Economic Views

Chinese trend growth: The future for new China

In the final part of our China series, we look at what is in store for the country as it seeks a transition to a consumption-led economy. Can China find new drivers of growth?


Craig Botham

Craig Botham

Emerging Markets Economist

In the final part of our China series, we look at what is in store for the country as it seeks a transition to a consumption-led economy. Can China find new drivers of growth?

So far in this series of notes on China, we have examined the prospects for Chinese trend growth, given the demographic outlook, planned urbanisation, and the scope for investment.

In this third and final note, we address the issue of where this investment can go, and whether there is macroeconomic support for the planned transition to the new, consumption-led, China.

In general, are the themes identified in our first two notes: demographics and capital catch up, supportive of the hopes that China can find new drivers of growth?

Infrastructure gaps remain

One argument we have heard advanced in favour of a bearish stance on China is that investment cannot continue to drive growth because there is nothing left to invest in.

That is, China is now entering the “bridges to nowhere” stage of investment spending, as seen in Japan and elsewhere. We do not agree with this argument unconditionally.

While it is true that China has invested huge amounts of GDP, and spare capacity problems in certain industries (along with “ghost cities”) suggest overinvestment has occurred in some areas, we saw in the previous paper in this series that GDP per capita remains far behind the US or South Korean levels. There must be some gaps somewhere.

Starting at a simple level, Chart 1 shows some data on basic infrastructure across China.

The data is available at a provincial level, which is then grouped by region, each of which is generally recognised to be at a different level of development.

The eastern provinces, for example, are most closely tied to international trade and have seen the highest growth in GDP and income, and higher urbanisation rates.

Basic needs are broadly met across the provinces. Access to sanitation and clean water (not shown), for example, is near universal in urban areas.

But there are some gaps in provision of other basics. Access to gas, for example, is clearly much higher on average in the eastern provinces than in the west. Road density is also much higher in the east than west.

At this stage we are not attempting to make quantitative assessments of the amount of investment needed; this serves only as an illustration that investment is not “done” in China.

However, it will take more than catch up in gas provision and road density to generate meaningful scope for investment growth.

Manufacturing capital

One of the big drivers of investment and hence economic growth in China has been manufacturing, establishing the country as a workshop to the world for the first decade of this century.

But the problem of spare capacity in some industries and the negative producer price inflation (PPI, currently running at close to -6% a year) coupled with stagnant global trade would suggest further gains here are likely to be limited.

Drawing on data from a paper by Yanrui Wu , we have calculated current manufacturing capital stock for each Chinese province, and again grouped by region (Chart 2).

The intention here is to assess whether there is scope for investment to bring other regions of China in line with the more developed eastern provinces.

We look at regional averages rather than aiming for convergence to the province with the highest capital per capita, because we assume that manufacturing hubs will likely cross provincial lines, and that a province like Hubei has such a high level of capital because it is supplied with other resources by neighbouring provinces.

In much the same way that not every British city can be London, or every American city New York, not every Chinese province can be Hubei or Jiangsu.

As Chart 2 shows, regional averages for manufacturing capital per capita do not actually vary by much.

So there is perhaps something to the argument that investment here, at least, has run its course. This is not to say that China can no longer invest in manufacturing; some amount of investment will be needed to maintain the same level of capital stock per person thanks to population growth (for now) and depreciation, and to keep up with changes in technology.

There is also some scope for China to move up the value chain in manufacturing, producing higher technology goods to compete with developed market exporters. But the period of rapid, “catch up” growth in manufacturing may well be over.

Service sector playing catch up

Where the real gap lies between China and those economies with much larger capital stocks is the service sector (Chart 3).

While it is tempting to think of services as meaning things like tourism, finance and retail, none of which seem particularly capital heavy, it also incorporates telecoms, transport, and other infrastructure.

Again, visitors to the major cities like Beijing and Shanghai may think that even here the Chinese have done all they can; the situation is very different as we move away from the eastern provinces.

The right hand panel of Chart 3 shows that at the national level China still lags Korea in both high and low technology.

Even in the largest cities, the level of pollution and traffic alone implies that further investment in public transport would not go to waste.

Education and healthcare, too, are ripe for further investment, and will be essential to creating the human capital China will need if it is to compete in the highest value-added industries.

Arguably for service sector growth (and the associated investment) we need to see a growing consumer base.

One way to achieve this is to boost incomes through economic growth, but for an emerging market like China, incomes can also be boosted through urbanisation.

We went through this in more detail in our first note in this series, and to avoid repetition interested readers may want to read that paper for a more complete discussion.

Urbanisation of income and spending

Briefly though, the transfer of workers from the rural to the urban sector can be a powerful driver of growth given much higher productivity in the urban sector.

Given that pay is (generally) linked to productivity, this process also sees an increase in incomes for the workers involved.

As Chart 4 shows, urban dwellers typically have more than double the income of their rural counterparts.

Furthermore, the majority of this additional income translates into additional expenditures, with urban dwellers spending 2-3 times as much as those in rural areas.

Based on current income levels, if China were to achieve 80% urbanisation today (the developed world average), this alone would add consumption worth 3% of GDP.

Obviously, China will not achieve this level overnight. Happily, however, we have already conducted analysis of a likely urbanisation and implied trend growth path (see the first two notes in this series).

We can take advantage of this to calculate a probable path for consumption (Chart 5). We decompose growth in consumption into the contributions from urbanisation, population growth and income growth.

Urbanisation is assumed to proceed at a rate of 0.9% per annum, as laid out in the government’s urbanisation plan. Korea managed to urbanise more rapidly, so we do not feel overly naïve in accepting a government target on this occasion.

Our numbers for population growth are based on UN forecasts, and we assume that incomes grow at the same rate as labour productivity (based on an assumption around the growth rate of the capital stock, discussed in our first paper).

We make no change to the propensity to consume (the share of income consumed rather than saved), though given the current high saving rate in China one would expect this to increase over time – an upside risk to our forecast.

Household consumption

As with our trend growth forecast, much of the boost to consumption is expected to come from growing household incomes. Yet demographics also prove supportive for most of the period.

Urbanisation adds around 1% to consumption growth each year, with a further 1% added by population growth for the first five years, though this dwindles to become negative by 2029.

Overall, consumption trend growth is higher than trend GDP growth across the period, picking up the slack from weaker investment growth.

With household consumption accounting for just over 36% of GDP, compared to roughly 44% for investment, it certainly seems possible for consumption to take over as a driver of growth.


What, then, should we take away from all of this about China’s future? We think a few key themes are as follows:

  1. Whether considered from a demographic or capital accumulation perspective, trend growth in China is probably around 5.5%, and will decline to 3 to 4% over the next 15 years. Reforms and other changes can make some difference to this number but the margin is typically less than an additional percentage point.
  2. A declining workforce is not fatal to Chinese growth: gains in labour productivity, consistent with a more capital intense economy, easily outweigh the small drag on activity, and drive a growth rate which continues to exceed that of any developed market.
  3. There is ample scope for further capital accumulation, as is evident from a comparison of China and the US, or of China and Korea. Most of these investment opportunities now lie in the services sector. But the biggest catch up gains in investment are behind us.
  4. When considering GDP from an expenditure side, it is clear that consumption has the potential to be the main growth driver.

Of course, these are all long-term themes, and do not preclude a crisis in the short term.

Like others, we are concerned about the buildup of debt in China and see the financial system as the likely source of any hard landing.

But we see little evidence that the economy is overheating, looking at the data and at our estimates of trend growth.

In addition, a financial crisis need not throw China completely off track – a reversion to trend should be possible.

The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.