China: Five Headwinds To Long Term Growth

Concerns about long-term growth in China into the 2 half of the decade are increasing, which is a concern for global growth given China's contribution to global GDP over the past 20 years.

Figure 1: China GDP Growth Forecasts to 2030 (%)

Source: Continuum Economics

China's Long-Term Growth Problem

China 2025-2030 growth trajectory depends on five different forces, which we feel will slow growth in the 2 half of the decade after our forecast of a slowdown to 4.2% growth in 2024 (here), where population aging and the residential property drag are already kicking in.

• Aging population and peak labor force. The effects of China population profile (caused by 50's/60's baby boom and insufficient births since) are already hitting, with the labor force having shrunk by 41mln between 2019 and 2022. Some of this could be workers leaving the labor force due to long COVID; caring for the ill or scared to work, but we feel that population aging is already having an impact. Separate Ministry of human resource data estimates that 40mln people will retire between 2021-26. Figure 2 shows the projected 2025 percentage of the population by 5yr cohorts using the 2022 UN estimates. A high percentage is in the 50-59yr group coming up to retirement. In 2022, China authorities promised to raise the retirement age (men currently 60 and women 50-55), but a popular backlash has stopped any desires being translated into concrete plans. Figure 2 also shows a low percentage of 20-29yr old, which will be a drag on the absolute level of consumption across the economy. The normal solutions to these problems are immigration; increasing the female participation rate or getting the 50-70yr old group to work more. Female participation in China is already close or better than large OECD countries, while large scale immigration is unlikely to be approved by the CCP for political/control and cultural reasons. Additionally, over 50's working due to economic pain (more years to qualify for a pension/raising retirement age) or Japan style encouragement of part time (26% of over 65's are employed in Japan v 6% in the EU) could be a solution, but current progress appears slow. Thus we see China population profile hurting consumption for people in their 20's and 40's; reduced new housing investment needs and persistent savings due to insufficient pension or healthcare provision by the state, being a bigger drag on China growth in the 2025-30 period.

Figure 2: China Population Distribution Versus U.S. (% in 5yr cohorts On 2025 Projections)

Source: UN 2022/Continuum Economics

• China food self-sufficiency and slowing rural to urban labor force shifts. One traditional growth driver for economies to move to high income status is a reallocation of workers from agriculture to high productivity industry and services. However, China still has a goal of 95% self-sufficiency for food, which will be hard to achieve given existing heavy land usage and as food demand keeps increasing per capita (middle income consumers eat more calories per day and meat than low income ones). Although, some further industrialization of farming can occur in China, the authorities will be reluctant to see a rapid shift in workers from rural to urban centers for fear of becoming too dependent on imported food. Additionally, though Beijing has encouraged local authorities to loosening the Hukou system that governs the shift from rural to specific cities (here), local authorities are slow as this increases social security spending at a faster pace than revenues (China income tax only impacts 10% of people, but Beijing is not making changes to widen this out). The rural to urban shift will help, but needs more radical change to the Hukou system to counterbalance population aging and retirement.
• Residential Property and Debt Hangover. The residential property problems are a clear negative drag and will likely knock around 1.5% off 2023 GDP growth. This negative drag on GDP will likely continue for the next couple of years, as a bust in housing sales and new construction is clearly evident – especially in tier 3 and 4 cities (here). The overhang of excess property in tier 3 and 4 cities will take years to clear, which will depress the normal bullish attitude towards property among China households. Abandoning the three red line policies, delivering a large cash transfer to households and nationalizing all the weak private property developers, would change the picture, but none of these seem likely. It is also worth noting that the house construction decline versus the 2010s (Figure 3) will continue to feedthrough to a lower level of steel/cement and housing related consumption and services. The situation could stabilize towards 2027 (L shaped), but then the adverse population profile will also be an issue. Debt overhang in the corporate (here) and government sector will also be a drag on growth (here), but less severe given that the China authorities have a heavy influence on domestic creditors and a fair portion of corporate debt is SOE/LGFVs (here).

Figure 3: Cumulative YTD Million Square Meters Residential Real Estate Development Versus Investment in Real Estate Development (%)

Source: Datastream/Continuum Economics

• Net Export growth Structural Headwinds. China's export performance in the past year has been disappointing, with exports consistently shrinking in the monthly trade data. However, this is not just simply the slowdown in the global economy, with the EZ imports from China falling sharply (Figure 4 bottom) and U.S. imports in China have also declined despite the soft landing in the U.S. economy (Figure 4 top). One explanation is that China filled a gap in global trade in 2021 when exports/production were sustained better in China than the EZ and U.S. However, 2023 bilateral trade balance have deteriorated for China but improved for Mexico with the U.S. and for the U.S. into EZ. The change in global supply changes is already underway, with companies switching from China centric global supply chains to multiple supply chains. Our country economists have highlighted iPhone production in India, surging FDI and exports from Vietnam and healthy exports from Mexico that means that U.S. imports from Mexico have now surpassed China. The COVID crisis prompted a desire for onshoring in certain industries, while the Ukraine war boosted production in countries with cheap energy (e.g. U.S.) rather than energy importers like China and the EU. However, the huge economic and financial sanctions imposed on Russia has also prompted companies to confront the doomsday scenario of what would happen if China invaded Taiwan. We see a 5% probability of a full invasion in the next 5 years and a 20% probability of a blockade – which would also cause huge economic problems due to Taiwan advanced semiconductor exports (here). These probabilities are high enough to get companies to diversify global supply chains away from being ultra-China centric. This is a big structural headwind for China exports growth in the 2 half of the decade.

