in the IMF’s elite basket of Special Drawing Rights. The Chinese currency’s continuing ascendancy is predicated upon the continuing opening up of China’s financial system. However, recent stock market gyrations and irregularities informed the Chinese leadership that all is not well with the state’s regulatory system. Pending the build-up of a more robust financial system, certain reflex actions and market interventions were introduced, for better or worse. It is part of China’s learning curve. But these ad hoc measures must not be conflated with rolling back financial reform.
According to a research paper (16 March, 2015) of the Fung Global Institute, a Hong Kong-based think tank, the overall shadow banking asset size is still moderate compared with the size of the financial sector and GDP. At the end of 2014, China’s total shadow banking risk assets rose to RMB 32.2 trillion, or 51% of GDP, compared with a global average of 117% of GDP.
China has an exceptionally high level of corporate deposit holding equivalent to 90% of GDP, compared with only 7% of GDP in the United States. As loans are often recycled back to the lending bank as deposits, this enables the banks to earn high interest spreads and acts as a cushion against any exigencies.
China’s household debt (and gearing) remains comparatively low and does not support the contention of a massive mortgage crisis.
Despite rise in credit volumes, China’s economy is not over-indebted while the government possesses adequate capacity to absorb losses. There are also massive private savings, offering scope for the corporate sector to undertake debt-equity swaps.
Nevertheless, shadow banking has morphed into a roundabout-way of funding local government and private sector investments in real assets with moral hazard implications. China’s slower growth and adjustments in the property sector could escalate domestic financial risks impacting foreign banks and investors. China’s shadow banking sector is now closely monitored by various regulatory authorities. Nevertheless, more systemic reform and improved governance remain a critical issue.
As for debt, a look at McKinsey Global Institute’s Debt-to-GDP Ratio -Country Ranking in 2Q 2014 may help to put the matter in a little perspective. At 217%, China ranks 22nd out of 47 countries, compared with the following countries in the top ten rankings -
Moreover, a significant proportion of China’s debt is going into building infrastructure for history’s largest and fastest urbanization, which is not yet completed. This scale of urbanization is essential to overcoming China’s “middle-income trap” and is likely to supply the needed economic impetus.
Urbanization, hukou system, and the consuming middle-class
According to a report of the McKinsey Global Institute, the world’s top 600 cities will account for 60% of global growth to 2025. Of 136 new cities to enter the top 600, all will be from developing countries, with 100, the lion’s share, coming from China.
The country is undertaking the fastest and most extensive urbanization drive in human history. By 2025, China will have 221 cities with one million–plus inhabitants—compared with 35 cities of this size in Europe today—and 23 cities with more than five million. By 2030, China's urban population is expected to hit the one billion mark. In 20 years, China's cities will have added 350 million people, more than the entire population of the United States today.
It’s no surprise that China recently decided to revamp the hukou (household registration) system, granting millions of rural migrants their urban citizenship with social entitlements. On the cards are measures to provide them with financial support by allowing them to lease their rural land and to assist their accommodation in empty urban housing. Many of these migrants are still trapped in poverty. But by dint of hard work, many are eking out a livelihood for themselves and their dependents back home. Some have made good and become successful entrepreneurs. Given time, many will fill the lower ranks of China’s exploding consuming middle class. According to a report in The Telegraph (28 January, 2016), using a floor as having wealth double the annual medium income for their country, it estimates that China’s middle-class has now grown to 109 million, larger than the United States.
Moderatelyhighgrowth compatible with reform?
There is little doubt that the Chinese leadership is determined to push ahead with economic re-structuring towards a higher-value-added, if slower, growth. The coming 13th Five Year Plan is likely to incorporate the Made in China 2025 strategy released by the State Council on 19 May, 2015. The strategy focuses on 10 key sectors: New Information Technology; Numerically-controlled Equipment; Aerospace systems; High-tech vessels; High-Speed Rail; Energy Conservation; New Materials; Medical Devices; Agricultural Machinery; and Power Generation.
