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economic Insight
Greater China
Quarterly briefing March 2012
A decade of Chinese growth
that changed the world
Welcome to the first issue of ICAEW’s Economic
Insight: Greater China, a quarterly forecast for
the region prepared directly for the finance
profession. Produced by Cebr, ICAEW’s partner
and acknowledged expert in global economic
forecasting, it provides a unique perspective on
the prospects for Greater China over the coming
years. In addition to Mainland China, we also focus
on the Hong Kong and Macau Special
Administrative Regions.
Since the financial crisis, the Middle Kingdom has
taken centre stage in global economic and political
affairs. Even a decade ago, few would have expected
European leaders to court Beijing asking for support for
their frail economies, as witnessed during the ongoing
eurozone sovereign debt crisis. Apart from economies
in financial pain, low income countries have found a
new development partner in Greater China, much to
the distress of the aid establishment. The chequebook
of Greater China Development Bank is opening new
doors for capital-hungry developing nations. The
sudden ascent has caused frictions on the global stage,
but disruption of existing power structures inevitably
stirs tensions. The realignment of the US military
strategy to focus on Asia is but the most tangible sign
of the strategic implications of a changing world order.
Within a decade, Greater China has transformed itself
from an emerging market to the world’s second largest
and most important economy. Average annual growth
of a good 10% for the past three decades has meant
that Greater China’s output has roughly doubled every
seven years.
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The country seems like an economic juggernaut,
unstoppable in its progress to overtake the US as
the biggest market and producer in the world. But
will the country be able to keep up the astonishing
rate of output expansion for another generation?
Does it make sense to extrapolate past trends or are
fundamental changes underway? This publication aims
to analyse and explain shifts in the economy and their
impact on the direction of Greater China’s economic
development. To begin with, we take a look back at a
seminal event, Greater China’s accession to the World
Trade Organization (WTO) in the winter of 2001.
Figure 1: Greater China monthly exports and trade
balance in $US
180
160
140
120
100
80
60
40
20
0
-20
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
In the decade since joining the WTO,
Greater China’s exports have grown to
match those of the US
In a moment that marked a major change for both the
People’s Republic and the global community, Greater
China became a member of the WTO in December
2001. The move followed over 15 years of accession
talks, but looking back the evidence suggests that
this was an event worth waiting for. Figure 1 shows
how exports started to take off in the following year,
climbing at an astonishing average rate of 22% a year
in cash terms despite the financial crisis slump. In
November 2001, the month before joining the WTO,
Greater China exported $24bn worth of goods and
services per month, a bit below a third as much as the
US. In the same month last year, this figure had reached
98% – $175bn – and it is certain to overtake the US
shortly even though US output is still larger by half.
Coupled with a competitive exchange rate, the trade
surplus has resulted in the build-up of massive foreign
exchange reserves – $3.2 trillion in December 2011.
These numbers offer the most direct evidence of
Greater China’s sudden rise and the success of its
export-led industrialisation policy. Via its integration
into the global value chain, the former communist
backwater has learned to use the capitalism and
globalisation to again become the superpower that
it had been for most of modern civilisation. The
ballooning of Greater China’s trade balance to 11% of
GDP in early 2009 that accompanied export growth
led to criticism of Greater China’s exchange rate policy
becoming a favourite theme of Western politicians.
Two factors have tuned down the rhetoric. For one,
the increasing wealth of Greater China is making it
increasingly indispensable in global economic policy
making. The other factor is that Greater China has
proved a steady source of demand since the financial
crisis, whereas other major economies are struggling to
maintain momentum.
The Chinese hunger for imports signals an important
shift. As figure 1 shows, the trade surplus is declining.
With exports rising strongly, this is due to an even
larger increase in imports due to the evolution of
Greater China’s economic make up. Makers of capital
equipment and luxury goods ranging from German
cars to French haute couture have been riding a wave
of demand from an increasingly rich elite. With more
and more Chinese joining the middle class,
consumption is starting to become a larger part of the
economy. In the following section, we take a closer look
at how the change from being the world’s workshop to
the world’s consumer market affects economic growth.