Figure 4: Imports from China for U.S. ($Blns pm) and EZ (Eur Blns pm)

Source: Datastream/Continuum Economics

• Productivity Growth. Here economists usually refer to total factor productivity (TFP) growth once changes in the labor or capital stocks changes have been penciled in. TFP is usually regarded as a function of innovation, smart management and institutional arrangements that favor businesses and growth. On the plus side, China has the “Made in China” 2025 policy to boost high growth areas, while China's people have a well know entrepreneurial character trait. China also scores highly on patents and R&D expenditure as a percentage of GDP. On the negative side, President Xi shift towards state socialism is restraining private enterprise, while technology regulation has swung too far in certain places and has not reversed materially over the past year. Additionally, the increase in military spending risks lower productivity in a segment of the economy, while state owned enterprises (SOEs) remain a major part of the economy but suffer from lower profitability and less innovation. However, economies like China still have a lot of catch up growth and productivity momentum with advanced economies and China can benefit from some of the investment boom of the past 20 years and reshaping of business and consumer processes. China adoption of the internet from industry, services and consumption is if anything of a par with advanced economies, where, for example, southern Europe has been slower to adopt the benefits of better technology than the U.S. or UK. Plenty of scope remains to lift productivity towards advanced economies levels in some industries, especially given the organizational skills of the Chinese people. However, excess infrastructure investment has also occurred and may not provide the same benefit to productivity.

One way of looking at this is to compare China with other countries that have previously at a similar GDP per capita level. Figure 5 shows Japan and S Korea progress after they reached $3000 GDP per capita, which China achieved in 1994. These countries were able to sustained high growth rates until their economies became more mature. However, success is not automatic and Brazil is a clear example, where GDP per capita failed to break higher and the economy got stuck in the middle income trap. It is worth noting that Japan/S Korea in the 1950-1980 period did not suffer the population profile faced by China, as the population and labor force will still growing and added to growth via labor inputs.

Figure 5: GDP Per Capita Select Countries ($1000)

Source: BOJ 2021 Year T is defined as the year when the GDP per capita of each economy surpassed US$3,000. Figures are based on output-side real GDP at chained PPPs (in mil. 2017 US$).

Overall, the catch-up productivity argument would point towards 4-5% growth in China in the 2025-2030 period. However, we are concerned that the residential property downturn and rewiring of global supply chains will be persistent headwinds for China GDP growth in the coming years and that the adverse population profile will also act as a drag. Additionally, the switch to state socialism under President Xi means that China is unlikely to have as much productivity pick-up as seen in Japan and S Korea in their earlier development stage. We are now forecasting 4% GDP growth in 2025, 3.5% in 2026 and then 3% from 2027-30 (Figure 1).

One question is whether these GDP numbers will actually be reported if they are the reality. While China authorities have endorsed a slower 5% GDP target in 2023, a 3% GDP growth target could be politically unacceptable in the 2027-30 period and this leaves the risk that the reported GDP could be higher than the reality in the 2 half of the 2020s.

Disinflation and Tighter Labor Market

What about the long-term outlook for CPI inflation in China?This depends on a number of considerations.

• Disinflation like Japan. The overhang of the residential property sector, plus the large cumulative debt of government/corporate and households to GDP has echoes of Japan in the 1990s. Add in the fact that headline inflation is already close to zero and fund managers worry that China faces ultra-low inflation or deflation. China is however a middle income country, while Japan was a high income country in the 1990s. The process of productivity catch-up can generate profits that are shared by companies and individuals. However, the reluctant of China authorities to take radical measures to support households on a cyclical and structural basis means that Japan style major fiscal stimulation is unlikely.
• Excess production and disinflation. One of the reasons that China inflation is currently low is that weak exports have seen China production directly to the domestic economy, which in some areas is causing excess production. The government focus on SOEs being an important part of the economic transition also means creative destruction is not really in place in China to undermine weak companies or industries and remove excess production. This all risks a disinflation force for China in the coming years.
• Tighter labor market with population profile. China labor market can get tighter with the expected surge of retirement in the coming years and as large scale immigration not an option due to politics. This could mean labor mismatch problems in terms of skills and availability of workers in the urban community. A transfer of rural to urban workers can partially fill the gap, but with slow reform in the Hukou system this may not be enough. However, though this could eventually push up wage inflation and underpin CPI inflation, it could take years before this comes through, given existing underemployment and also youth unemployment.

Overall, we feel that China will suffer disinflationary headwinds that are unusually strong for a middle income country that still has scope to catch-up and were inflation forces are normally more prevalent. Figure 6 shows our 2025-30 forecasts and we project 2025 inflation of 1.0% and then moving to 1.5% by 2030.

Figure 6: China CPI Inflation Forecasts to 2030 (%)

Source: Continuum Economics