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Economic Insight: Greater China Welcome to ICAEW’s Economic Insight: Greater China, the quarterly forecast for the region prepared directly for the finance profession. Produced by Oxford Economics, ICAEW’s partner and acknowledged expert in global economic forecasting, it provides a unique perspective on the prospects for Greater China as a whole and for the region’s individual countries. We focus on Greater China as being mainland China, Hong Kong and Macau. Quarterly briefing Q2 2016 This issue of Economic Insight: Greater China provides insight on the dynamics of productivity growth in the Chinese economy. We focus on China given its weight in the region.1 Is China’s productivity surge in the past? Key findings • China’s economy delivered impressive gains in productivity through 2000–2015, three times as fast as the ASEAN average. But comparing China’s performance to the transition path of Japan and Korea in past decades is a more appropriate benchmark. China’s productivity performance since 2005 is well aligned with Japanese productivity growth from 1960 onwards, and Korean productivity growth from 1980. • Productivity growth is expected to ease in the 2016–2020 period, as capital investment slows. But nevertheless the mechanisation of agriculture, diversion of investment towards more profitable manufacturing sectors, and increasing role for higher value-added services, should support productivity growth. We also assess latest economic developments in China and the wider region, including Hong Kong and Macau. • Recent stimulus measures in China have supported a recovery in real estate investment, as well as spurring long-term infrastructure development. An expansionary fiscal stance has also supported household spending in the first half of 2016. As a result, we have revised upwards our forecast for Chinese GDP growth from 6.3% to 6.5%. • However, we continue to expect a gradual slowing in GDP growth over the next few years as the economy rebalances. China’s transition from an export and investment-led model of growth towards consumer spending and more service sector activity remains the priority. An impressive productivity performance China’s entry into the global economy, accession to the World Trade Organization and integration into world supply chains, has yielded a rapid increase in productivity in recent decades. Output per worker has risen an average of 9% per year from 2000 to 2015 (see figure 1), increasing the level of output per worker 260% over the same period. This is BUSINESS WITH CONFIDENCE icaew.com/economicinsight three times as fast as other emerging market regions such as ASEAN or Central and Eastern Europe. Elsewhere in the region, Macau’s output per worker has increased by an impressive 5.4% per year over the same period. Hong Kong delivered a productivity performance within the range of other emerging Asian economies – at 2.5% per year productivity growth was 0.5 percentage points (pp) slower than the ASEAN average, but 0.5pp faster than in Malaysia and 1pp faster than Singapore. Figure 1: Emerging markets’ productivity performance % average annual growth in GDP per worker, 2000–2015 10 8 4 2 China Macau ASEAN Africa Central and Eastern Europe Hong Kong Turkey Middle East Latin America 0 Figure 3: Contributions to Chinese productivity growth % 12 Source: Oxford Economics/Haver Analytics Output per worker in China in 2000 was just $1,700 – around half the level of the Philippines or Thailand at the time, and a fraction of the output per worker in Malaysia and Singapore. As such, there was massive scope for catch-up growth versus higher-income economies. China’s performance is comparable with the rate of economic development seen in Japan and Korea as they industrialised (see figure 2). Japan also experienced double-digit productivity growth through much of the 1960s, and Korean productivity growth was only slightly lower during the 1980s. In both economies output per worker growth eased in subsequent decades as the early gains from urbanisation, switchover from agriculture to manufacturing and integration into world supply chains are absorbed. This is the phase China now appears to be entering. Figure 2: Chinese productivity – historical comparisons % annual growth in output per worker 16 China, 2005 onwards 14 Korea, 1980 onwards 12 Japan, 1960 onwards OE forecast 8 6 4 2 0 -2 -4 4 7 10 13 16 19 22 25 28 Sectoral shift Sectoral productivity growth TFP 10 Capital Accumulation 8 6 4 2 0 2000–2005– 2006–2010 2011–2015 2016–2020 Source: Oxford Economics/Haver Analytics However, measurement of China’s physical capital stock is notoriously difficult, and different studies have as a result produced very widely varying estimates of TFP growth.2 As such, an alternative means is to examine sectoral allocation of workers and break down overall productivity growth into a contribution from sectoral shift and growth in output per worker within each industry. In this case, there is a contribution of around 1.5–2.5pp from shifting workers into higher value-added sectors, and 6-8pp per year from productivity growth within sectors. This sectoral productivity growth incorporates both TFP and capital deepening elements within a given sector. Once sectoral shift is complete, this component is likely to be the principle driver of overall productivity growth. 