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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 one of the world’s foremost independent global
advisory firms, 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 Q1 2016
How well is China managing transition?
Coinciding with the start of the 13th five-year plan, the first
Economic Insight of 2016 gives us an opportunity to examine
how China is managing the transition from a growth model
focused on external trade and physical investment, to a more
balanced model with a greater role for services and consumer
spending. We find reasons to be cautiously optimistic about
China’s progress.
• A solid labour market, aided by government measures to
boost low incomes, is helping consumer spending outstrip
other parts of the economy. But more ambitious reform will
be needed to channel a larger share of income to low and
middle-income households.
• Service sectors will provide an increased share of economic
growth and job creation in the years ahead, with an
additional 4m jobs in financial and business services from
2015-2017 and almost 2m in consumer sectors.
• The manufacturing sector should continue its move up the
value chain. However, allowing market forces, rather than
industrial policy, to determine the path of development will
be key to ongoing success.
A crucial component in all of the above will be better incentives
for capital to flow to productive sectors. Property investment
is coming down, responding to large inventories of unsold
housing, while recent measures have boosted infrastructure
spending and investment in R&D. But finance continues to flow
to sectors that have little need for additional capacity.
Overall, therefore, we are confident that underlying economic
forces are pushing China towards a more sustainable growth
model. However, more can be done by policymakers to remove
barriers to this process.
A new plan – a new era for growth?
China’s growth record in recent decades has been one of the
world economy’s most impressive. But the consequences of
this record, combined with the changing global economic
environment, mean that a new economic model is needed
in China. The ‘easy wins’ of increasing market share in low
value added manufacturing are long since exhausted, while
more moderate growth rates in the advanced economies will
mean slower import demand in China’s key customers. China
will therefore need to look increasingly inward to generate
economic growth.
BUSINESS WITH CONFIDENCE
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Moreover, as the government has sought to cushion the blow
of the global slowdown of recent years, debt has accumulated
through the corporate sector. Total non-financial corporate
debt relative to GDP in China is uncomfortably high by
international standards. Much of this debt lies in sectors
where future prospects are much less promising than past
performance. As such, there is a need to ensure that moving
forwards, capital flows more to the sectors where it will be
used most productively.
Figure 1: China, outstanding debt
300
% GDP
2015 data
up to May
250
200
150
100
50
0
2007
2010
2013
Households
Financial sector
Local government
Central government
2014
2015
Non-financial corporations
Source: Oxford Economics/Haver Analytics
These are key objectives in the 13th five-year plan, which was
published in late 2015 and covers the period 2016-2020. In
this edition of Economic Insight, we look in more detail at how
China is faring in tackling these policy objectives and what
the outlook is for China’s economy as a result.
Objective 1 – increase consumption
Attention often focuses on the GDP growth targets set by
the Chinese Government. Yet rising GDP is only a means to
an end – the end, of course, being rising living standards for
the Chinese population (Chinese economic policymakers
are hardly alone in this respect). Consequently, what is more
important than simply ensuring continued growth of the
economy is to raise the share of economic activity that is
devoted to serving households. Consumer spending in China
amounts to just 38% of nominal GDP in our latest estimates,
10-20 percentage points (pp) lower than in most other
emerging Asian economies.
Figure 2: Consumer spending
Nominal consumer spending as % of nominal GDP, estimated 2015
The macroeconomic consequences of low consumer spending
and high saving are twofold. Firstly, the high volume of
household savings lowers the cost of capital, and with
restrictions on the convertibility of the Yuan, high ‘captive
savings’ result in period asset price booms and busts. Recent
gyrations in Chinese stock markets are at least partly a result
of the high degree of retail investors, who are more prone to
herd behaviour and shocks to confidence than institutional
investors. In turn, these asset price swings deepen households’
instinct for precautionary savings.
Secondly, since investment and global trade are typically more
cyclical than consumer spending, a lower role for consumption
in economic growth raises the volatility of growth and makes
economic policymaking harder.
In this context, the government is aiming to raise the share
of household income in overall GDP. Generous increases in
the minimum wage (albeit unevenly so across the country),
plus recent easing in monetary policy, have both helped to
this end. Retail sales rose 15.8% in the year to Q4 2015, the
fastest rate since mid-2011, while car sales in the same quarter
set a new record high, up 18% on a year earlier. This rise in
‘big ticket’ spending is particularly encouraging, given that
it implies consumers are confident not only about near-term
prospects, but also their longer-term financial health.
Positive as these moves are though, they have also been aided
by a strong labour market (possibly artificially so, in light of the
evident spare capacity in heavy industry) and the recent slump
in commodity prices. As a result it is difficult to be confident
that stronger consumer spending is necessarily robust to the
economic cycle.