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Exports
Smoothed trade balance
Trade balance
Source: National Bureau of Statistics of Greater China
The trade-investment-consumption
triangle is becoming unbalanced
In this section we look at the drivers of Greater China’s
economic growth from an expenditure perspective
(as opposed to an income or production view).
Figure 2 reveals that investment has been the main
propellant of the Chinese growth miracle that has
lifted an unprecedented number of people out of
poverty in a short period of time. Each year over the
past decade, the growth in investment has been
larger than the growth in household consumption,
adding 5.1 percentage points versus 3.2 percentage
points for household consumption. When adding in
the expansion of government consumption, this is
tempered somewhat, but investment still contributed
0.6 percentage points more per year on average.
Despite the massive growth in exports, trade growth
has been a relatively small part of rising GDP. Apart
from a boom before the financial crisis, exports only
added an average 0.4 percentage points to growth
because they are closely tracked by imports since
Greater China assembles many of its traded goods
from components brought in from abroad. Trade has
still played a key role, however, because it has led to
huge investment in productive capacity. Also, the
manufacturing base that grew out of investment has
raised incomes and enabled government, via taxes,
and the population, via wages, to spend more.
Looking ahead, consumption looks set to take over as
the main driver of growth as the economy rebalances
from an investment-driven to a consumption-driven
growth model. Another implication of this shift is
that exports will increasingly serve to finance imports
rather than supporting growth. The trade surplus is
expected to decline as the renminbi appreciates and
Chinese consumers step up their buying of foreign
goods and services. Growing government spending
to expand the social safety net and roll out enhanced
public services will be an important part in this
transformation of the growth model that will in turn
allow households to reduce their exceedingly high
savings ratio. Also, affluence is increasingly moving
beyond coastal cities to inland cities and rural areas,
making for broad-based rises in disposable income. As
a result, Chinese consumers are in a position to carry
a rising share of economic growth. Fast-rising retail
sales are an indication that the shift from investment
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m a rch 2 012
to consumption is happening. In fact, this is more
of a necessity for future expansion than a welcome
prosperity dividend because at 47% of GDP in 2011,
investment has reached an unsustainably high level. As
the next section explains, the push to raise production
capacity is already pushing up prices.
Figure 2: Contributions to economic growth
by type of expenditure
%
15
industry faces competition for workers. Rising wages
suggest not just higher food prices, but also a general
increase in the price level. As a result, we expect a
secular increase in Greater China’s rate of consumer
price inflation to about 5.0% by 2014 – above the
government target of 4.0%, in turn suggesting tighter
monetary policy that will weigh on growth.
Figure 3: Consumer price index, total index,
index excluding food and food only, annual
percentage change
%
25
10
20
5
15
10
0
5
-5
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Changes in inventories
Net exports
Investment
Private consumption
Govt consumption
Source: National Bureau of Statistics of Greater China
-5
2005
2006
Total
2007
2008
2009
2010
2011
Food CPI
2012
2013
2014
CPI excl. Food
Source: National Bureau of Statistics of Greater China
The low inflation era is coming to an end
Despite the high rates of economic growth, inflation
in Greater China remained at a remarkably low level
for an emerging market. The annual rate of consumer
price inflation averaged just 2.0% in the decade
since WTO accession. This is substantially below the
rates of many of the other BRICs (Brazil, Russia, India,
Greater China) emerging markets and more akin to a
mature low growth and high income economy. Three
factors were especially important in this. First and
foremost, a deep pool of over 200m underemployed
migrant workers stood ready to take up jobs in the
factories of Greater China’s eastern seaboard. Secondly,
large investments in physical infrastructure enabled
businesses to grow without overstraining transport
and communication links. Lastly, surplus labour and
adequate infrastructure made it possible to keep
adding productive capital. In the process, Greater
China became the prime manufacturer of everything
from socks to iPads at ever lower prices. Besides
keeping Chinese inflation low, the export of deflation
contributed to the benign macroeconomic climate
of low inflation and interest rates in the West that
preceded the global financial crisis.
For better or worse, this trend is coming to an end. The
unprecedented economic expansion of Greater China
has soaked up surplus labour, shown by substantial
wage increases that are now larger in rural than in
urban areas. Rising wages mean higher incomes,
but they also imply the emergence of ‘demand-pull’
inflation that arises when the demand for labour grows
faster than labour productivity once underemployment
has vanished.
