TELLUS Something New

China in the Long Run

A Macro Update by Torgeir Høien, Portfolio Manager
of SKAGEN Tellus

St
Stavanger, Norway,
N 3 March
M h 2011
Chi
Chinese long-term
l t perspectives
ti

“It’s too early to tell”

Chinese prime minister Chou En-Lai’s reply when asked by French

students whether anything good came out of the 1789 French Revolution
Th road
The d travelled
t ll d since
i 1978

GDP in USD
• The Chinese economy came to life in 1978
15,0 15,0 when the government substituted central
planning with a market-based economy.
12 5
12,5 12 5
12,5 • Here is what has happened since the
economy was let loose:
US • From 1980 to 1990 real GDP grew
10,0 10,0 9.3 percent per year.
Trillion USD

Trillion USD
• From 1990 to 2000 real GDP grew
10 4 percent per year
10.4
7,5 7,5
• From 2000 to 2010 real GDP grew
Japan
10.5 percent.
5,0 5,0 • Measured in USD, Chinese GDP was larger
than Japanese GDP in 2010.
• After impressive growth numbers since the
2,5 2,5
China 1950s, Japanese GDP plateaued in 1990.
Why? Could this happen in China too? And
0,0 0,0 when?
1980 1985 1990 1995 2000 2005 2010

Source: Reuters EcoWin

 Japan hit a demographic wall and got caught up in the global frontier

• A significant
g part of Japan’s
p p recent ggrowth
Japanese real GDP per capita decline is due to demographics. The labour
force began to shrink in 1998, the population
4,5 4,5
peaked in 2005. This had a direct impact on
GDP growth.
4,0 4,0
• Per capita
p g growth too was veyyppoor duringg the
1990s, in the aftermath of the real estate bust.
3,5 3,5
From 2002 to 2007, however, GDP per capita
advanced 2 percent per year. Since then the
007 JPY

007 JPY
3,0 3,0
great global recession has reduced GDP per
p
capita. Trend ppeer capita
p growth has clearly
g y
Million 20

Million 20
25
2,5 25
2,5
been lower over the last 20 years than the 3.6
percent Japan averaged between 1970 and
2,0 2,0
1990.
1,5 1,5
• The main reason for stagnating per capita
growth is that Japan
g p had been benefitting g from
catch-up growth in previous decades. Japan
1,0 1,0
was a poor country after WW2, and this set the
stage for rapid growth during a transition
0,5 0,5
period. Since the early 1990s, however, per
1960 1970 1980 1990 2000 2010 p
capita GDP in Japan
p has been around 90
percent of the US level, when measured in
Source: Reuters EcoWin USD. This signals much less scope for catch-
up growth.
 C t h
Catch-up growth
th in
i Chinese
Chi “offshoots”
“ ff h t ”
• Chinese-populated Taiwan and Hong Kong
and heavily Chinese-populated Singapore,
GDP per capita
it iin USD began catch-up
catch up growth much earlier than
China. In 1980 GDP per person in Hong Kong
50000 50000 and Singapore was already 40 percent of the
45000 45000
US level. In Taiwan it was 20 percent.
USA • Since then all three countries have closed in
40000 40000 on the US,
US particularly Singapore,
Singapore where GDP
Singapore
per capita is now 90 percent of the US level.
35000 35000
Hong Kong In Hong Kong it is 70 percent and in Taiwan
30000 30000 40 percent.
Taiwan • On average GDP per capita growth between
USD

USD
25000 25000 1980 andd 2010 was 6.9
6 9 percentt ini Singapore,
Si
20000 20000 5.8 percent in Taiwan and 4.8 percent in Hong
Kong. Average annual population growth in
15000 15000 was 2.5 percent in Singapore, 1.1 percent in
Hong Kong and 0.9 percent in Taiwan during
10000 10000 the same period.
period
5000 5000 • The purchasing power of local currencies has
edged higher versus the USD but they are not
0 0 yet at parity. Hence in purchasing power
1980 1985 1990 1995 2000 2005 2010 adjusted terms, GDP per capita in Singapore
andd Hong
H K
Kong now tops
t th t off the
that th US,
US while
hil
Source: Reuters EcoWin the Taiwanese GDP is 80 percent of the US
level.
 China still has huge potential for catch-up
catch up growth

GDP per capita

50000 50000 • GDP per capita in China was USD 4300 in
PP-adjusted volume in 2010 prices 2010, measured at current exchange rates.
45000 45000 That is 9 percent of the US level. Adjusted
C
Current
t USD for the different purchasing powers in the
40000 40000
two countries, per capita GDP in China last
35000 35000 year was 20 percent of the US level.
• A low GDP per capita level means that there
30000 30000
is still a massive catch-uppp
potential in China.
USD
D

USD
D
25000 25000 China is still far off the GDP per capita
levels that Japan had when its economy
20000 20000 slowed down in the early 1990s.
15000 15000 • High growth rates during a catch-up period
PP-adjusted volume in 2010 prices is what traditional macroeconomic theory y
10000 10000 predicts. A precondition for catch-up growth,
Current USD and USDCHY though, is free market institutions. Political
5000 5000 reforms are not irreversible, though. Hence,
0 0 should China become more “planned”, its
GDP g growth will slow down and could tail
1980 1985 1990 1995 2000 2005 2010
off.
Sources: Reuters EcoWin and The Conference Board
 P capita
Per it growth
th depends
d d on investment...
i t t