We anticipate consumer spending to continue to grow at a
relatively healthy pace in our forecast − averaging more than
7% per year in 2016-2017, only marginally slower than the
8% average per annum in the 2013-2015 period. But this
pace of spending growth will do little to meaningfully lower
precautionary savings – we expect the household savings rate
to remain above 40% until late in this decade and decline only
modestly thereafter.
In the long run of course, a growing middle class should aid
the shift to a more consumer-led economy, as households
have more income available for discretionary purchases. But
this is a gradual process. Our estimate is that still less than half
of Chinese households have an annual income of $20,000 or
more in constant price purchasing power parity (PPP) terms.
This should rise gradually over the coming years though,
reaching 49% in 2017 and 55% by the end of the decade.
Figure 3: Household numbers by income level
80
Millions of households, income in 2012 constant PPP prices
70
500
60
Forecast
450
50
400
40
350
30
300
20
250
10
200
0
China
Korea
Thailand
Taiwan
Indonesia
India
Vietnam
Philippines
Source: Oxford Economics/Haver Analytics
Consumer spending is low relative to GDP as a result of
substantially higher household saving than in neighbouring
economies. The household saving rate has gradually trended
upwards, ever since the economic reforms of the late 1970s
which introduced the ‘Hukou’ regime that places major
constraints on access to social security and public services.
icaew.com/economicinsight oxfordeconomics.com
150
100
50
0
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
$70k+
$20-70k
$10-20k
$0-10k
Source: Oxford Economics/Haver Analytics
ECONOMIC INSIGHT – GRE ATER CHINA Q1 2 016
Ambitious reform of the Hukou system would go some way to
accelerating this shift. In particular, enabling migrant workers
to access welfare and public services in provinces other than
their own would substantially ease the need for precautionary
savings among the country’s 150m or so inter-province
migrants. The reforms of the 13th five-year plan are a modest
step in this direction, improving migrants’ access to public
services.
However, China is unlikely to have a fully-flexible system
for welfare and public service provision until there is a
better matching of the expenditure responsibilities of
local governments with their revenue raising powers −
only 32% of total local government resources are raised
locally through taxation, with the remainder coming from
central government or land sales. Uncertainty about the
dependability of these resource flows undermines provinces’
ability to extend coverage for services and welfare to large
migrant populations. Consequently there is a need to
either extend the tax-raising powers of local government,
or transfer more responsibility for spending to central
government. Such measures were conspicuously absent in the
13th five-year plan and growing local authority indebtedness
places a further hurdle to such an arrangement. As such, it
seems likely that only gradual reform of Hukou, and falls in
precautionary savings, will take place over the near term.
Firstly, service sectors are typically less capital-intensive
than primary1 or secondary2 sectors, so an increased role
for the service sector should ease the accumulation of debt
among Chinese firms. Secondly, the corollary of lower
capital intensity is of course higher labour intensity – and
as such a lower rate of GDP growth can generate the level
of job creation needed to ensure rising living standards.
Finally, a greater role for the service sector would ease the
toll that economic development in China has taken on the
environment.
Figure 4: Particulate matter 2.5, annual exposure
Micrograms per cubic metre, 2013
Coverage = all countries covered by World Development Indicators
80
China
India
60
Vietnam
40
South
Korea
Brazil
30
US
Figure 5: Employment by sector
Millions
900
Forecast
800
700
600
400
A complementary objective to increasing the role of the
consumer is to increase the importance of the service sector
in the economy. Additionally, the development of a growing
service sector has a number of other key advantages to
China’s economic development.
50
We estimate that around half of the new jobs created in
private services through the 2015-2017 period (4m of a
total 8m) will be in financial and business services, with the
remainder broadly split between distribution & hospitality
and transport, storage & communication. Overall, the share
of these three sectors in total employment in China will have
risen from below 11% in 2004 to 15% in 2014 and on to
17% by 2017 – a gradual continuation of the shift towards a
greater service sector.
500
Objective 2 – reorient towards services
70
Looking ahead therefore, we expect the service sector to
become the key driver of employment growth in China
in the coming years. From 2004-2014 manufacturing was
responsible for 47% of the increase in non-agricultural
employment in China, with private services3 generating
just 21%. For the 2015-2017 period though, these roles will
reverse substantially, with private services generating 65% of
new jobs, while manufacturing employment remains broadly
stable.
Russia
20
10
0
Source: Oxford Economics/Haver Analytics
Part of the job of increasing the service sector’s share of the
economy is being done by the market – overcapacity and
falling prices in a number of industrial sectors is slowing the
pace of growth relative to more stable service sector demand.
But government policies (set out in the five-year plan) to
open up service sectors to greater demand should also help.
