Every investor needs to better understand the fundamentals of China’s economic growth, including its impact on the U.S. economy. This is increasingly important as political tensions between China and the West are rising, along with China’s importance to the global economy.
In this article, I will outline the five most important and most misunderstood aspects of China’s economic rise. My perspective is based on almost four decades of experience, first as an American diplomat and then as a financial sector analyst, including more than 20 years based in China.
China drives global growth
In the 10 years through 2019, China, on average, accounted for about one-third of global economic growth, according to data from the International Monetary fund—larger than the combined share of global growth from the U.S., Europe, and Japan. In 2020, China most likely accounted for almost all of the world’s economic growth, as was the case during the global financial crisis. But that will likely return to “only” a one-third contribution this year.
At the same time, most investors have little direct exposure to this driver of global growth. We estimate that in the average American investor’s portfolio, China accounts for only about 3% of holdings.
China is rebalancing for sustainable growth
China is in the midst of a rebalancing away from an economy dependent on manufacturing to an economy that, like developed economies, is driven by services and consumption.
Last year was the ninth consecutive year in which the services and consumption (tertiary) part of China’s GDP was larger than the manufacturing and construction (secondary) part, as rebalancing continued despite the pandemic.
Consumption does not yet play as large a role in China’s economy as in most developed countries (consumption is about 56% of China’s GDP, compared to an OECD average of 73%, according to World Bank data). But this transformation toward a domestic demand-driven economy is well underway and will continue. China’s dynamic services sector provides investors with opportunities similar to those in the U.S. market.
China is entrepreneurial
One frequently overlooked structural shift is that Chinese companies have become entrepreneurial, and privately owned firms drive job creation and innovation.
When I first worked in China, in 1984, there were no private companies—everyone worked for the state. You couldn’t even find a privately run restaurant. Today, almost 90% of urban employment is in small, privately owned, entrepreneurial firms, according to data from China’s National Bureau of Statistics (NBS). With the state sector continuing to shrink, all of the net, new job creation today comes from private companies.
The extent of private ownership in China may surprise many investors. A recent study published in the U.S. by the National Bureau of Economic Research found that in 2019, individuals owned 69% of registered capital of all Chinese companies, up from a 52% share in 2000.
The world’s best consumer story
The Chinese government spent a couple of decades focused on building out public infrastructure—from roads and bridges to power generation and distribution, as well as high-speed rail lines to connect the more than 150 cities with populations over 1 million. This, along with the rise of entrepreneurial, privately owned firms, laid the foundation for a consumer-driven economy.
In 2020, retail spending in China, converted to dollars, was equal to 88% of retail sales in the U.S., up from 52% a decade earlier, based on data from NBS and the U.S. Census Bureau. Between 2009 and 2019, the real compound annual growth rate of consumption in China was 8.5%, compared to 1.9% in the U.S.
This strong consumer spending in China has been fueled by dramatic income growth. Over the 10 years through 2019, inflation-adjusted income rose at an average annual pace of 7.9% in China, compared to 1.9% in the U.S. and 0.7% in the U.K.
I expect China’s strong consumer story to remain resilient in the coming years. Income growth is likely to accelerate as the impact of COVID recedes further. The year-over-year growth rate is likely to slow gradually, but should remain much faster than in other large markets.
And a high propensity to save also backstops strong spending. Household bank deposits have been rising at a double-digit year-over-year pace since late 2018, and as of 2020, the savings rate was 38% for urban families and 20% for rural, according to NBS data. In 2019, household bank deposits in China, converted to dollars, were larger than the combined GDPs of the U.K., Brazil, India, Russia, and Italy.
Engagement with China has been good for Americans
While some insist that China’s rise has had harmful effects on the American economy, the evidence shows that overall, economic engagement with China has been good for American employment. Some manufacturing jobs have been displaced by imports from China, but other manufacturing jobs have benefited from lower-cost inputs from China as well as from exports to that fast-growing market. Trade is not the problem. Rather, our domestic policies have failed to adequately help workers who have suffered the negative consequences of change, whether due to imports or to technology.
A study by economists at the St. Louis Fed found that although those imports do cause short-term pressure, “manufacturing industries across U.S. states are better off in the long run,” and “the U.S. economy is better off, as it benefits from access to cheaper goods from China.”
And engagement with China has helped keep prices lower for American families, especially low-income households, who spend more on tradable goods. (Higher-income consumers spend relatively more on services.)
A recent study by Fed economists concluded that “U.S. consumer prices fell substantially due to increased trade with China,” and that “these price effects are particularly large in product categories selling to low-income consumers.” This has been critical while so many Americans are working and studying at home, as more than 90% of laptop imports have come from China. (More details on the benefits of U.S. engagement with China are discussed in a recent issue of Sinology, my newsletter for investors.)
Risks: Investing in China is not, of course, without risks. In another recent issue of Sinology, I discuss China’s aging population, rising debt levels, shadow banking, and the residential property market.
It is, however, important to understand these risks and to put them into context. These challenges are significant but are being addressed by regulators. They are, in my view, unlikely to disrupt the longer-term growth story that makes China an important factor for every investor to consider.
Andy Rothman is an investment strategist for Matthews Asia and the author of the Sinology newsletter.
