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February 16, 2011 Economic development still reliant on industry for now — The global recession has revealed weaknesses in China’s growth model, which relies on exports and investment as its drivers. By ramping up domestic economic activity it is planned to make the country’s expansion less reliant on global trends. This should benefit precisely the services sectors. Economics & politics Research Briefing Structural change in China — The twelfth Five Year Plan is expected to shift the focus of economic policy in this direction. Revaluation of the yuan, higher minimum wages and state investment in the healthcare system could help strengthen the tertiary sector. However, any changes in economic policy are likely to be moderate. Especially in the Special Economic Zones, industry will remain a vital employer. — Consumer services should continue to catch up on business-related services. The rising number of people participating in the country’s prosperity, e.g. through higher minimum wages, will fuel consumer demand. Chinese economy hallmarked by industry China’s economic development as measured by its gross domestic product is still sustained primarily by industry. Exports and investment deliver the bulk of growth – and have done so for the past four decades. However, services have become steadily more important since the 1980s, bringing their share of economic output close to that of the secondary sector. Only in boom periods 1 did industry temporarily widen its lead. In 2009 the secondary sector contributed just three percentage points more towards economic output than the tertiary sector (46% to 43%), the smallest differential since the beginning 2 of China’s reforms and new policy of openness. Author Philipp Ehmer +49 69-910-31879 [email protected] Editor Tobias Just The Chinese government is aiming for a services-based economy, as this holds out the prospect of more stable growth than the present model. Services rely more heavily on domestic demand and are less susceptible to global economic fluctuations. The global recession has clearly highlighted the disadvantages of export-oriented growth. What is more, with wages rising and initial signs of stagnation in the supply of labour becoming apparent, China is increasingly forfeiting the advantage of abundantly available cheap labour on which its growth model rested. To make matters worse, trade partners are putting pressure on the Chinese government to revalue its currency because they believe the yuan is undervalued and view this as an export subsidy. Protectionist retaliation is further jeopardising the Chinese growth model. Technical Assistant Sabine Berger Deutsche Bank Research Frankfurt am Main Deutschland Internet: www.dbresearch.com E-mail: [email protected] Fax: +49 69 910-31877 Managing Director Thomas Mayer 1 2 A slowdown in the pace of structural change in boom periods and acceleration in cyclically slack periods is typical of the transformation to a services society, see Ehmer (2009). Crisis year 2009 accelerating pace of structural change in Germany. Deutsche Bank Research. Talking Point. August 20, 2009. However, in terms of employment China’s economy still bears an agricultural stamp. In 2009 the primary sector employed 38% of the labour force; services accounted for 34% and the secondary sector a scant 28%. The discrepancy between economic performance and employment in the various sectors points up the productivity gains in the course of structural change. Research Briefing Industry-driven growth Clear industrial focus in comparison to other emerging markets Contribution to GDP growth, pp 53-59 60-69 70-79 80-89 90-99 00-09 Primary Secondary 9 8 7 6 5 4 3 2 1 0 Tertiary Source: CEIC 1 Industry-based economy Sector shares in China, % of GDP 60 50 40 30 20 10 50 60 70 Primary 80 90 00 Secondary 10 0 Tertiary Source: CEIC 2 Different economic structures Sector shares, % of GDP 60 50 40 30 20 10 0 Secondary Tertiary Secondary Tertiary BRI C(hina) 1990-1999 2000-2009 Source: EIU 3 The Chinese economy is following the pattern of development in the West. Here, too, industrialisation preceded the step to a service society. Similarly, the process of tertiarisation in China only got underway as per capita incomes started to rise. However, China’s development path differs from that in other emerging markets, where services played an important part very early on and where it was often the case that industry at no time generated the lion’s share of economic output. In Brazil, India and Russia, for example, in 2009 manufacturing industry accounted for a weighted average of just 30% of GDP. While the agricultural sector is similarly important to that in China, services in these countries dominate the economy (62%) – and have done so for more than 20 years. In contrast, China stands for a strong industrial sector as the “workbench of the world” and world export champion. Why do services in China not yet enjoy the same status as industry? China’s economic pattern stems less from a weakness in the services sector than from the headlong pace of industrialisation. Industrial growth was fostered chiefly by the intensification in world trade and the international division of labour triggered by globalisation. However, over the past three decades services have caught up in importance, expanding by an average of 19% p.a. – roughly three percentage points faster than the secondary sector. The marked industrial focus relative to other emerging markets can be explained first by China’s economic policy. In the past the government prioritised the development of industry. The wide variety of support mechanisms it used to further this aim ranged from subsidised loans for state-owned enterprises through export subsidies, import controls and support with foreign investment to Special Economic Zones and industrial parks featuring tax or customs incentives. Secondly, the competitive pressure in some Chinese markets is relatively slight by international standards as they are still dominated 3 by state enterprises. These markets lack the compulsion to operate efficiently which elsewhere causes