These seem likely to be less controversial (relatively speaking)
than decisions to be made on the closure/scaling back of
traditional heavy industry.
icaew.com/economicinsight oxfordeconomics.com
300
200
100
0
2003
2008
Primary
Manufacturing
Financial and
Business services
Transport
2013
Construction
2017
Distribution
and Hospitality
Govt and
non-market
Source: Oxford Economics/Haver Analytics
Objective 3 – move up the value chain
A transition to a more consumer-focussed, service-driven
economy does not mean that there is no role for the
manufacturing sector, however. Manufacturing employment
is likely to remain relatively stable in China over the
coming few years, albeit at over 170m. Indeed, if China’s
manufacturing workforce were an independent nation, it
would be the seventh most populous in the world. Ensuring a
sustainable and prosperous future for the sector is, therefore,
critical to social stability.
China’s manufacturing sector will nevertheless need to adapt
over the coming years – for financial and environmental
reasons as already discussed, but also because of competition
from lower-wage economies. Recent increases have driven
minimum wages above $300 per month in some regions
and these minima have now risen between 60-100% since
2010 depending on the region. This pressurises margins of
manufacturers, undermines China’s competitive edge and
demands that China increasingly competes further up the
value chain.
One manifestation of China’s success here is in the growing
portion of components used in its factories that are
sourced in-country rather than imported. Data from the
Japanese External Trade Organisation (JETRO) for in-country
procurement for Japanese firms undertaking FDI overseas
show that China is able to provide an increasing share of
the components of manufactured goods, as well as the
manpower required to assemble them into finished goods.
The in-country content of Japanese firms’ manufacturing
ECONOMIC INSIGHT – GRE ATER CHINA Q1 2 016
output in China rose by 6pp from 2010 to 2015, compared
to stable or falling shares in most other emerging Asian
economies.
Figure 6: In-country procurement, Japanese FDI
70
clear that more could be done to remove barriers to marketdriven upskilling in Chinese manufacturing.
Objective 4 – less (and better) investment
Finally, the corollary of a growing share for consumer
spending in economic output is the need to reduce the
importance of investment from current levels (approaching
45% of GDP) to a level more sustainable from a financial and
environmental perspective. Too much of China’s investment
is still being made in sectors where there is no obvious
economic case for additional capacity; in particular in heavy
industrial firms which are financed by state banks or local
government.
%, China data refers to 2015
60
50
40
30
Figure 8: China, real estate construction and sales
20
China
2010
Thailand
Malaysia
Indonesia
Vietnam
Philippines
1,600
2014
1,400
Source: Oxford Economics/Haver Analytics
1,200
An alternative perspective is to look at the composition of
China’s exports and in particular the share of total export
value that is driven by processed goods (eg, smartphones
assembled from imported components). This share has been
falling steadily over the past decade or so, suggesting that
more of the value embedded in China’s exports is staying in
China rather than leaking out via component imports.
1,000
800
600
400
200
0
2000
Figure 7: Processed goods, % Chinese exports
70
% of total current price exports accounted for by processed goods
55
50
45
40
35
30
25
1997
Actual
1999
2001
2003
2005
2007
2009
2011
2004
2006
2008
2010
2012
2014
Sold
Source: Oxford Economics/Haver Analytics
60
1995
2002
Started
65
20
Millions of square metres
2013
2015
Trend
Source: Oxford Economics/Haver Analytics
Key to ongoing success in moving up the value chain is
that capital is permitted to flow to sectors and activities
that aid this process, discussed in the next section, and that
other aspects of government policy support market forces.
In this respect the government’s caution over levelling the
playing field between State Owned Enterprises (SOEs) and
private firms and strengthening SOEs’ budget constraints,
is a disappointment. For example, recent falls in commodity
prices have been used not as an opportunity to liberalise the
prices SOEs pay for energy, but rather to lock into cheaper
deals that ease some of the financial stress that might
otherwise have forced rationalisation.
Meanwhile the SOE reform plan released late in 2015
emphasised the role of SOEs as ‘pillars’ of the Chinese
economy, while the 13th five-year plan calls for ‘the
construction of a new industrial system’. This type of
language suggests an ongoing desire to direct the structure
of economic activity that may be at odds with the most
efficient allocation of resources.
Additionally, the insistence of the government in having
a GDP growth target (6.5% per annum for the five-year
period 2016-2020, a target we expect to be missed by 1pp
or so) raises the risk that a weeding out of spare capacity
could be deferred in the pursuit of economic expansion.
This would be a mistake in our view. Consequently, it seems
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This failure to allow market forces to rationalise such sectors
has led to a substantial increase in the exports of industrial
materials from China. For instance, the country’s steel exports
doubled in the two years to December 2015 and for 2015
overall were around 5% higher than total US demand for steel.
This surplus is being widely blamed for job losses in the sector
across the world. As a result, China faces a difficult balancing
act between the competing objectives of stability in major
industrial cities and the financial and diplomatic consequences
of failing to rationalise capacity.
