Wednesday, March 5, 2014

China's rise likely, but not preordained

I got a number of responses to my last post on China that I would like to clarify (see Is China spawning an American Renaissance?). I would like to address the growth path of China, both for the next few years and next few decades.

The objections that I received were mainly in two categories. Some writers indicated that China has seen turbo-charged growth rates which far exceeded growth seen in the West and developed economies and these writers believed that Chinese growth rates will continue to grow at levels exceeding the developed markets. Others objected to the implication that my thesis suggested that somehow that America and the developed markets were "robbing" China of growth potential.

Not a zero-sum game
First of all, I would like to make clear that my last post did not represent a zero-sum game of American vs. Chinese growth. China's growth path is independent from America's and one country does not necessarily grow at the expense of the other. The growth path of any country or economy as large as China depends mainly on its own policies, rather than the action of others.

In addition, I would like to make the point that China's ascendancy. while likely, is not preordained. As the chart below from Nomura (via Business Insider) shows, China and India accounted for roughly 50% of global GDP in the 18th and the first half of the 19th Century (annotations are mine). Given their history, it would not be surprising to see these economies regain their former positions of dominance.

On the other hand, nothing is etched in stone, and the growth path of any economy depends on the proper set of economic policies. The FT documented two countries which about 100 years ago showed equal promise, but their paths diverged significantly:
A short century ago the US and Argentina were rivals. Both were riding the first wave of globalisation at the turn of the 20th century. Both were young, dynamic nations with fertile farmlands and confident exporters. Both brought the beef of the New World to the tables of their European colonial forebears. Before the Great Depression of the 1930s, Argentina was among the 10 richest economies in the world. The millions of emigrant ­Italians and Irish fleeing poverty at the end of the 19th century were torn between the two: Buenos Aires or New York? The pampas or the prairie?

A hundred years later there was no choice at all. One had gone on to be among the most successful economies ever. The other was a broken husk.
The article is well worth reading in its entirety because it details the differences in culture and openness of the two economies (also see my comments in Inequality, does it matter?):

Two challenges to growth
China suffers from two major challenges. The near-term challenge is a transition from an export and infrastructure based growth model to a consumer led growth model, while recognizing the significant tail-risk posed by non-productive infrastructure investment fueled by excessive credit growth. These problems are not insurmountable. I believe that, in the long term, China would be better off by implementing harsher reform policies of market adjustments now even at the price of a hard or crash landing, than to try to kick the metaphorical can down the road as it seems to be doing now. Such an adjustment would enable the Chinese economy to transition to a more sustainable growth path based on quality, not quantity.

The transition to consumer based growth would address the second challenged faced by China as she approaches a Lewis Turning Point. The combination of an aging demographic and the rapid utilization of cheap labor means that China cannot sustain rapid export growth based on low-cost labor. The economy need to transition to higher value-added activities, which translate to better paying jobs compared to just lots of low-paying jobs under the old growth model.

Neither obstacle is insurmountable. Even if China were to undergo a hard landing and experience a recession, which is not in anyone's spreadsheet, it doesn't necessarily mean that China growth will come to an abrupt stop.

Analysts need to differentiate between the cyclical effects of the Chinese and global economy and the long-term secular effects of China's growth policies.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). The opinions and any recommendations expressed in the blog are those of the author and do not reflect the opinions and recommendations of Qwest. Qwest reviews Mr. Hui’s blog to ensure it is connected with Mr. Hui’s obligation to deal fairly, honestly and in good faith with the blog’s readers.”

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this blog constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or I may hold or control long or short positions in the securities or instruments mentioned.

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