businesses to outsource activities that extend beyond their own core competencies, thereby shifting them into the marketplace. In other newly emerging economies specialist service providers, for example in IT, accounting and consultancy, take over work of this kind. Such outsourcing increases the share of value creation attributed to the tertiary sector, boosting structural change statistically. What is still missing for a service economy? Higher income in urban areas Per capita incomes in China, RMB '000 20 16 12 8 4 85 89 93 Urban 97 01 05 09 Rural Source: CEIC 2 0 In comparison to more mature economies there is also a lack of stimulus from the demand side. Consumer goods in more advanced economies are characterised by market saturation, causing consumer spending to turn to services with higher saturation levels. Although per capita incomes in China are rising exceptionally fast particularly in urban households, there is still pent-up demand for consumer goods among broad sections of the population, especially 4 outside the metropolitan centres. 3 4 4 For example the financial and telecommunications sectors. State enterprises enjoy massive financial support, among other things. See Dyck (2010). China’s provinces. Digging one layer deeper. Deutsche Bank Research. Current Issues. Frankfurt am Main. 16 February 2011 Structural change in China Unsaturated goods markets Durable consumer goods per 100 urban households in China, 2008 70 60 50 40 30 20 Coast North South Centre North-east West 10 Sources: China Statistical Yearbook, DB Research 0 5 Low education level Level of education completed in 2008, % of population No education or primary education Secondary education Tertiary education 0 OECD 20 40 60 China Sources: OECD, CEIC 6 Outlook: Service economy will still take time The factors that drive the development of Western service societies are also intact in China, yet for the present the People’s Republic is likely to remain an industry-based economy. This is suggested, first, by the extensive investment in manufacturing capacities and, second, by the people’s level of education. Whilst progress has been made in latter years, the population in general is not yet sufficiently educated to carve out a services sector along Western lines. There, knowledge-intensive business services like contract logistics and product development are extremely important, whereas in China simple services such as in the retail trade or the hotel and restaurant industry are still predominant. Even so, the country’s comparative advantages are shifting. So far, massive inflows of capital have enabled the modernisation of production plants, bringing a rapid boost to productivity. As a result China has won out against rival emerging markets as a centre of industry. But as per capita incomes and labour costs in the Middle Kingdom escalate, so other countries will become more attractive as manufacturing locations for low-end products. However, in recent years the improvement in the general level of education has broadened the range of goods that China is able to offer. Increasingly – often with help from foreign companies – more sophisticated, capital-intensive goods are being produced (e.g. semi-conductors). Whilst China’s transformation to a service economy will still take time, given the rapid pace of development in the tertiary sector it will predictably become the economic heavyweight within the next ten years. Going by developments over the past decade, it could even achieve this by 2015. Owing to the global recession, however, the importance of services relative to industry is overstated for 2009. In 2010 the pattern will presumably have reverted to a slight edge for industry, implying that the tertiary sector may have to wait until 2020 (at the latest) before gaining ascendancy in the economy. China’s demographic situation is working in favour of structural rebalancing, because expenditure by older people concentrates on services – with the healthcare system as an example. Twelfth Five Year Plan likely to refocus economic policy Ageing population Shares of population in China, % 60 50 40 30 20 10 1950 1970 1990 0-19 40-59 2010 2030 0 2050 20-39 60+ Source: UN 7 But the main argument for accelerated tertiarisation is a refocus of economic policy. The twelfth Five Year Plan covering the period 2011 to 2015 will presumably strongly prioritise the development of 5 services. This has the twin aims of making present capital-intensive economic growth more labour-intensive and putting more people in work, while consumption is to take over from exports and investment as the growth driver. There are various ways of achieving this: 6 First, minimum wages were already ramped up massively last year. A further increase is likely and should stimulate private consumption. Second, the government has announced greater commitment to the healthcare system. In 2011, for example, 90% of the Chinese popu7 lation are to be covered by health insurance schemes. Overall, these measures should lower China’s extremely high savings rate. At the same time policy-makers plan to urge companies to retain less of their earnings and pay higher dividends, which will reduce 5 6 7 16 February 2011 See Ma et al. (2011). China: Themes and Strategy for 2011. Deutsche Bank. Minimum wages are set decentrally. In 2010 most provinces raised minimum wages – the capital Beijing by 20%, for example. With this move policy-makers are looking to narrow the income differentials in the population. See Hansakul/Huelser (2010). Reforming China’s healthcare system necessary for growth rebalancing. Deutsche Bank Research. Talking Point. July 5, 2010. 