Fixed capital investment and the net real rate of return • Investment in fixed capital as a share of GDP
has been trending upwards over the last 30
47,5 30 years, and was over 45 percent in 2009. If
that rate is sustained, there is a huge yearly
45,0 27
addition of capital per person in the labour
42,5 24 f
force. Thi drives
This di up productivity.
d ti it
• The rate of return on capital was on average
40,0 21 over 20 percent from 1992 to 2005. During
of GDP

Net real rate of return on capital (r.s.) this period the rate of return fell somewhat in
37,5 18

Perccent
state-owned enterprises, but it increased in
Percent o

35 0
35,0 15 privately owned enterprises.
32,5 • Thus, the high share of output devoted to
12
investment has not had a significant negative
30,0 9 effect on the overall rate of return. Net real
return on capital was a solid 24 percent in
27 5
27,5 6 2007, about the average from 1978.
Investment share of GDP (l.s.)
25,0 3 • A high rate of return indicates that the
investment share will remain high for some
22,5 0 time. Hence, capital accumulation should
1980 1985 1990 1995 2000 2005 keep per capita g growth rates solid in the
future.
Sources: Reuters EcoWin and Professor Jessie Zhenjie Qian
 …and
d on technology
t h l

Annual technological growth • Technology refers broadly to how labour and

capital produce GDP. In the short run it is mostly
10,0 10,0 about politics. In the long run it is about science
and engineering.
7,5 7,5 • Substitution of central planning with a mixed
economy set the Chinese economy in motion.
5,0 5,0 But there is still room for huge improvements, as
state owned enterprises dominate in certain
industries and the capital market is still tightly
2,5 2,5
ent

ent
g
regulated. Whether China adopts p Hong g Kong g
Perce

Perce
style capitalism remain to be seen. But how far
0,0 0,0 China institutes reforms determines the per
capita GDP level China can expect when it has
-2,5 -2,5 caught up with advanced economies.
USA • When the catch-up p ppotential is exhausted,,
-5,0 -5,0 further per capita growth depends on how fast
China the sciences advances.
-7,5 -7,5 • Participation of Chinese scientists should help to
speed up that process, as will the output from
1990 1995 2000 2005 research universities and firm
firm-level
level R&D in other
flourishing emerging markets.
Source: The Conference Board
 Demographics is China’s Achilles heel

Population and labor force

• The Chinese population is set to grow up to
1,5 150 2030, with an average growth rate of 0.3 percent
1,4 140 per year from 2010 to 2030. The growth rate is
dwindling g though,
g and the g growth rate in the 20-
1,3 130 ties will be modest to say the least.
1,2 120 • Labour force growth has slowed down since
1990. Over the last 20 years it has grown on
1,1 110
Chinese population (l.s.) average 0.8 percent per year. During the same

on
1,0 100 period p
p population
p growth was 1.1 p
g percent pper
on

Millio
Billio

Japanese population (r.s.) year.

0,9 90
• Japan gives a hint at what is on the cards for
0,8 80 China: although the population grew until 2005,
0,7 70 the labour force peaked in 1998. This suggests
that the labour force in China will grow very
0,6 60 slowly until late this decennium and then start to
Chinese labor force (l.s.)
0,5 50 shrink.
Japanese labor force (r.s.) • A slowdown and eventual negative rate of labour
0,4 40
growth means that while GDP per capita may
1980 1990 2000 2010 2020 2030 2040 2050 still grow rapidly,
rapidly overall GDP growth will slow
down markedly over the coming decades.
Source: EcoWin, IMF, The World Bank IMF and the UN
 Some highly uncertain long
long-term
term GDP projections
• I estimate that real GDP growth will average 10
percent per year over the next 10 years, and then
fall to 7 percent the following decennium, then 5
percent from 2030 to 2040, and 3 percent from
Projected GDP in current USD
2040 to 2050.
300 300 • Overall GDP growth slows due to demographics.
Growth rates per capita dwindle over time as the
capital/labour ratio increases,
increases since the marginal
250 250
productivity of capital falls with a higher ratio.
China will nevertheless manage to grow more
China
200 200 than the US in per capita terms until at least
2050, though, due to lingering catch-up effects.

USD
USD

• For comparisons in USD terms I am assuming

Trillion U
Trilion U

150 150 US growth of 3 percent from 2010 to 2050, in line

USA with the historic trend. I also assume 2 percent
inflation in both the US and China plus 2 percent
100 100
annual renminbi appreciation. This closes the
purchasing power gap by 2050.
2050
50 50 • According to these projections, Chinese GDP will
surpass US GDP in USD terms in 2023. In 2050
Chinese GDP per capita will be 85 percent of the
0 0 US level and China’s GDP is 150 percent higher
1980 1990 2000 2010 2020 2030 2040 2050 the US GDP.
GDP If China institutes Hong Kong style
capitalism, this will either speed up growth in
Source: SKAGEN Funds coming decades or prolong the period of catch-
up growth beyond 2050.
Conclusion
• Chinese growth has been very impressive since 1980 and is set to
decline only gradually over the next 40 years.
• The most important drivers are market reforms and a high investment
share of GDP.
• The Chinese labour force will begin to fall around 2020. This will curb
GDP per capita growth rates.
• Adapting to a dwindling labour force could be problematic, as seen in
Japan But over time it should not reduce GDP per capita gains.
Japan. gains
• Convergence in GDP per capita levels is a time consuming process.
But in 2050 China might end up with a GDP per capita that is just 15
percent lower than in the US.
US
• The overall Chinese economy will then be 150 percent higher than the
US economy, both in current USD and purchasing power terms.
• Whil there
While th might
i ht be
b paper wallsll for
f the
th Chinese
Chi economy, there
th i no
is
reason to think that it cannot continue to grow substantially over the
next 40 years.