China in the midst of an economic rebalancing on a scale the world has never seen before.
Traditional drivers of economic growth such as investment and exports are being replaced by services and consumption, contributing to a slowdown in the Chinese economy. This prospect has rattled financial markets over recent months, a predictable reaction given the heightened levels of uncertainty this will mean for the global economy in the decades ahead.
Some believe it will all end in a disastrous mess with China’s ballooning private debt loading crimping growth, leading to a hard landing for the world’s second largest economy. Declining levels of industrial production, fixed asset investment and import demand, amongst others, already suggests the economy is in trouble.
Others, on the other hand, take a more measured approach, suggesting that while the economy will slow as it moves towards more sustainable forms of economic growth, it will offer up a world of opportunities for other nations in the decades ahead.
ANZ, Australia’s super-regional Asian bank, fits into the latter grouping. In an excellent note out today, the bank’s economic research team, headed by chief economist Warren Hogan, outlines why it believes the Chinese households are the “sleeping giant” in terms of powering future economic growth.
At 38% of GDP, consumption in China is unusually low. In most of the world’s economies, consumption lies between 50% and 70% of overall economic activity. The Chinese economy has been characterised by extraordinarily high rates of investment and saving. The next stage of the ‘China Story’ will be a moderation in saving rates and a rapid growth in consumer spending. In addition, disposable incomes (per capita) in China’s urban regions are set to almost quadruple over the next 15 years. So we could be seeing the beginning of the most significant change in global consumption patterns since the rise of the US middle class at the turn of the 20th century.
This chart from ANZ measures private household consumption as a percentage of national GDP compared to GDP per person in the Unites States as a percentage in purchasing power parity terms (PPP).
As it shows, consumption in China is low by global standards, and GDP per person is also significantly lower than that in the US, sitting at just over 20%. Still, Chinese consumption totalled $3.8 trillion in 2014 in nominal terms.
That’s nearly as large as Germany’s entire economy.
It’s a huge figure, and one that sets to grow substantially in the decades ahead.
ANZ notes that consumption as a share of GDP normally starts off high when incomes are low, then falls, and ultimately rises again. It’s a three-step process:
- Initially, consumption share is high as most household income is spent buying basic necessities like food.
- The consumption share then falls due to a rising portion of GDP going towards investment – particularly investment in infrastructure needed for industrialisation.
- A final increase in the consumption share reflects a fall in investment once the necessary infrastructure for industrialisation is in place. It also reflects that incomes have normally reached a level (around $10k per capita) where people can afford luxury goods and services.
ANZ suggest that China is nearing the end of the second phase, with the infrastructure build still underway. However, with per capita GDP nearing the $10,000 level, they suggest that Chinese consumption is now poised to climb steeply, something they believe will need to occur to avoid an economic crisis from forming.
The expected pathway for consumption and per capita income is shown in the chart below. ANZ estimates that should the projections for China turn out to be correct, Chinese household consumption alone will be the same size as the entire US economy in today’s dollar terms by 2030.
That’s a staggering statistic: Just one component of Chinese GDP could equal the size of the largest economy in the world today in just 15 years. While there are no doubt risks attached to the economic rebalancing – a policy misstep or global shock emanating from developed nations could place further downside pressure on the Chinese economy – should the Chinese government succeed in moving from investment and export led growth to that powered by services and consumption, the potential benefits to the global economy will be enormous.
Even Australia, having hitched its economic fortunes to China as a result of the country’s commodities wealth, can benefit from China’s economic transformation. Yes, demand for our resources may diminish, but that slowdown is likely to be more than offset by increased Chinese demand for services exports such as tourism and education.
ANZ forecasts that Australian exports to China may double to $175 billion over the next 15 years, something that is akin to 10% of Australia’s economy in current dollar terms.
That’s only one nation of just over 23 million people. Imagine what that could mean to the other six billion-plus residents of the world. As ANZ points out, it could be the beginning of the most significant change in global consumption patterns since the rise of the US middle class at the turn of the 20th century.