Investors should worry about China’s recent crackdown on many of its stock market superstars. They should worry even more about what the crackdown says about the country’s slowing growth.
The rapid-fire moves by Chinese regulators and courts to brutally rein in the power of many of the country’s most innovative firms, ranging from online retailer Alibaba Group Holding Ltd. to ride-hailing giant Didi Global Inc. , has rattled shareholders and spurred concern about Beijing’s shifting agenda.
But the simplest explanation rests on the idea that the crackdown is in large part a reaction to China’s slowing growth, a development that has prompted Beijing to reassert its control over the economy.
After a 1990 to 2010 golden era in which it routinely expanded its economic output at around 10 per cent a year, China has faded back to more normal levels over the past decade and is on track for further deceleration. A rapidly aging population, a questionable economic model and growing international tension are some factors helping to slam the brakes on the country’s long-term growth potential.
For now, gushers of government stimulus and favourable comparisons to the recessionary lows of the COVID-19 crisis last year are masking those trends. They should become more visible in the second half of the year, observers say.
“We are expecting a significant slowdown” for the Chinese economy over the remainder of 2021, Mark Williams, chief Asia economist at Capital Economics, told a webinar this week.
He predicted a year of two very different halves. In the first three months of the year, China’s economy surged higher at a record 18.3 per cent annualized pace, boosted by stimulus spending and flattered by favourable comparisons to the depths of a year before. The same factors helped Chinese output to advance at a still frenetic 7.9-per-cent pace from April through June.
In contrast, the economy will barely grow during the second half of the year and may even shrink, Mr. Williams warned. The immediate cause will be reduced fiscal stimulus from Beijing and a new wave of coronavirus infections caused by the Delta variant, he predicted.
But even after those issues fade, China is unlikely to return to its glory days, Mr. Williams added. He forecasts that growth will slump to around 2 per cent a year over the decade ahead.
Others have a similarly downbeat outlook. They pin a large part of the blame on an economic strategy that emphasizes infrastructure construction, property development, heavy industry and other forms of state-guided investment at the expense of a more market-oriented, consumer-focused approach.
Rural poverty, in particular, remains a problem because of what Matthew Klein, publisher of The Overshoot newsletter on global economics, calls “the Chinese government’s long-standing preference for showy capital investments over the provision of public services.”
He argues the biggest gains from China’s top-down approach have already occurred. If so, the implications are disturbing: Economists once assumed Chinese living standards would one day come close to U.S. levels, following the pattern set by Japan, South Korea and Taiwan. That no longer seems such a safe bet.
On the eve of the pandemic, the average income in China was just under a quarter of the U.S. level, according to Mr. Klein. The convergence of Chinese living standards with those in the developed world “paused (or stopped?) around 2014,” Mr. Klein wrote this week. “From this perspective, the right comparisons for China might be Brazil, Mexico and the Soviet Union, rather than Japan, South Korea or Taiwan.”
Michael Pettis, a finance professor at Peking University, has warned for years about the limitations of China’s economic model. By suppressing the earnings of labour, encouraging savings, and directing those savings in state-controlled banks toward badly needed infrastructure, Beijing was able to achieve startlingly fast growth in the early stages of opening up to global commerce in the 1990s. The problem is that once infrastructure has been built, the payoffs from that strategy fade.
Other countries that followed similar strategies, notably Japan and South Korea, rebalanced their economies away from building highways, rail systems and airports, and toward household consumption. To do the same, China would have to boost the household share of its gross domestic product from its current level around 50 per cent to at least 70 per cent, Mr. Pettis calculates.
“Beijing has long wanted to do this, but with limited success despite a decade of trying,” Mr. Pettis wrote last year in the Financial Times. “There is still little to suggest the [Chinese Communist] party is willing to tackle the institutional implications of the large wealth transfer from local governments and elites to households this entails.”
The ambivalence of the country’s leadership is on display in the murky “dual circulation” strategy it announced last year. The strategy advocates a boost in Chinese consumer spending (“internal circulation”) to help reduce China’s dependence on foreign trade, while simultaneously encouraging the promotion of Chinese manufacturing worldwide (“external circulation”) to dissuade other countries from engaging in trade wars with China.
What does that mean in practice? In a speech last April, Chinese President Xi Jinping paid lip service to his country’s booming digital economy, but added that the “real economy is the foundation, and the various manufacturing industries cannot be abandoned.”
He left little doubt where his affections lay. “We must sustain and enhance our superiority across the entire production spectrum in sectors such as high-speed rail, electric power equipment, new energy and communications equipment,” he said, with the goal of tightening “international production chains’ dependence on China, forming a powerful countermeasure and deterrent capability against foreigners who would artificially cut off supply” to China.
The recent crackdown on China’s U.S.-listed tech firms further clarifies Mr. Xi’s intentions. His regulatory assaults against superstars such as online retailer Alibaba, ride-hailing giant Didi, as well as food delivery services and the private-education sector, suggest Mr. Xi’s priority is maintaining control of his country’s economy, not maximizing growth or encouraging innovation.
“The government does not like alternative centres of power,” Mr. Williams of Capital Economics said.
Beijing seems willing to shift resources to sectors that will allow China to stand alone, even if they are slower-growth industries. “Online gaming is not going to help China’s strategic position in 10 to 20 years,” Mr. Williams said. But a robust manufacturing capacity could.
The country’s desire to insulate itself from international pressure speaks to the increasingly chilly relationship with Washington. It may also reflect how growing demographic pressures are encouraging a sense of vulnerability.
China’s fertility rate has plunged in recent decades, in large part because of a one-child policy between 1979 and 2016. The policy gave China a big boost from favorable demographic trends in the 1980s, 1990s and early 2000s, with lots of workers but a shrinking percentage of young dependents.
Now the downside is becoming evident. China’s working-age population (those between 16 and 59) shrank by a staggering 40 million people between 2010 and 2020, according to last year’s census.
To be sure, the total size of the workforce remains large, at 880 million, but the shrinking pool of potential employees means it will be difficult for the country to come anywhere close to the growth rates of a decade ago.
The good news for investors in Canada is that a Chinese slowdown in the second half of this year would have only limited impact on recoveries elsewhere, because China is not a big source of demand for goods other than industrial metals, Capital Economics says.
But a slowing Chinese economy does call into question the gospel of emerging market investing. Those who buy emerging market stocks usually do so on the basis that the strongest growth is likely to occur outside the developed world. In the case of China, that now seems like a long shot.
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