Relatively speaking, much progress has been made in the
real estate sector where the pace of investment has slowed
markedly in response to ‘macro-prudential’ policy measures.
After growing by an average of 17% per annum between 2011
and 2014, real estate investment (in cash terms) was broadly
flat for 2015 as a whole and should fall modestly in 2016. In
response, the backlog of excess homes is clearly moving back
towards a level that poses less risk of damaging price falls.
We are increasingly confident that the real estate sector is
becoming less of a risk to financial stability.
Figure 9: R&D expenditure as % of GDP*
% * Malaysia data refers to 2002, 2008, 2012
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
China
2003
Korea
2008
Japan
Malaysia
Singapore
2013
Source: Oxford Economics/Haver Analytics
ECONOMIC INSIGHT – GRE ATER CHINA Q1 2 016
China is also making progress towards increasing the share of
investment spending devoted to research and development – a
further step towards moving up the value chain − as evidenced
by a target for R&D expenditure expected to reach 2.5% of GDP
by 2020. But there are question marks over how effective this
will be given the state’s role as both a financier and conductor
of research. The OECD’s economic survey for 20154 found
that ‘Chinese innovation performance is still weak in terms of
international patenting and trademark registration’ and that ‘the
bulk of university research is not relevant for business’. Measures
set out in the 13th five-year plan to improve fiscal incentives
and strengthen intellectual property laws could therefore help
improve the effectiveness of R&D.
Overall we expect a gradual fall in the share of investment in
GDP over our forecast period, from 44% in 2014 to 43% in
2015 and on to 42% in 2016 and 41.5% in 2017. But more
could certainly be done to ensure that investment spending is
optimally targeted to achieve the greatest impact on China’s
potential output.
Outlook in the wider region
At face value, a more modest pace of economic growth
in China is worrying news for neighbouring economies,
particularly Hong Kong and Macau. Certainly, the impact of
gyrations in the Chinese stock market on high-value tourism
does seem to have been a key factor in Macau’s sharp recession
in 2015, when we estimate GDP to have fallen by 20%. Looking
into 2016-17 though, we expect 5% annual growth in the
volume of Chinese tourist arrivals, sufficient to aid a modest
recovery in GDP.
Figure 11: GDP growth in Hong Kong and Macau
% change on year ago
12
10
8
6
4
2
Prospects for 2016–17
We are reasonably cautious about the degree of progress China
is making towards its new growth path. True, the importance
of both consumer spending and services sectors to overall
economic growth has increased and should continue to do
so in the coming couple of years. This should gradually mean
that growth becomes more sustainable (from a financial and
environmental perspective) and stable.
But the pace of reform remains too modest to provide a
meaningful step change in either consumer behaviour or the
degree of government control over the industrial sector. As
such, there is the risk that ‘good money follows bad’ into heavy
industrial sectors, building up financial risk for future years
(even though the property bubble seems to be being tackled
successfully).
Our forecast is, nevertheless, for services to make an increasing
contribution to overall GDP growth, although not to the extent
that the slowing contribution from manufacturing will be
offset. As a result we expect a modest slowing in GDP growth
from 6.9% in 2015 to 6.3% in 2016 and 6% in 2017. But with
a slowing rate of labour force growth and the greater labourintensity of services, this should be more than fast enough to
sustain job creation and keep unemployment from rising.
0
-2
-20%
-4
2013
Hong Kong
2014
2015
2016
2017
Macau
Source: Oxford Economics/Haver Analytics
For Hong Kong the outlook is slightly more positive in
the near term, thanks to a more diversified economy. The
labour market remains tight, supporting wage growth
and consumer spending. However, the external sector
is weakening more widely thanks to the slowing pace of
growth in China (and lower trade traffic through Hong
Kong’s ports) plus the damage to competitiveness from a
strengthening US dollar – to which the Hong Kong dollar
is pegged. Additionally, prospects of higher interest rates
to keep step with the Fed is raising concerns that property
prices may fall substantially. This could have implications for
financial stability, given that private debt relative to GDP is
the highest in the region (at over 200%).
Figure 10: Contributions to Chinese GDP growth
9
% point contribution
8
7
6
5
4
3
2
1
0
2012
2013
Manufacturing
2014
Construction
2015
2016
Services
2017
Agriculture
GDP
Source: Oxford Economics/Haver Analytics
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ECONOMIC INSIGHT – GRE ATER CHINA Q1 2 016
ENDNOTES
1 Mining and agriculture.
2 Manufacturing and (for our purposes, although not conventionally) construction.
3 Our definition of private services includes: distribution and hospitality, financial and business services, and transport,
storage and communication. We exclude construction and government/non-market from this definition.
4 OECD (2015) Economic Survey of China 2015.
For enquiries or additional information, please contact:
Juni Ngai, Director, Hong Kong
T +852 2287 7277 / 6381 1687
E [email protected]
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