10 1 Capital accumulation has contributed a relatively stable 5pp or so per year to output per worker growth in China through the past 15 years, with larger variations in TFP – from as much as 5pp in 2006–2010 to 1.7pp in the most recent five-year period. Looking ahead, our forecast assumes a relatively modest pace of TFP growth, contributing around 1.2pp per annum to overall productivity growth in the coming five years. Similarly, the degree of spare capacity in many manufacturing sectors, and a greater role for less capitalintensive service sectors will mean slower growth in the capital stock. This means the contribution to productivity growth from increased capital per worker will ease to 4.4% per year during the 2016–2020 period, 1.4pp slower than in 2011–2015. 6 -2 contribution to worker productivity of changes in the level of capital (ie, machinery) available for each worker, and improvements in total factor productivity (TFP) ie, the efficiency with which labour and capital are combined. TFP is driven by a range of wider economic and social factors, including worker skills, the flexibility with which businesses can operate and deploy workers, and the environment for innovation and research. We will explore these drivers in more detail in the next edition of this report. 31 34 37 Years from starting point Source: Oxford Economics/Haver Analytics China’s rapid growth has been facilitated by high levels of investment, peaking at 45% of GDP in 2013 and only easing by around half a percentage point of GDP since. Figure 3 shows a ‘growth accounting’ perspective of China’s productivity growth, which separates the icaew.com/economicinsight oxfordeconomics.com 40 Looking forward, there seems less scope for contribution from sectoral shift at a broad level. An ever-increasing share of China’s remaining rural population is aged above 40, meaning less scope for migration. In any case China will still need a substantial agricultural workforce to feed its (still growing) population. Plus, of those migrants that do make the switch to the city, an increasing share will be employed in service sectors, which although still far more productive in level terms than primary sectors (defined as agriculture, forestry and fishing), generate around 40% less output per head than manufacturing (see figure 4). ECONOMIC INSIGHT – GRE ATER CHIN A Q2 2 016 Figure 4: China sectoral productivity levels and growth Annual average % growth, 2000–2015 120 9 8 100 7 6 80 5 60 4 40 3 2 20 1 0 Primary Secondary 0 Tertiary Source: Oxford Economics/Haver Analytics Looking ahead therefore, with less gain from sectoral shift, prospects depend more heavily on productivity gains within broad economic sectors – agriculture, manufacturing and services. Supporting ongoing productivity in the manufacturing sector will also be crucial. Much of the sector’s productivity gains in recent years came via substantial capital investment, particularly in heavy industrial sectors. But with excess supply in many of these industries, capital spending needs to be redeployed towards more profitable sectors. This seems to already be happening. Figure 6 shows average changes in investment spend for Chinese heavy industry and manufacturing sectors through 2014–2015 and the corresponding profit ratio for the sector in 2014, the latest point for which data are available. During this period, more profitable sectors were attracting higher rates of investment growth – an encouraging development. And in light of the slump in commodity and steel prices, it seems likely profit margins in these sectors will have fallen further through 2015 and into 2016. Figure 6: Investment and profitability in Chinese industry 30 As the red markers in Figure 4 show, China’s agricultural sector has achieved impressive efficiency improvements in recent decades, and is well ahead of many other emerging market economies in some measures of productivity. Average cereal yield per hectare in China is currently just over 5,000kg, around 1,000kg higher than in Latin America. Moreover, the yield of Chinese farms looks to be well correlated with performance in the US, allowing for a 10-year lag (see figure 5), suggesting further gains in the years ahead. Sustaining this productivity performance is critical to ensuring continuity in domestic food supply that has long been a key policy goal for successive Chinese governments. China will need to feed a still-growing population with a shrinking agricultural workforce. Cultural and sports items 25 Average growth in investment 2014–2015 Thousand yuan per worker 2015, 2005 prices Furniture Printing and recording Clothes 20 Food 15 Pharma Non-metallic minerals Computers 10 Instrument & Meter Chemicals 5 Chemical fibres 0 Paper making Other metal extraction NF metal processsing -5 Fuels -10 -15 Ferrous metal processing 0 Ferrous metal extraction Coal extraction 2 4 6 8 10 Profits as % of sales revenue, 2014 Figure 5: Agricultural productivity in China and the US Source: Oxford Economics/Haver Analytics Cereal yield per hectare, thousand kilogrammes But it will require substantial political commitment to allow spare capacity in heavy industry to close down. There are signs that in some regions, part of the lending triggered by recent stimulus measures has found its way into sectors with spare capacity. If productivity growth is to be sustained in manufacturing in the years ahead, it will be important for firms in profitable sectors to have the access to capital and workers they need to expand in the years to come. Given the increased role household spending will play in economic growth, this will be especially pertinent for consumer-facing manufacturers. 