On the one hand, these strategic goals signify a technological catching-up process. On the other hand, they are preparations for a new industrial era as highlighted in The Fourth Industrial Revolution, a report commissioned by Indian business and software services giant Infosys and launched at the January 2016 World Economic Forum in Davos. The investment opportunities as well as risks of epoch defining disruptive innovations and technologies (estimated to affect 5 million jobs across the globe) are likely to be huge.
China is also embarking on massive state and private outward investments across the globe. These investments are not confined to resources, technologies and markets for China’s goods, but extend to real estate, brands, telecoms, and a host of other businesses. A report in The Economist (16 January, 2016) on how Western enterprises are warming to Chinese acquisitions in such sectors as chemical businesses and the world’s largest cinema chains, speaks volumes.
This outbound trend is set to accelerate in the context of China’s game-changing, trans-continental One Belt, One Road (OBOR) initiative, linking China even more closely to Asia, the Middle East, Eurasia and Europe through infrastructure, trade and investments. This initiative is backed by the China-led Asian Infrastructure Investment Bank (AIIB) and a $40-billion Silk Road Fund.
While it is early days yet, China is already winning contracts in building high-speed rail in a number of countries along the Silk Road both in Asia and in Eurasia. President Xi’s first state visit to post-sanction Iran also signals that this global strategic initiative is for real.
As the world’s largest trading nation and the major trading partner of many countries along the OBOR, China remains central to the global supply and production chain. This, together with surging outward investments, is well positioned to yield economic dividends all around, including infrastructural building, corporate investments, expanded markets and trade links. All these will benefit China’s economic growth.
Indeed, according to the latest statistics, China’s economic performance is not as dire as it is portrayed to be. In 2015, total import at $1.68 trillion remained the second highest in the world, including increases in soybeans by 14.4% and crude oil by 8.8%, a historic milestone. Outbound direct investment surged to $127.6 billion, an increase by 10%. Outbound tourism registered 120 million visitor-trips, an increase of 12%, with spending overseas reaching one trillion RMB, a 20% increase.
China’s demographic dividend is exhausted as the country starts to age. As highlighted in the Goldman Sachs report, the Two-child Policy recently launched cannot arrest the aging trend until a couple of decades later. But China’s development is changing course towards a less-labor-intensive and more innovation driven economy. Less rather than more labor, and quality rather than quantity, now fit the bill. A great deal, of course, depends on education and the prospects for innovation.
China’s spending on education has grown by 20% per year since 1999. Some 7 million university graduates are produced every year. By 2030, China is poised to have some 200 million graduates, more than the entire US current workforce, although most may not be able to measure up to best international standards.
Additionally, China is putting more and more resources on R & D. The country is on track to become the world’s top R&D spender by around 2019, according to an OECD report in late 2014.
Moreover, according to a March 2015 report of ICEF Monitor, a market intelligence resource for the international education industry, 459,800 Chinese students went abroad in 2014,11.1% increase over the year before. 92% were self-funded. Chinese students are also returning to China to pursue their careers in greater numbers. 364,800 students returned to China in 2014, an increase of 3.2% over 2013. Since 1978, a total of 3.5 million Chinese have studied abroad. The total return rate for the period from 1978 to 2014 stands at 74.5%, thanks in part to an “overseas professional returnees program” with attractive terms. These highly educated returnees are enriching China’s human capital.
According to the World Intellectual Property Organization (WIPO), China has been topping the world in the filing of patents and trademarks every year since 2012, responsible for a third of all patents filed. Click here While quantity does not equal quality, these statistics show that China’s education is not all rote learning. Although China still lacks Nobel Laureates, world-class Chinese entrepreneurs are beginning to emerge who are defining the rules of business – Alibaba, Tencent, Xiami, to name just a few. (Edward Tse, China’s Disruptors, Portfolio Penguin, 2015).
China has compressed centuries of industrialization into several decades, together with accompanying unbridled pollution. Now the nation has woken up to this existential threat. Hence, China was taking a leading role at the recent Climate Change Paris Summit.
