China’s economy was expected to rebound strongly this year, following the scrapping of zero-COVID restrictions and more supportive monetary policy. But we’d been saying that the bounce would probably be short-lived, and a longer-term decline in the speed limit on China’s trend rate of economic growth looked set to resume.
Right on cue following the Economist’s provocative “Peak China?” headline in early May, the latest data on Chinese production, retail sales and investment all disappointed expectations.
It remains to be seen whether these latest figures are just a blip, or signal the denouement of China’s post-COVID bounce. Either way, our analysis of what’s reflected in market pricing suggests that investors may not have fully accounted for China’s diminished longer-term growth prospects.
Not so long ago it was thought inevitable that China would soon surpass the US to become the world’s largest economy, and few would’ve questioned the notion. Many still see China as a place to invest for superior profit growth opportunities in comparison to the major developed markets. Yet we are already about 15 years into a structural slowdown in China’s economy, and the longer-term challenges facing China haven’t changed.
Over the coming decade, we believe the average growth of China’s economy is likely to be much closer to that of advanced economies than the rapid rates it experienced in the 2000s and much of the 2010s. After peaking in 2007, growth in China decelerated steadily through the 2010s, coinciding with a generally underwhelming period for China’s equity markets, despite strong showings from a few tech firms.
Economists think of the long-term output of an economy as a function of the supply of labour, the supply of capital, and productivity (how efficiently labour and capital are deployed). All three of these ‘pillars’ face long-term headwinds in China.
1. Swimming against the demographic tide. China’s working-age population rose rapidly during its golden age of growth in the 2000s, but broadly stagnated in the 2010s and is now starting to decline. A key reason that it is likely to contract more quickly as the decade goes on is a prior drop in fertility/birth rates.
2. Capital: the limitations of China’s investment-led model. During the 2000s and 2010s China grew its capital stock at a breakneck pace, with few parallels in history. Yet there are clear reasons to doubt that this will continue. Such capital formation included housebuilding, which grew rapidly amid a then-growing and rapidly urbanising population. But this demand has been slowing since pandemic and there’s already plenty of supply from previous overbuilding. Another key element — infrastructure building on a massive scale – is also likely to be slower in future. China now has good infrastructure, and the biggest one-off projects like road and high-speed rail networks don’t need to be built twice.
3. Productivity: more state control, more decoupling from the West. Since 2000, China has grown from a low- to an upper-middle-income economy. History shows the next step, breaking out of the middle-income bracket to become a rich country on a per head basis, is hard. To do so, China will need to deliver consistent productivity growth. One factor that may stand in the way is the role of the state in the economy. The success of state-led development has been the exception rather than the rule, and depended on some key factors not present in China today. Another is the increasingly hostile external trade and investment environment, with the US committed to a tough line on China.
Lastly, regardless of China’s long-run economic prospects, growing legal and practical hurdles may make buying Chinese equities increasingly unappealing for foreign investors.
You can read more about these headwinds, and why we believe investors should be wary of chasing the recent rally in Chinese assets, in our full report, China past its peak.
