Investors adjusting expectations
Modern, dynamic industries are replacing China’s slowing sectors to create a two-speed economy, Cecily Liu reports.
China is now growing as a two-speed economy, with the slower, more traditional sectors making way for newer, dynamic industries.
Analysts say the shift from old to new will help China transition from rapid growth to a more sustainable, high-quality growth pattern, but it also has big implications for foreign companies investing in China and for industries worldwide.
So which Chinese industries are slowing and which are speeding up?
Simply put, heavy industries such as coal, cement, glass and steel — the backbone of China’s economic growth for decades — are on the slide, while service-oriented industries such as healthcare, financial services, tourism and education, as well as those related to the Internet and alternative energies, are rising.
To put this in context, data released in October by the National Energy Administration show China’s electricity consumption, which is most affected by heavy industry, has grown just 0.3 percent year-onyear, which indicates the old GDP drivers are nearly, if not already, in recession.
By contrast, the latest China index compiled by research company MSCI suggests newer industries are becoming true growth drivers. The index, covering about 85 percent of China’s equity universe, including large and mid-cap stocks, puts the country’s growth at 5 percent. Yet if we discount the data for the banking sector (old and dominated by State-owned enterprises) and the energy sector (strongly linked with traditional, heavy industries) then the rate rises to 25 percent.
Yet experts say foreign investors in China need to recognize these varying speeds of growth to form realistic expectations. While China’s growing consumption may be providing a large market for service-oriented companies, countries that rely on exports of commodities to China for growth may need to fundamentally adjust their long-term strategies.
“Often when Western firms look at China’s economy, they immediately think of the manufacturing industry, which is slowing down, but that is not the whole story because now service industries account for about 50 percent of China’s economy,” said Hui Tai, chief market strategist in Asia for JP Morgan Asset Management.
Manufacturing is slowing, but it is also finding new ways to grow, he said. For example, the industry is increasing its use of big data, the Internet, automation and technology. Meanwhile, many new industries are emerging, and Hui predicted their share of China’s economic growth will become more important.
“The rebalancing of China’s economy has had larger implications than previously thought on the global economy,” said Robert Bergqvist, chief economist for SEB bank in Sweden. “Apparently, the super cycle for commodities and energy seems to have come to an end, and world trade volume is now moving sideways.
“The world has become aware of China’s importance for the global economy, and China’s economic and financial challenges are shared by all countries around the globe, right now especially by many commodityand energy-intensive exporters.”
The two-speed structure implies slower average GDP growth in China overall. This year, during high-level discussions on China’s 13th Five-Year Plan, the nation’s blueprint for growth between 2016 and 2020 that will be finalized in March, the government said it had a target to double GDP between 2010 and 2020. This would require growing the economy by an annual average of 6.5 percent over the next five years.
This rate signifies a major slowdown from the rapid growth that the country experienced over the past three decades, but it points to a more sustainable long-term growth model.
“China is reducing its GDP growth rate projections because it is realizing that a manufacturing-driven model is not sustainable, especially considering the adverse impact it has on the environment,” said Kerry Brown, a professor of Chinese studies and director of the Lau China Institute at King’s College, London.
“The country is in a process of transitioning into a morediverse economy with bigger service and financial sectors. But as these sectors take time to build, China needs to accept a slower growth rate in the transitioning process.”
The two-speed economy is a reality of that process, according to Fang Jian, managing partner in China for Linklaters, the London-based law firm.
“There will be industries that will become less competitive in this environment, so the challenge is maintaining stability and managing change to minimize economic disruption,” he said. “This will be achieved by equipping the workforce of tomorrow with the skills and education to keep pace with technological change. As China moves its reliance in GDP growth from infrastructure investment and exports to consumption, the high growth of its new economy will be critical.”
One big advantage of the two-speed economy is its ability to help China avoid the socalled middle-income trap, said Robert Davis, a senior portfolio manager at NN Investment Partners, formerly ING Investment Management.
The middle-income trap is when a developing economy starts to lose its low-cost labor competitiveness but does not have the technology to compete with advanced countries.
For example, newly industrialized countries such as South Africa and Brazil have not, for decades, left what the World Bank defines as the middleincome range. They suffer from low investment, slow growth in secondary industries, limited industrial diversification and poor labor-market conditions.
“China’s rebalancing program is intended precisely to move across this gap and avoid the trap,” Davis said. “The difficulty is that reforms are usually needed to allow for productivity growth and innovation development’’ that are needed for this to happen.
Unlike South Africa and Brazil, China’s two-speed growth model is driving investment into services and high-tech industries, while making its manufacturing industry more high-tech. Within this context, industries like e-commerce, Internet industries and healthcare insurance are growing fast because of the emergence of China’s middle class and the growing spending power of this population.
China’s service purchasing managers index measured 50.5 in September compared with 49.8 for manufacturing. The PMI is an indicator of business activity based on surveys measuring perceptions of key business variables.
In addition, many of China’s other economic indicators also paint an optimistic picture. For example, the retail sector is registering 11 percent yearon-year growth, according to official data.
The manufacturing sector has been vital to China since the government started the process of reform and opening-up in the late 1970s, which led to an export-driven boom. During this time, China made good use of its low-cost labor supply and its domestic production’s economy of scale to manufacture low-end products. This model of growth coincided with the debt-fueled demand for goods by many Western countries.
Jan Dehn, head of research at Ashmore, an emerging-markets investment management company in London, said this model was successful between 1980 and 2008, but after the financial crisis its basis disappeared due to weakened demand from Western countries, the appreciation of the renminbi and rising labor costs.
To find new ways to grow the economy, he said, China should rely more on domestic consumption, which the country can realistically achieve because its savings rates are almost 50 percent. Also, its exporters must increase productivity, so that they can continue to be competitive despite a stronger currency over the medium term and rising labor costs at home.
Contact the writer at cecily. email@example.com
A woman makes a digital payment at a supermarket in Shanghai on Dec 12. Consumer spending and the services sector are increasingly driving growth.
A worker checks the gears of a machine in a factory in Dalian, Liaoning province, in December. China’s manufacturing industry is turning to innovation to maintain its competitive edge.