8 China, lagged 10 years 7 US 6 5 4 3 2 1 1961 1966 1971 1976 1981 1986 1991 1996 2001 2006 2011 Source: Oxford Economics/Haver Analytics Facilitating the mechanisation of agriculture is a key priority for the 13th five-year plan, covering the period 2016–2020, aided by (as yet relatively unclear) plans for land reform. A key feature of monetary stimulus in recent months has therefore been targeted lending towards the sector, building on progress made in compiling a credit register of farmers in the past few years. Lending by the Agricultural Development Bank of China rose by $60bn in the first quarter of 2016, twice as fast as during the same period of 2015. So while demand of investment goods for manufacturing or residential construction may grow less quickly than in recent years, demand for capital in the agricultural sector could in fact grow more strongly, providing opportunities for both domestic and overseas producers of such goods. icaew.com/economicinsight oxfordeconomics.com Finally, sustaining growth in service sector productivity will require creation of higher value-added service sector roles. Data on employment by detailed service sector in China is only available for urban workers (output data is only available for the whole economy), making comparisons of productivity across the service sector impossible. Nevertheless, growth in high value-added sectors suggests productivity growth in the service sector as a whole should also be rising. Around 30m new service sector jobs were created in China from 2003–2014, and the share of total service employment in finance, real estate, business, science and IT has risen from 17% to 24% over the same period (see figure 7). Sustaining this job creation in higher value-added sectors will rely on a range of productivitysupporting factors though, in particular ongoing improvement in training and education to enable firms to find the skilled workers such positions need. ECONOMIC INSIGHT – GRE ATER CHIN A Q2 2 016 Figure 7: Service sector employment Figure 9: Social financing in China % of total urban service sector employment % of GDP, 3 month moving average 100 60 80 50 Total social financing ex equity and other Bank lending Shadow banking (Oxford Economics) 60 40 40 30 20 20 0 2004 2006 2008 2010 Finance, real estate and business, science and tech, ICT 2012 Transport, consumer 2014 10 Public, other 0 2012 2013 2014 2015 2016 Source: Oxford Economics/Haver Analytics Source: Oxford Economics, CEIC Data Nevertheless, across sectors productivity performance is likely to be somewhat weaker in the coming 5 years than the average of the past 15, consistent with the continuation of the ‘catch-up’ pattern illustrated in figure 2. Within this, productivity growth in industrial (ie, secondary) sectors will slow most, as capital investment is slower than in past decades. Productivity in the primary and tertiary sectors, where it is harder to argue there has been excessive investment, should be more robust. Figure 8: Sectoral productivity forecasts For now, it looks as though the recovery in price growth (see figure 10) remains relatively contained to Tier 1 cities (Beijing, Shanghai, Guangzhou and Shenzhen). As such, for now there seems less reason to worry about the sustainability of China’s property market than during previous episodes of investment growth. Figure 10: House prices in Chinese cities % change, month on month 4 First tier cities Second tier cities Third tier cities % growth per year 2000–2015 9 2016–2020 3 8 2 7 6 1 5 4 0 3 2 -1 1 0 Primary Secondary Tertiary Source: Oxford Economics/Haver Analytics -2 2011 2012 2013 2014 2015 2016 Source: Oxford Economics/Haver Analytics Latest China economic outlook As part of efforts to diversify the economy, as well as support activity during a period of weak global trade, the Chinese Government set out ambitious targets for lending growth. This led to a surge in borrowing, among agricultural firms as already noted, but also for other forms of fixed investment (see figure 9). Both traditional bank lending and ‘shadow banking’3 were part of this pickup, and the overall ratio of social financing to GDP rose to its highest rate since 2013. However, some of the pickup in credit has found its way into the property market – residential sales were up sharply, as more worryingly was the area of new residential property under development. This has supported activity across the industrial sector, particularly in construction materials. It will be important for the government to ensure this rebound remains sustainable for two reasons. Firstly, averting price bubbles and the consequent risks to financial stability. As important, though, is the need to ensure market signals to the heavy industry sector about the need to cut capacity are not blurred by periods of temporarily higher demand. icaew.com/economicinsight oxfordeconomics.com The other main beneficiary of renewed stimulus has been investment in infrastructure. Fixed asset investment in infrastructure grew by 21% in the year to March. However, along with the measures to support workers affected by industrial job losses, this has meant a substantial increase in the public deficit, approaching 4% of GDP in the first half of 2016. Consumer spending has also held up well in recent months and should continue to provide a key growth driver in the near term. Weakness in energy prices, otherwise subdued inflation and ongoing wage growth and service sector job creation, have supported household spending through the