Why China’s consumers are unlikely to support a soft landing
China’s consumption decline
The below graph reflects the decline in consumption in the private sector in China as a percent of China’s overall gross domestic product (or GDP). While a quick glance at this declining line might lead you to believe consumption is collapsing in China, the reality is quite different. You have to keep in mind that China’s emergence as a major league exporting powerhouse has been a rather recent phenomenon. While consumption as a percentage of GDP has certainly declined, you should remember that China has also experienced rapid growth in its economy, including export and import–related economic growth. This article explores the net effect of explosive growth in GDP and investment over consumption, and it considers the implications for China’s equity markets.
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China’s export-driven growth
As noted in the previous article in this series, China has built an impressive export-driven economy since it embraced a more free market economy post-1976. Exports as a percentage of GDP in China were around 5% in 1976, though they rose as high as 39 in 2006—currently standing closer to 29%. In comparison, Japan’s exports as a percentage of GDP were approximately 14% in 1976, though they’ve ranged between 10% and 18% since, while currently standing at approximately 15%. So you can see that China’s economic growth and development, relative to Japan, has been approximately twice as dependent upon exporting to foreign markets. With an economy that’s now approximately 33% larger than Japan’s, China’s reliance on trade for growth has become a larger issue.
China is still considered a poor country
Plus, with a GDP at over $8 trillion versus $16 trillion for the US and $6 trillion for Japan, China is finally reaching critical mass in terms of overall economic size. However, you should also remember that China is still a “poor” country. Consumption is still limited, as the average Chinese worker earns and produces far less than his or her American or Japanese counterpart—on a GDP-per-capita basis: $49,965 per capital GDP for USA versus $36,938 for Japan and $9,233 for China (purchasing power parity basis, World Bank 2012).
Given the low GDP per capita and high growth rates of China, it’s easy to see why the Chinese worker—or corporation, for that matter—has a strong preference for saving and investing over consumption. This dynamic is captured in the above graph, which stands in stark contrast to the strong growth in consumption as a percentage of GDP for both the US and Japan.
Given China’s low per-capita GDP relative to developed economies such as the US and Japan, it’s difficult to expect a surge in consumerism in China. Just as Japan had hoped to bolster consumerism after the economy topped in 1990 and its currency continued to strengthen, so too will China likely experience a similar trend. With exports at 29% of GDP, China’s extremely reliant on exports to maintain the modest dollar-denominated per-capita consumption that it currently enjoys.
Trade data is key to investors
So as goes the trade data, so goes China. Until China develops a much larger GDP-per-capita economy, which is at least a decade or two away, depending upon global economic conditions, it wouldn’t be wise to presume that a surge in domestic consumption in the near term will suffice to maintain China’s historical growth rates. While China may offer great long-term growth opportunities relative to Europe (and possibly the US at the moment) you should remember that China’s economy, including corporate profits and their associated stock prices, are extremely reliant upon and sensitive to weak economic data in the US and Europe. Essentially, China is likely to behave as a levered investment in the global economy. Investors focused in near-term investment gains in Chinese equities will have to watch the data very closely, as the post-2008 data has been very choppy.
For investors who think China can orchestrate a smooth deceleration in economic growth without significant disruptions to the banking system and also contain inflation, enhance productivity, manage investment growth, and grow domestic consumption, perhaps the weakness in Chinese equity prices over the past two or three years would present a more attractive price. China’s iShares FTSE China 25 Index Fund (FXI) is down roughly 15% from its November 2011 post-2008 highs. For China skeptics seeking to embrace the more recent economic trends seen in Japan and the United States, as reflected in Japan’s Wisdom Tree Japan Hedged (DXJ) and the iShares MSCI Japan (EWJ), as well as the USA S&P 500 via the State Street Global Advisors S&P 500 SPDR (SPY) and Blackrock’s S&P 500 Index (IVV), the US and Japan markets may appear more attractive than China’s iShares FTSE China 25 Index Fund (FXI) and South Korea’s iShares MSCI South Korea Capped Index Fund (EWY). For further analysis as to why Chinese equities could continue to underperform Japanese equities, see Why Japanese ETFs outperform Chinese and Korean ETFs on “Abenomics.”