In her Intended Nationally Determined Contribution (INDC) under the COP21 Paris Climate Agreement, China committed, by 2030, - (a) to achieve the peaking of carbon dioxide emissions around 2030 and making best efforts to peak early; (b) to lower CO2 emissions per unit of GDP (emissions intensity) by 60-65% from the 2005 level; (c) to increase the share of non-fossil fuels in primary energy consumption to around 20%; and (d) to increase forest stock volume by around 4.5 billion cubic meters over the 2005 level. A 20-billion-yuan China South-South Climate Cooperation Fund will be set up to support other developing countries in combatting climate change.
The share of non-fossil fuels in primary energy consumption is mandated to expand to 15% by 2020 and 20% by 2030. To achieve these targets, a green dispatch system is to be implemented in favour of renewable sources in electricity distribution. China’s rapidly growing solar and wind capacities will support this system. Clean coal measures, coal caps and coal-free zones are to be introduced while vehicle fuel quality standards are to be enhanced.
According to a Brookings Institution paper of November 2015, China aims to double wind capacity to 200 gigawatts and to more than triple solar capacity to 100 gigawatts by 2020 from 2014 levels. This expansion is supported by the dramatic momentum of growth of non-fossil generation capacity over 2010-2014. Solar capacity has jumped by 3,161.6% to 28.05 gigawatts, wind capacity by 225.8% to 96.37 gigawatts, nuclear by 83.7% to 19.88 gigawatts, biomass by 72.4% to 9.48 gigawatts, hydro by 39.7% to 301.83 gigawatts, and geothermal by 7.1% to 0.03 gigawatts. Overall, the increase has been 73.3% to 455.64 gigawatts in just four years.
Half of China’s energy use today is subject to mandatory efficiency standards. With a national emissions trading scheme expected in 2017, the Chinese economy is on the way towards becoming 85% less energy-intensive, compared to the past 25 years. With large-scale deployment of wind, solar, hydro and nuclear power, China’s CO2 emission growth is expected to flatten and then peak around 2030.
Conclusion - Walled in?
Arguing that China would inevitably follow the path of Japan’s “lost decades”, the Goldman Sachs report (pp. 56-57) concedes that China has three advantages compared to Japan in the 1990s. First, while China’s debt-to-GDP is very high, it is still lower than Japan’s in 1990. Second, while China’s Total Factor Productivity (TFP) growth rate has dropped from its recent peak of 4%, it remains more than double that of Japan in 1990. Finally, China has a record of implementing significant reforms in the face of almost impossible odds.
China’s reform efforts since the country opened up in 1978 have never been smooth. Few would doubt the scale of challenges in lifting over 600 million people out of abject poverty in 37 years in a country not noted for abundance of natural resources. Dilemmas are plenty to be found. Take, for example, Deng Xiaoping's decision "to let the few get rich first". Or a strategy to favor cities in preference to the countryside. Or going for labor-and-energy-intensive including polluting industries outsourced from the West. Or opening up the country’s economy to gain entry into the World Trade Organization (WTO). A similar dilemma now applies to switching to slower but more innovative and sustainable growth.
Regardless of what seemed impossible odds, successive Five-Year Plans were formulated and delivered, not without difficulties and twists and turns. But warts and all, the results are there for all to see.
As the country of over 1.377 billion people is undergoing seismic changes, there is a great deal of pain and trial and error. These have global repercussions as China is firmly embedded in the world economy. But this doesn’t mean that China is necessarily more “walled in” compared with what she has experienced before. What is more, this doesn’t mean that China’s leadership will roll back reform. Indeed, as evident above, the pangs of a “New Normal” of slower growth belie a new China struggling to be born. China’s new reform agenda will become clear in the soon-to-be-unveiled 13th Five Year Plan (2016-20).
Do I want to bet against China’s chances of fulfilling the targets in the coming Five Year Plan? Because this time is different as China is between a rock and a hard place? While I would not vouchsafe for the certainty of success, looking at broken crystal balls betting on “China’s coming collapse” during the past fifteen years, I am hesitant to say that for now, the only path for China is walking hamstrung towards sunset.