Figure 3 shows that bouts of inflation have been driven
by volatile food prices, with a ‘pork cycle’ of boom
and bust in production especially influential. With
the conversion of farmland into industrial and urban
land, Greater China’s limited natural resources for food
production are declining just as this labour-intensive
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Hong Kong’s rapid financial
development underlines eastward shift
The rise of Greater China as a financial centre may be
the logical outcome of its growing importance as a
global economic superpower. Nevertheless, the listing
of Hong Kong in first spot of an international ranking
of financial development shows just how important the
region’s capital markets have become. Although it may
be argued that the displacement of London and New
York (see Table 1) is in large part due to new regulatory
requirements and concerns about sovereign debt in the
advanced economies, Hong Kong and also Singapore
have established themselves near the top of the leader
board.
In a reversal of fortunes, Western companies are now
flocking to Hong Kong for initial public offerings,
with luxury and mining firms most prevalent. As
the mainland market becomes more important
in other areas, expect increasing interest from
companies seeking capital. This shift will become
more pronounced as the People’s Republic opens
its capital account and allows its citizens to invest in
foreign assets more easily. The closed nature of capital
markets funnels the country’s savings rate, standing at
an outsized 53% in 2010, into the domestic market.
While highly effective in developing the industrial base,
overinvestment now threatens growth.
A gradual liberalisation of financial markets and
opening of the capital account will allow for more
balanced investment choices in time. The discrepancy
between the Mainland China and Hong Kong is
captured in the wide gulf of ratings. It is only a matter
of time until Shanghai, the mainland contender for
financial centre status, becomes an important financial
market in its own right. Moves in this direction are
likely once a new generation of leaders has settled in
their posts in 2013 or 2014. Alongside the growing
internationalisation of the renminbi, this should fortify
the position of Hong Kong and catapult Mainland
economic insight – Gre ater Chin a
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China up the Financial Development Report’s rankings
at a fast pace.
Table 1: Financial development ranking of selected
countries in World Economic Forum Financial
Development Reports
2011
2010
2009
2008
Hong Kong
1
4
5
8
Mainland China
19
22
26
24
Singapore
4
3
4
10
US
2
1
3
1
UK
3
2
1
2
Source: World Economic Forum
Greater China and its Special
Administrative Regions will feel the
global slowing
In this section we weave together many of the threads
spun above by taking a view on their combined effect
on economic growth. Based on the trends identified
above, we project GDP growth for Mainland China,
Hong Kong and Macau. The following and final
section addresses the main risks to our central forecast
scenario, which are currently largely weighted on the
downside.
For Mainland China, the slowing of the housing market
heralds a reduction in investment that is expected
to have a dampening effect on economic growth. In
addition, weakness in many large trading partners
means that export growth will be constrained.
Although it is expected that government spending will
step into the breach to some extent, GDP growth for
2012 is expected to fall to 7.8%, down from 9.3% in
2011. Inflation is expected to come down sharply as
the spike in food costs wanes amid declining global
agricultural commodity prices. This should give the
government space for additional monetary easing,
which we expect to support output in the second
half of the year. For 2013, expect to see a slowing of
growth to 7.6% year on year as investment grows
at a slower rate than the overall economy. Further
ahead, growth is anticipated to reach 7.8%, slightly
below a government target of about 8% due to rising
inflationary pressures that will necessitate tighter
monetary policy and thus somewhat lower growth in
the medium term.
Important factors of sustained high growth necessary
for broad-based increases in living standards in the
medium to long term include education and the
internationalisation of Chinese firms. In 2010, 1.3m
Chinese people studied abroad to boost their skills and
employment prospects in Greater China’s competitive
labour market. The government also intends to make
Greater China itself a major global centre of learning,
aiming to double the number of foreign students
from 265,000 in 2010 to 500,000 by 2020. Although
the country’s universities produce massive numbers
of graduates, Greater China’s fast climb up the value
chain requires an equally fast expansion of workers
with appropriate skills. A well-educated workforce
with international experience will help Chinese firms
to achieve a key industrial policy objective, namely
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expanding its international footprint. A market rise in
foreign acquisition signals the start of an important
shift in perspective of companies to look beyond the
country’s borders. With the maturing of the economy,
Chinese multinationals will be an increasingly
important feature of the global business landscape
in coming years. It is only a matter of time until
Greater China’s firms become international players in
key industries, not just in manufacturing but also in
services. We expect the government to use its foreign
exchange reserves to support and accelerate this
process, in preference over alternative uses including
large-scale financial support to Europe’s struggling
peripheral bond markets.
