By Ichiro Suzuki
It is widely expected that China overtakes the United States as the largest economy at some point in the 2030s. Before taking this common view as a done deal, however, a few factors that drive growth need to receive close examinations. With $21 trillion, the U.S. economy is currently 50% larger than that of China. Closing this gap can take longer than it is often believed. In the most pessimistic case, it might not happen at all. If and when China becomes the largest economy, China is unlikely to leave the U.S. far behind as it did on Japan a dozen years ago.
1. Trend growth’s sharp fall
China continues to boast of higher economic growth rates than the most of the rest of the world, especially among the economies of significant size. However, its growth rate has fallen materially from the numbers seen in early years of the 21st century. In those years, the Chinese economy not only posted 12-13% growth rates in RMB but had another boost by the currency’s few percentage point annual rise against the U.S. dollar, for growth rates of blazing mid-teens year after year. Adding another few percentage points on inflation gave nominal growth rates in USD close to 20%. Of course, growth rates are officially reported in real terms that exclude inflation factors. Nonetheless, financial and real estate markets are quoted in ‘nominal’ numbers that include inflation. So nominal numbers do have some meaning. Anyway, growth rates have decelerated considerably in recent years.
The RMB has stopped rising already and the currency factor could work against growth rates as measured in USD. On the other hand, growth rates for the U.S. has slowed in recent years, too, but at a much lower rate of deceleration than China. In fact, Goldman Sachs forecasts the U.S. economy to grow 6.8% in 2021 faster than the Communist Party’s official target at 6.0%+ for China. This U.S. upswing could be followed with a 4.5% hike in 2022. President Biden’s fiscal response to the coronavirus-driven economic downturn is making a huge difference on the U.S. economy whereas Beijing chose not to mobilize fiscal policy aggressively. While 2021 and 2022 are going to be aberrations, the growth gap between the two countries has narrowed down to a few percentage points as China keep slowing.
2. Demography
China’s working age population has already hit its peak in the middle of the last decade and has got onto a slow descending trend. While overall population still keeps growing due to aging effects, population is expected to reach its peak at around 2030. This is consistent with the pattern witnessed in Japan that is ahead of the world in aging. Japan’s working population had peaked out in the mid-1990s, followed by peaking-out of overall population by the middle of the last decade. Lifting of the infamous ‘one child policy’ has had little effect on the birth rate in China. High costs of raising kids in large cities keep young people from having a second child, or from getting married at all. Quite contrary, it is reported that growing numbers of divorce cases have given a rude awakening to the Communist Party. In addition, worldwide population bust is hitting China, too, as a result of a sharp economic downturn and uncertainty about the future caused by the pandemic.
The United States is also hit by the coronavirus population bust, and the U.S. population is getting old, too, with its birth rate below the replacement level. Nonetheless, the U.S. birth rate still remains higher than the rest of the developed world, and immigrants keep flowing in to the U.S., whether the majority of the country likes it or not. U.S. population keeps expanding even at a more modest rate than in the past. Population growth remains one of the two pillars of economic growth, along with productivity growth. This matters.
3. Dependence on foreign capital
In the 2020s and beyond, China needs to import vast amount of foreign capital to finance its economy’s growth. China’s current account surplus that was once over 10% in relation to the size of the economy, has almost disappeared by the end of the last decade. While China continues to run distinct trade surplus, Chinese tourists’ spending in their overseas vacation sites made a sizable dent on the country’s external account. The pandemic made Chinese tourists to stay home in 2020, and the current account has rebounded. In the first three quarters of 2020, China recorded current account surplus at 1.6% of the economy, as cross-border service transactions fell more than 40% from a year ago. Current account did become positive but the number was relatively modest at time that was considered as an aberration caused by the pandemics’ outbreak. For instance Japan constantly runs current account surplus at 3% of its GDP though its trade account is almost balanced. As the 2020 current account rebound could be one-off, China would continue to have to import a large amount of capital from abroad. China offers higher government bond yields than U.S. Treasury securities, let alone other government bonds in the developed world. The Chinese economy’s higher growth rates continue to attract foreign capital that is looking for places to invest in a world of slow growth. Nonetheless, foreign exchange controls could keep China from receiving as much capital as they would like. Foreign capital is unlikely to be interested in funding state-owned enterprises (SOEs) due to their lackluster financial performances. SOEs still need to be funded and they represent more than half of the stock market. SOEs put a downward pressure on overall rates of returns from investments into China. The Chinese economy would have to learn to satisfy foreign investors before they conclude their returns from China investments are below what they had hoped. This factor could put a damper on economic growth on a long-term basis.
4. Capital Controls
It’s been already four and a half years since China’s renminbi (RMB) went into the Special Drawing Rights (SDR), an international reserve asset created by the IMF. Unlike other countries whose currencies are components of the SDR, capital controls remain firmly in place for China, rather than being lifted or loosened as was hoped at the time of the RMB’s entry in 2016. It seems that the Communist Party does not afford to lift the controls for the foreseeable future. Lifting them would almost certainly unleash a flood of money fleeing, both from the household and the corporate sectors, into overseas assets for better investment opportunities. Even Communist Party dignitaries would do it, probably clandestinely. A vast amount of cash has been trapped inside China by regulations and it has been so anxious to get out of the country. Lifting capital controls would drive money out of China, thus pressuring down the value of the RMB. A weaker currency works against the economy’s rise vis-a-vis others.
5. Leveraged households
After an era of export-driven frenetic growth is already over for China, it is expected that China turns to the household sector for further growth, especially in terms of lifting per capita income. While China is already the second largest economy, overtaking Japan, a dozen years ago, its per capita income had reached $10,000 only recently and still lags developed countries considerably. It is essential for China to lift per capita income through household consumption that has been systematically suppressed for years as public sector investments have been given a higher priority. However, the household sector is already heavily indebted, as the sector is carrying debt outstanding approximately 120% of the economy that can rank in developed countries’ league. From a different perspective, debt outstanding at 120% of the economy had brought China’s per capita income only to $10,000. Greater consumption would almost certainly accompany higher levels of debt. The market would have to tolerate household debt to rise to much higher levels.
About the author: Mr. Suzuki is a retired banking executive based in Tokyo, Japan.
