Economic Perspective - The Chinese Economy in Transition

by Robert F. DeLucia,
CFA Consulting

Summary and Major Conclusions:

• The Chinese economy has been in a powerful transition over the past two decades, and has changed markedly when compared with 2005. Whereas China was more dependent upon the rest of the world in previous decades, the world economy has now become more dependent upon China.
• As a developing country in the 1990s and 2000s, China was deeply engaged in industrialization, with an emphasis on manufacturing. China’s industrialization process is now well advanced, diminishing the relative importance of manufacturing and increasing the importance of the service sector and private consumption.
• Because of an abundance of cheap labor, China was able to develop a highly competitive export machine, mainly in the first decade of the 2000s. However, explosive growth in wages has reduced China’s competitiveness in world export markets, though it has also supported consumer spending.
• As a consequence, the composition and internal structure of the Chinese economy has changed dramatically over the past 15 years. Manufacturing, mining, and exports have declined in relative importance, while private consumption and services have increased as a share of GDP.
• China’s GDP growth has been in a steady decline since 2010, when its growth rate peaked at 12.5%. The Chinese economy grew by 10.2% during the decade ending in 2015, but has risen at an annual rate of only 6.8% since then.
• My forecast assumes annualized growth of only 5.5% over the next five years. A progressively slower growth rate can be attributed to a diminishing role of China’s industrialization process; a slower pace of rural migration; a vastly increased debt burden; and the sheer size of its economy (the law of large numbers).
• Explosive growth in Chinese debt over the past 12 years has significantly weakened the country’s economy and financial system. As a share of GDP, China’s total debt has risen from 125% of GDP in 1999 to nearly 300% last year.
• The government understands that debt has risen to dangerous levels and has responded accordingly. Policymakers have suppressed credit creation and implemented a deleveraging campaign in 2017 to mitigate the growing risks to the banking and broad financial sectors.

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