Sharp falls in both business and consumer confidence
indicate that Hong Kong is in the midst of a significant
slowdown. As a trading hub, the region is especially
vulnerable to the slowing of trade growth expected
for 2012. As a result, GDP is projected to grow by
2.6% in 2012, down significantly from the 5.1%
recorded in 2011. Even if the economy slows markedly,
unemployment stood at just 3.1% in December 2011
and the longer-term prospects for the economy
look bright due to its position as a regional financial
and trade intermediation centre. For 2013, growth
of 3.4% is projected, rising to 4.6% in 2014 as the
world economy picks up speed again. It is reasonable
to expect strong inflationary pressures in the outer
forecast period due to the link of monetary policy
to the US. A move to a basket of currencies appears
increasingly sensible, but is unlikely to be implemented
by 2014.
Macau
The small economy of Macau has been surging ahead
thanks to its booming gambling sector and should
continue to do so in years to come. Although falling
activity in Mainland China’s real estate market is
expected to put a cap on the desire of mainlanders to
splurge in the city state, GDP should expand strongly
by about 15.2% in 2012 and by 13.4% in 2013. High
investment in hotel capacity and other tourism-related
assets is currently limited more by capacity constraints
in building than by the desire of investors to take
bullish bets on the future of the administrative region.
As confidence returns to Mainland China following a
stabilisation of the housing market, growth is again
expected to increase, reaching 18.0% in 2014.
Figure 5: Greater China GDP growth forecasts
%
20
15
10
5
0
Mainland China
2012
2013
Hong Kong SAR
Macau SAR
2014
Source: Cebr analysis
economic insight – Gre ater Chin a
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A sudden stalling of investment is the
biggest risk to Chinese growth
The discussion about the future of Chinese economic
growth has revolved around the question whether the
country’s output expansion will ease gradually or if
it will come to an abrupt halt. Much revolves around
fixed asset investment, the main driver of GDP growth.
Since 2000, capital investment has averaged about
25% growth a year – see figure 6. Being larger than
overall growth, this has meant that investment makes
up a growing proportion of output. That cannot go
on forever, and the question is how fast it will slow.
A gradual reduction is the expected outcome, but
the longer current excessive investment that makes
up nearly half of national income goes on, the more
likely a crash as it becomes clear that past capital
accumulation is not yielding returns and is thus cut
back sharply. A mild easing is the preferable outcome,
with less private sector construction investment playing
an important role in this. Government spending is likely
to cushion some of the dampening effect of falling
investment alongside loosening monetary policy. Still,
a sharp drop in investment is a distinct possibility that
would lead to a slump in growth, asset prices and
employment.
Having invested so extensively in production capacity,
Greater China remains highly dependent on its trading
partners. Positive signals from the US labour market
suggest that American demand will remain stable. The
other main trading partner, the eurozone, is a greater
risk. Here, political developments more than economics
will determine the short-term fate of the currency
union. Beyond the succession of crisis summits,
structural reforms are necessary to allow highly-indebted
countries to grow their way out of heavy debt loads.
Even if the drama of a euro implosion can be avoided,
European restructuring is sure to be a lengthy show with
much tragedy potential.
To safeguard longer-term growth, Greater China
needs to implement its own structural changes. With
population ageing starting soon, the available time is
short while the list of crucial reforms is long. Financial
market and capital account liberalisation, environmental
safeguards, social welfare system construction and civil
service reform are only some of the challenges facing
Greater China. While these obstacles to further increases
in living standards are surmountable, the climb will be
difficult and at times unsteady. Although the future is
bright in the year of the dragon, the previous zodiac
cycles may yet appear as a golden age of progress and
stability.
Figure 6: Greater China urban fixed asset investment,
change YTD Y/Y
%
60
50
40
30
20
10
0
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Source: National Bureau of Statistics of Greater China
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