Chinese growth mirage

Edition 25. China looks strong, yet it may not be enough to power a global recovery

5 months and 25 posts delivered (almost) weekly! I started this newsletter because I was absolutely overwhelmed with news and wanted a simple explainer about important trends and events during COVID-19. Thank you for following along, the regular feedback, and your shares! 🙏

Countries are now reporting their quarterly growth and the development in China is fascinating. While the rest of the world, led by the U.K., sunk to historic contractions, the Chinese economy actually grew at a decent clip. I want to deconstruct trends behind the Chinese growth miracle today and look at why this might still be insufficient to save the world like it did in 2008.

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Chinese economic resilience

When the 2008 crisis hit, the developing countries, led by China powered the global recovery. Chinese government’s massive ~$590B stimulus (~13% of the GDP in 2008) powered a quick rebound. The government spending financed high-speed rail, roads, bridges, airports, and housing. The state-led financiers too lent aggressively. Such was the pace of the frantic construction in the country that it set up a global bull market for commodities.

Increased consumer and industrial appetite in China in turn helped countries like Brazil, Germany, and Australia whose trade volumes increased and helped offset the impact of tepid growth in the rest of the world. Chinese growth which had dipped to ~6% by the fourth quarter in 2008, rebounded sharply to ~10% by the third quarter of 2009. The Chinese policymakers by their swift actions had helped the global recovery and, as a result, covered themselves in glory.

Urban Dictionary: Mao Zedong

As the COVID-19 crisis took over the world, it is the Chinese growth that is again in focus. Yet, it seems like this time is not going to be an encore of 2008.

Globally, COVID-19 has taken a once in a generation toll on the global economy.

It’s not just the breadth but the extent of contraction itself which is eye-popping as seen by the data released by major European countries.

Meanwhile, China has come out surprisingly strong from the coronavirus induced melee with the economy growing by 3.2% in the quarter ending June. For context, the economy had shrunk by ~7% in the first quarter - the country’s first economic contraction since the Cultural Revolution in 1976.

What explains the rebound?

Understanding the structure of the Chinese economy is helpful to answer that question.

While the share of services in the economy has steadily grown, industry contributed to over 40% of the total economic output. It is hard to overstate the importance of this metric. Contribution of industry to other manufacturing powerhouses such as South Korea and Germany is considerably lower - ~33% and ~29% respectively. The same number for India is ~30% and in the developed services-oriented economies like the USA and UK is <18%.

Hence, even as consumer spending remained low, China as the ‘factory of the world’ got back to work after successfully curbing the virus. All metrics and anecdotes point to the continued strength of Chinese manufacturing. The story of manufacturing face masks during the pandemic offers perhaps the best example of the formidable prowess of the country.

At the start of February, China made about half the world’s supply, 10m a day. Within a month, output of masks had increased to nearly 120m. It was thanks to having “the world’s most complete supply chain”, as Xinhua, the state-run news agency, put it. A simple surgical mask consists of a woven layer fused to a non-woven layer, elastic loops that go around your ears and a thin metal band to fasten it to your nose. More sophisticated masks add a thin plastic filter and an activated carbon filter. Any country hoping to make masks on its own needs companies with expertise in textiles, chemicals, metallurgy and machining, along with sufficient supplies of raw materials, factory space, trained workers, engineers and capital. It cannot just be done from scratch, and a similar story plays out across thousands of products.

No wonder that as countries shut down, China’s share of global exports during the pandemic actually increased. Nearly a third of all goods imported by Japan and a quarter of goods imported by Europe today come from China. Here is an interesting chart of countries that China does not have a trade surplus with (exports from China to Country X minus exports of Country X to China).

Does something stand out?

All these countries are either commodity (Saudi Arabia, Australia, Angola), luxury goods (Switzerland), or high-tech manufacturing (Germany, South Korea) hubs. Even there China has prioritized to reduce the deficit with as it increasingly ramps up its production capacity in high-tech manufacturing such as semiconductors.

Hence, despite the talk of the imminent demise of Chinese manufacturing, I believe that the potential of that playing out in the medium term is overstated. Global supply chains are fiendishly complex and it simply takes years if not decades to mimic what is ‘the world’s most complete supply chain’.

Despite the strength of the economy, it is not all roses. Consumer spending continues to be lower than last year’s defying forecasters who were expecting it to grow.

The implications of low consumer spend reach much further than the national borders of the country. In 2008, rising spend by consumers, powered economies from Europe to Latin America. Moribund consumer sentiment could make that much harder to achieve this time.

Three factors are playing a part this time.

One, the stimulus announced by the government in the wake of COVID-19 is less than 5% of the GDP. Reckless lending fuelled by the stimulus in 2008 saddled the private sector in China with the highest debt levels in the world. There is limited capacity or willingness among the policymakers to finance another debt binge in the country.

Second, unlike the stimulus measures announced by countries such as the USA or the UK which focused on putting money in the hands of people, the Chinese stimulus has once again prioritized construction. While that is again increasing the global price of certain commodities such as iron ore, it also means that many small businesses in the country are still struggling.

Third, as China has developed, it has also become more self-sufficient in manufacturing reducing the need for imports. A great example is Huawei which was the global leader in deploying the fifth generation of telecom equipment until Trump decided to intervene. The company is still digging in and deploying their networks in large parts of the world including South East Asia.

Umm…I suppose persistence pays.

The challenge which the policymakers have in Beijing is unenviable. In the face of slowing global demand, they have decided to turn inwards to attempt to increase local household spending. While relying on the state-owned network of 130,000 enterprises in the past has yielded dividends, doing so this time threatens to tip over the debt bubble and increase the already high share of bad loans in the economy.

I will be watching how the Chinese consumers respond in the coming months, the global growth will take its cue from it.


In other news

The Chinese premier, Xi Jinping is executing probably the most ambitious economic program in the country since Deng Xiaoping who opened China to the world. Xi Jinping is mixing party control intimately with market mechanisms. It will shape the countries for years to come. I recommend this great briefing in the Economist.

The US stock market has reached its highest levels ever. Did someone say there was a global economic crisis?

Epic Games, the maker of the blockbuster franchise Fortnight, fired back at Apple after being taken down from the iOS app store after circumventing the rules which prohibit apps from soliciting payments directly from users. The response of Epic Games has to go down as among the strongest corporate burns inflicted in a long time.


That’s all for the week. If you enjoyed the post, do share it! The encouragement keeps me going. Write to me at romitnewsletter@gmail.com, Twitter, or leave a comment. Stay safe!

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