Sustainable Growth Ahead: No Bubble or Bust for China
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No bubble, no bust
What is missing from the chart above is the sort of exponential growth that typically characterises a bubble, after which there is then a catastrophic drop as participants realise that the “Emperor” has no clothes after all. China has had occasional and short-lived periods of excessive property price growth in the past, that is all. What follows is likely to be a period of much slower property price growth or even some slight declines. From an aggregate point of view, that is neither particularly worrying nor all that undesirable.
Turning now to the equity markets. If we superimpose the recent price developments of the Shanghai composite index onto the Tokyo stock exchange in the period running up to the bubble, what we see is that China’s stock market has for some time been extremely average. There is no sense at all here of an excessive surge that requires a long period of dismal performance to compensate. That’s not to suggest a particularly bright future for Chinese stocks, but it beats a Japan-style collapse.
China's stock market performance has been moribund
Growth will be slower, but more sustainable without a construction boom
Ruling out a deflationary collapse is clearly a positive standpoint. But we also don’t see Chinese growth at much more than 5% over the coming few years. And we have a tough time explaining to people why this is actually a perfectly reasonable growth rate which doesn’t require a panicked response. But here goes…
In previous years, China’s GDP growth had taken a disproportionate boost from property development. Not only does construction provide a substantial direct boost to activity and labour demand, but it also requires a lot of inputs from industry: cement, steel, copper, aluminium, PVC etc. That also provides a big boost to things like energy demand. And new property sales also require furnishings, and that in turn pushes up this aspect of retail spending.
But the amount of growth that construction was delivering to the economy had grown to totally unsustainable levels. In some years, in nominal terms, construction contributed up to almost three percentage points of total GDP growth, often about a third of the total.
Contribution to Chinese nominal GDP growth from construction
Disaster potentially averted...
To try to highlight how anomalous this was, if you look at average Asian GDP growth rates pre-Covid relative to GDP per capita, China was a huge outlier, growing several percentage points faster than you would expect for an economy of its state of development. And that deviation can be largely put down to growth generated by excessive construction activity. This was essentially construction-driven GDP “bought” with debt and ultimately, unsustainable.
Maintaining this sector at pre-Covid growth rates could have ended up in disaster. Maybe a Japan-style disaster. What the Chinese authorities have done, quite sensibly, is to nip this in the bud before this happens, though this of course is going to mean reversion to slower (more sustainable) growth rates that are more in line with an economy of China’s stage of economic development.
The property development sector is currently being kept on life support – allowed just enough access to credit to finish the vast stock of unfinished properties which they have sold in advance to a quite understandably nervous household sector. It is unlikely that they will embark on much in the way of new investment until this process is complete. And it is also not clear that Chinese household’s love for property as an investment asset will rapidly, or fully recover after this experience.
So if we can no longer rely on construction to power the economy ahead, then growth will likely average something closer to 5% than the 6-8% China averaged pre-Covid. And in our view, that is surely superior to faster debt-fuelled property-led growth for a few years, followed by a Japan-style collapse. Because while China’s current situation is far from that of Japan in 1990, that is not to say that that future could not have happened if things had run on unchecked as before.
GDP per capita and average GDP growth rates for Asia
