Can China meet its growth targets?

The Chinese government’s official goal is to double GDP per capita between 2020 and 2035, implying annual growth of about 4.5% between now and then.

In the past, we felt this was possible given the experience of Korea and Taiwan (see Active Strategies Outlook here and Asset Allocation Outlook here). China has followed a similar growth model and, so far, has matched their impressive growth records. When South Korea and Taiwan were at China’s level of development, they managed to grow well above 4.5% for another 15 years. However, in this piece we take another view.

By looking at the country’s various sources of growth, we find that China is in a weaker position than its peers were 35 years ago.

Past GDP growth can be broken down into the growth of production factors such as labour, capital and human capital (weighted by their income share in GDP) added to productivity gains. Productivity gains are backed out as the residual GDP growth that factors of production cannot explain. One can then make reasonable forecasts for each of these production factors and productivity to derive long-term GDP forecasts.

Starting with labour, we find that South Korea and Taiwan were in a more favourable position in the late 1980s than China is today. Their working age population was to grow by 0.8-1.2% per year for the next 15 years. By contrast, China’s working age population is forecast to contract by 0.6% per year over the next 15 years.

The accumulation of human capital will buffer the contraction in China’s labour force. Specifically, every additional year of schooling should boost the output of a given labour force by 7%. With the average Chinese student leaving school after nine years, there is still significant potential for catch-up to the 13 years of schooling observed in higher-income countries. But this does not set China apart from its Asian peers, which had similar levels of schooling in the late 1980s.

Turning to capital, we find that China has a much higher capital stock per worker than its peers had at similar levels of development. This is due to the sizeable and frequent stabilisation programmes following the global financial crisis that were usually driven by infrastructure and property investment. Going forward, we assume that China’s capital stock will re-converge with that of its peers, implying slower growth of the capital stock.

Finally, we observe that productivity growth has slowed prematurely in China. Too rapid investment bursts could have led to misallocations of capital, or easier access to credit for less profitable state-owned enterprises could have played a role — we can only hypothesise. But it is reasonable to assume that productivity growth moves sideways from here. That would bring it broadly in line with that of peers at similar levels of development.

Putting it all together suggests that China will struggle to meet the government’s 2035 growth target. We find that China would grow by 3% per year through 2035, well below the 4.5% target. Forecasting all the way to 2050 yields an annual average growth rate of 2.5%.

The key reason for China’s slowdown is overinvestment in the past, not demographics. Demographics — despite all the attention it receives — only starts to matter in the next decade and even then will shave only 0.7 percentage points off growth.

It has been said that China could moderate its growth slowdown by raising the retirement age. Indeed, the statutory retirement age is six years below the OECD average, while life expectancy is only three years lower. We would maintain that what really matters is the actual retirement age, and that is bang in line with the OECD average. Even so, if we assume for the sake of argument that China raised its retirement age by three years, this would merely add 0.3 percentage points to our baseline growth of 3%.

The global angle

How would the world look in 2035 or 2050 with China growing much slower than assumed so far? In terms of living standards, China would rival some of the poorer European countries in 2050. Its GDP per capita would amount to 70% of the Portuguese level, but still only about 30% of the US level.

By 2035, China would account for 22% of global growth, with the US and Europe accounting for another 21% and 16%, respectively. This is a significant fall from the 35% we became accustomed to in the past decade.

On this trajectory, China would only overtake the US to become the world’s largest economy around the middle of this century. This is significantly later than 2032, the point where it would do so if it met the 4.5% growth target.

By 2050, China would account for 22% of global output. This compares to an output share of 53% for the ‘West’, loosely defined as the US, EU, Anglosphere, Japan and South Korea. When this sinks in — and provided we are right — China may be perceived as less of a threat by Western policymakers.

The investment angle

How does all this influence our investment decisions? These conclusions are a reason to aim for lower medium-term exposure to China.

Recent political changes (see Xi's the one) and geopolitical tensions ( see Active Strategies Outlook here) are other considerations to factor into investment decisions.

Taken together, this helps explain our preference for lower medium-term exposure despite having a much more aggressive growth outlook for 2023 than consensus.