first quarter. Retail sales were up 9.8% on a year earlier in Q1, while car sales (to dealers) were up 9.7% in the year to March. This was an encouraging sign of resilience given the volatility in global financial markets. We have revised up our forecast for GDP growth in 2016 from 6.3% in our last report to 6.5% in this edition. However, the support from the most recent bout of stimulus will fade through 2016 and into 2017, and as such the pace of growth is likely to slow (barring further ECONOMIC INSIGHT – GRE ATER CHIN A Q2 2 016 such measures). We continue to expect GDP growth of just about 6% per annum in both 2017 and 2018, easing further thereafter. Within this, consumer spending growth should remain a key driver, with public spending and investment making decreasing contributions to growth in later years. Figure 11: Contributions to GDP growth in China Percentage point contribution to GDP growth 20 15 Forecast 10 Greater China economic outlook The resilience in Chinese activity does not yet seem to be spilling over to the wider Greater China region though. Hong Kong has continued to lose economic momentum in the first half of 2016, with merchandise exports falling for an 11th consecutive month in March 2016, and the Purchasing Managers’ Index4 falling to 45.5 – a seven-month low. Falling tourism and concern over domestic economic activity have driven a sharp fall in retail sales, down 12% on the year in January and February. Owing to this weakness in Q1 2016 we have revised down our forecast for GDP growth in 2016 by 0.3pp to 1.3%, with 2.2% now expected for 2017. Net exports Private consumption Investment Macau suffered after a 20% contraction in 2015, thanks to a confluence of several damaging one-off factors impacting the tourism sector. These included the easing of visa regulations for Chinese tourists visiting other parts of Asia, the introduction of a smoking ban in casinos, and strict new anti-corruption and money laundering regulations in China. With these factors unlikely to reverse we view the contraction of 2015 as a level shift. As such we expect only the most modest rebound in 2016, with GDP growing by 2%, picking up to 4.4% next year. Public consumption Stockbuilding GDP (% year) Figure 12: GDP growth in Greater China region 5 0 -5 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 Source: Oxford Economics/Haver Analytics Even this pace should be more than enough to spur sufficient job creation to absorb new city-dwellers and those facing job losses in manufacturing, as long as the right support for redeployment and retraining is provided. 12m new jobs were created in net terms in 2015, and rebalancing toward less capital-intensive service sectors will mean growth becomes increasingly ‘job-rich’ in the years ahead. But it may not be sufficient to meet the government’s target of doubling the level of real GDP between 2010 and 2020, set out in October 2015. This only seems likely with further stimulus, which could in turn undermine the pace of rebalancing and accentuate the risk of bad debt accumulating in the property and industrial sectors. icaew.com/economicinsight oxfordeconomics.com % 10 5 0 -5 2015 2016 2017 -10 -15 -20 China Hong Kong, China Macao, China Source: Oxford Economics/Haver Analytics ECONOMIC INSIGHT – GRE ATER CHIN A Q2 2 016 ENDNOTES 1 IMF estimates of US$ GDP for 2015 indicate that China accounted for 97% of GDP across the three economies. 2 For example, the Asian Development Bank found that average TFP growth from 1980 to 2010 was around 4% per annum, while the Chinese Centre for Economics and Business estimates TFP growth for 1977 to 2012 at just 1% per annum. 3 Financial intermediation outside the traditional banking sector. This includes a number of different types of instruments, including: corporate-to-corporate loans (otherwise known as ‘entrusted’ loans), letters of guarantee (known as ‘bankers acceptances’), trust loans (in which a trust company intermediates between a borrower and investor for a fee), and corporate bonds. 4 A widely-watched measure of business activity, with 50 indicating flat output, above 50 indicating expansion and below 50 indicating contraction. For enquiries or additional information, please contact: Juni Ngai, Director, Hong Kong T +852 2287 7277 / 6381 1687 E [email protected] Oxford Economics Oxford Economics is one of the world’s foremost advisory firms, providing analysis on 200 countries, 100 industries and 3,000 cities. Their analytical tools provide an unparalleled ability to forecast economic trends and their economic, social and business impact. Headquartered in Oxford, England, with regional centres in London, New York, and Singapore and offices around the world, they employ one of the world’s largest teams of macroeconomists and thought leadership specialists. ICAEW is a world leading professional membership organisation that promotes, develops and supports over 145,000 chartered accountants worldwide. We provide qualifications and professional development, share our knowledge, insight and technical expertise, and protect the quality and integrity of the accountancy and finance profession. As leaders in accountancy, finance and business our members have the knowledge, skills and commitment to maintain the highest professional standards and integrity. Together we contribute to the success of individuals, organisations, communities and economies around the world. Because of us, people can do business with confidence. 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