By Daniel Archibald | CFA
China is the largest country on earth by number of people, with just over 1.3 billion citizens (give or take 200 million). The size of China's middle class is bigger than that of the United States while the upper middle class now numbers over 100 million. Even though more than half of China still live a rural life or live in poverty, the amount of wealthy Chinese men and women continues to grow exponentially.
Australia has been, and will be, a major beneficiary of this continued growth. But how long will this party continue and how well might Australia, and the rest of the world, adjust to the added fluctuations that will occur in the global economy due to likely growing pains.
The good
- Urbanisation = productivity growth
As we have seen throughout the developed world over the past 200 years since the industrial revolution took hold, the efficiencies garnered through technological advances have seen wealth explode and the workforce move from farms into factories and now factories into services. China is not short of factories, but with almost 50% of the population still living in rural communities, there is an overwhelming source of economic growth possible through increased productivity of the labour force - Globalisation and regulatory reform = productivity growth
If there was any country that might be excused for holding a grudge against international openness, surely it would be China. From the controversial opium wars (how dare China stop the trade in dangerous substances), to the Boxer rebellion. To the atrocities of WW2; is it any wonder China has decided to maintain isolation for a good part of 50 years. In saying that, China has taken large strides over the past few years to open up their economy to the world. This has included the partial floating of the Yuan, the establishment of an international market for Chinese equities, and the increase in trade pacts with the western world. This ongoing move to a more free economy will help with the flow of investments and workers and this will likely increase economic growth through gains in capital and labour productivity - Innovations = productivity growth, sustainability
Despite their large carbon footprint, China has led the world in the turnaround to embracing cleaner energy sources. And despite the fact that many still think that the Chinese population is living in the middle ages, Chinese companies are at, or close to, the forefront in many of the world's up and coming technologies. This type of innovation is likely to see China skip past much of the developed world's evolutionary process and will be an important source of productivity gains and sustainability - Foreign reserves = stability
China was the world's manufacturer for most of the past 20 years. Almost everything was "Made in China" and, as such, China's trade balance has been in surplus since 1994. This has allowed China to build its reserves up significantly. Even though it is has been reducing its reserves over the past couple of years, total foreign currency holdings sit at $U 3.2 trillion. Though this is likely to continue to slide over the coming decades, this large stash of foreign assets is likely to assist the central authorities in enacting stimulus measures, which will help provide stability to the economy - Demographics = political stability
Despite the west's abhorrence of unelected officials, the current situation in China seems to be working. This is somewhat benefited by the one-child policy of the past and China's aging population. It would seem that much of the unrest and riots around the world are grown out of the angst and testosterone of young males (controversial). The reason why this might not be so much of an issue for China is the fact that young males are making up less and less of the population. Furthermore, as most are the only child to aging parents (who, culturally-speaking, they are duty-bound to take care of) the opportunities for them to gather and discuss revolution are minimised. This may be a key factor for political stability, which would likely lead to increased economic stability
The not so good
- Demographics = labour decline, unsustainability
Despite the political benefits derived from Chinese aging population, sooner or later the working class, relative to children and retirees, will shrink to unsustainable levels. And regardless of large technological advances, the less productive members there are in society, the less well-off that society can be. This relative labour force decline will likely be a large drag on future economic growth - Pollution = labour and capital decline
Another catalyst for a declining labour force is the high pollution problems. As the Chinese middle class gets wealthier, and as global labour markets grow, emigration out of China may grow rapidly. This is a key reason why China is working hard to reduce their dependence on fossil fuels, but clean air in Beijing may still be a few decades away. This flight of labour and associated capital is likely to be a drag on economic growth - Growing pains = political instability
It would seem that most industrial or technological revolutions have also coincided with political revolution. A growing middle-class equals a more informed middle class. Economic progression is always likely to upset a few people (just ask those who are losing their jobs to robots), and such growing pains may sow the seeds for revolution. Even though the west would welcome a more democratic China, the pathway to that end may be covered in blood - Corruption = financial and political instability
As stated above, China is a big country. It is governed by central authorities and there are over 3000 prefectures, districts and councils and almost 45000 cities, towns and villages. That means there are 100's of thousands of high level officials and millions of other government officers. Over the years, this hierarchical structure has fostered millions of ways for those in power to skim funds into their own back pockets. Despite the large effort to clamp down on corruption, the current system will still be victim to distrust and abuse, which is likely to increase both financial and political instability - Wastage = lower productivity
China avoided a major GFC slowdown by bringing forward a decade of infrastructure building. Even though building a city that no one was ready to move into seems like a huge waste, China is so big and builds things so quickly, that one ghost city doesn't really matter. Over 100 ghost cities, however, do matter. Though the assets are still there and part of the national wealth, there is major concern that many of these cities will decay quicker than they can be utilised. Also, the post-GFC boost from the overbuild will likely lead to a slump in construction. - Debt = financial instability
The is less 'no so good' and more 'very bad'. The amount of distressed or doubtful debt in the shadow banking system in China is likely to lead to large defaults and extensive bond losses (especially mortgages over ghost city assets). The central authorities have already flagged a reluctance to bail out financiers and investors, and any disorderly bursting of the debt bubble could see China fall into a 'relative' recession. This would indeed have ramification for global investors unless Chinese authorities act fast (which is much easier in a centralised Government)
The major question being asked of investors throughout the world is "does the good in the China story outweigh the bad?". Regardless of the which way the scale sits, there will be periods of ups over the coming years for China, and periods of down. Hopefully, central authorities can orchestrate a good balancing act.