3 Research Briefing China revaluing since 2005 Exchange rate RMB/USD 8.5 8.0 7.5 7.0 6.5 00 02 04 06 08 10 Source: Global Insight 6.0 8 Soaring export growth China's exports of goods, USD tr 50 60 70 80 90 00 09 Source: WTO 1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0 9 Third, revaluation of the currency should check the build-up of industrial capacities. A measure of this kind would heighten competitive pressure and compel industrial enterprises to improve efficiency. More outsourcing would presumably increase the weighting of services relative to manufacturing industry and lead to the creation of 8 new jobs in the tertiary sector. Revaluation could also resolve the currency dispute with the US and head off a protectionist reaction. The Chinese government has already announced a moderate appreciation in the coming years. The next Five Year Plan will be published this March. It is expected to contain suitable measures to speed up structural rebalancing. However, policy-makers will presumably make cautious use of the instruments since overly rapid appreciation of the currency, for example, could choke off the export-driven upswing. There also exists a danger of subsidising low-productivity services sectors (such as retail trade or hotels and restaurants) at the expense of 9 more productive branches of industry. Industrialisation of the West Transformation into a service society should make China less susceptible to fluctuations in the global economy. In terms of income distribution, however, we do not expect any positive effect, as providers of both consumer and corporate services can be expected to set up in what are already comparatively well developed regions. This means new jobs will be created mainly in the urban agglomerations. By deliberately establishing industrial parks in structurally weak regions, the government was still able to check this geographic concentration. In the past 20 years industrialisation in China has thus developed steadily westwards. It is, however, questionable whether service providers such as transport operators or communications service providers can be located effectively in the hinterland. Moreover, knowledge-intensive services lack highly skilled staff there, as a result of which many of the business parks created by the government will remain reliant on basic manufacturing jobs. Structure of Chinese services sector Percentage of value creation, 2009 19.6 39.4 demand for capital goods. Higher expenditure on education could further help to put better institutional arrangements in place for the provision of complex, knowledge-intensive services. 4.8 Secondary sector share (1990) 11.6 12.6 12.0 > 50% Trade Hotel and restaurant trade Transport & telecommunications Financial services Real estate Others Source: CEIC < 50% < 40% < 30% 10 Source: Deutsche Bank Research 8 9 4 n.a. See N’Diaye (2010). Transforming China: Insights from the Japanese experience of the 1980s. IMF Working Paper No. 10/284. See Qin (2004). Is the rising Services Sector in the People’s Republic of China leading to Cost Disease? Asian Development Bank. ERD Working Paper No. 50. 16 February 2011 Structural change in China Secondary sector share (2009) Intra-sectoral shift Percentage of value creation, 2009 36.3 39.4 100 80 > 50% 9.8 7.6 60 12.6 12.0 40 4.8 11.6 4.8 20 19.7 19.6 21.7 1980 Source: CEIC 11 Financial services expand, ... Average growth, % p.a. Financial services Real estate Others 1980-2009 Trade Transp. & telco. 10 15 20 25 30 35 1990-1999 2000-2009 Sources: CEIC, DB Research 12 ... but growth highly volatile Growth / standard dev., 1980-2009 Others Transp. & telco. Real estate Hotels & restaurants Financial services Trade 0 1 < 30% Source: Deutsche Bank Research n.a. Intra-sectoral structural change Trade Hotel and restaurant trade Transport & telecommunications Financial services Real estate Others 1980-1989 < 40% 0 2009 Hotels & restaurants < 50% 2 Source: DB Research 3 13 What is more, structural change is altering the pattern of industry within the tertiary sector. Over the past 30 years the financial and real estate sectors have expanded most. In the recent past other services, which include the state administrative, health and education sectors as well as corporate services, have been the most dynamic. In some sectors, however, the rapid growth has been extremely volatile, with particularly marked fluctuations in the retail and wholesale trade and the financial services sector, where years of strong growth were followed by some serious setbacks (e.g. in the financial sector towards the end of the 1990s). State services, on the other hand, have turned in more regular expansion. Amid robust global economic activity and uneven income distribution, up to the end of 2007 corporate services gained in importance over retail services. Nonetheless, services geared mainly to consumers, such as the retail trade or hotels and restaurants, are still disproportionately strongly represented in China in comparison to a developed economy such as Germany. Whereas these two sectors contribute a quarter of value creation in the Chinese tertiary sector, in Germany they account for a mere 17%. On the other hand, knowledge-intensive corporate services in, say, IT or advertising, are underdeveloped in China. For the coming years we expect broad growth, from which many services segments could benefit. With policy-makers aiming for fairer distribution of incomes and using higher minimum wages as one way of achieving this, an increasing number of Chinese are likely to participate in the country’s prosperity, creating demand for consumer services. State commitment and demographic change suggest that the healthcare system in particular will notch up aboveaverage growth. On the whole, consumer services should gain in importance relative to corporate services, as the additional consumer spending encouraged by rising incomes is likely to exceed the expansion in demand for business services due to increased outsourcing. Philipp Ehmer (+49 69 910-31879, [email protected]) © Copyright 2011. Deutsche Bank AG, DB Research, D-60262 Frankfurt am Main, Germany. All rights reserved. When quoting please cite “Deutsche Bank Research”. The above information does not constitute the provision of investment, legal or tax advice. Any views expressed reflect the current views of the author, which do not necessarily correspond to the opinions of Deutsche Bank AG or its affiliates. Opinions expressed may change without notice. Opinions expressed may differ from views set out in other documents, including research, published by Deutsche Bank. 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