China: Searching for a new equilibrium
By Michael Hasenstab, Ph.D., Chief Investment Officer, Templeton Global Macro
We find that most observers tend to fall into one of two camps on China: the die-hard skeptics and the perma-bulls. The skeptics are convinced that nothing about China—from the data to the banking system to the demographics—bears close inspection.
This school of thought argues that the official numbers are too unreliable to follow, and the imbalances too large to warrant detailed analysis. Skeptics envision an implosion of the Chinese economy, resulting from a bubble in the housing market, in local government debts, in the stock market—or frequently in all three. In their view, the collapse is impending, and has been for the last 10 years.
The smaller group of China bulls takes an extremely benign view of the country’s transformation. This group expects the China growth miracle to continue smoothly, with any moderation lasting only temporarily. This camp tends to shrug off concerns about imbalances, arguing that China has more than enough money, the right policies in place and an unparalleled control over its economy.
We try to take a few steps back and provide an objective assessment of where the Chinese economy currently stands, where we see it going and what risks we foresee in the period ahead.
We take a more nuanced and balanced view than either the die-hard skeptics or the perma-bulls. On balance we remain optimistic about China’s outlook, but we recognize that the country faces formidable policy challenges and substantial risks that bear close monitoring.
China today has reached a crucial juncture in its ongoing deep economic transformation. Its three traditional engines of growth have all stalled at the same time: The real estate sector is contracting after a protracted boom; local governments needing to deleverage have scaled back their investment; and many components of the manufacturing sector have been shrinking.
However, growth in consumption driven by rising wages, growth in the service sector and new infrastructure investments work to offset the simultaneous contraction of these other three sectors. The manufacturing contraction has been triggered by the Lewis turning point: a demographics-driven deceleration in labor force growth, which has boosted wage pressures, undermining the competitiveness of traditional export-driven manufacturing.
The slowdown in labor force growth, however, means fewer jobs are needed to maintain full employment: an estimated 3 million per year compared to a previous peak of 12 million. The faster growth of the service sector, which has taken over from industry as the leading job creator, should be enough to provide them. Therefore, the contraction in manufacturing, real estate and local governments has not caused an increase in unemployment—which would pose a thorny social and political problem.