Investments

A new way to think about China

July 2015

China’s slowing growth rate has made financial markets nervous of late. But is it all bad news from the People’s Republic?

World markets are anxious as China’s economy slows to a greater extent than initially expected. But a deeper look at what’s going on shows the slowdown is part of a very significant modernisation of the world’s second-biggest economy.

The latest data shows China’s manufacturing and industrial sector now only represents 46 per cent of the economy compared to the prior 10 years where its share was much higher. But it is very important to note that the share of the service sector, which includes areas such as retail, banks, real estate, health and education, was 51 per cent.

The rise of the services sector in China’s economy suggests it is beginning to embrace “new” growth drivers as it continues down the path of modernisation.

Not only is the service sector becoming a bigger part of the economy, it’s growing more quickly than China’s overall (headline) growth rate, which is being dragged lower by the industrial sector. Residential property oversupply, anti-corruption measures and higher local government project standards are all factors dragging industrial growth down.

At least in the short term, higher growth in the service sector should help to partially make up for this slowdown in the industrial sector, preventing a hard landing for the economy.

China’s next step, a big one toward a modern economy, is when consumers become the dominant force. Looking at the experiences of other developed market economies such as the United States, Japan and Korea, we can see that after the peak share of investment in the economy, growth slowed as consumer demand represented a larger share of the economy.

For consumption to be a greater driver of economic growth ahead, the rise of China’s middle class will play a big role. Currently about 75 per cent of urban Chinese households (or about 527.7 million people) enjoy middle-class status, which is defined as an annual household income above $US13,000.

Spending from China’s middle-class consumers is likely to grow faster in the next decade on continued wage increases and less of a bias towards savings. Using consumer patterns in Taiwan and Hong Kong, economies which share obvious cultural and geographic similarities to mainland China, it is likely that Chinese consumers will spend more on services such as telecommunications, property, education, recreation and medical services.

We can see China’s transition into a services economy though the robust growth of its e-commerce sector. It is now the world’s largest digital market, with 1.3 trillion renminbi spent online in a year according to a Bain & Company 2013 report. Domestic travel is another telling sector. According to the Chinese National Bureau of Statistics internal travel increased 9 per cent in the first eight months of 2015. And Australian Bureau of Statistics figures show tourism spending is jumping with Chinese visitors to Australia increasing 400 per cent from 2007 to 2015, spending an average of $6000 here.

As the Chinese economy evolves from manufacturing to services, growth is likely to be lower and new areas will come into focus. For Australia, China’s changing growth pattern will result in lower demand for commodities and with it lower prices. However, at the same time, higher demand for services such as education, tourism and healthcare provide further opportunities for growth.

China’s growth story is not ending but changing to a different tune. The extent to which individual economies can adjust to China’s changing growth pattern will invariably be determined by those industries who can adapt to the sector shift, and the role of governments to encourage structural reform to enhance competitiveness in China’s growth sectors of the future.

July 2015