17 Jul 2024
From 1979 to 2018, China's annual real GDP averaged 9.5% meaning that China has been able to double the size of its economy in real terms every eight years. Driven by industrial production and manufacturing exports, it’s no surprise that China's economy has grown to one of the largest and most powerful in the world over the past few decades and since the late 2010s and into the 2020s, China has been described as a superpower, posing the most significant challenge to the US of any nation-state in the world.
Is China still a key rival for pole position when it comes to economic leadership or is the superpower losing its edge? Since 1978, China has been a major part of the emerging markets sector but is China now more likely to be heading towards a lost decade? A look at Japan might give us some answers. Between the 1950s and the 1980s, with technological advancements and strong exports, Japan’s GDP surged, but it led to a massive speculative bubble that subsequently burst and in the late ‘80s, excessive lending, speculative investments and inflated real estate and stock prices led to a banking crisis which then triggered the start of Japan’s long deflationary story.
Are there key similarities between China and Japan and does the same fate await China? An aging population and stagnation have played a part in Japan’s lost decade. People over 65 tend to consume less and become more expensive to the system. An increasing elderly population in China is putting strain on their social services and creating a productivity gap. The one child policy adopted in China from 1979 to 2015 has shrunk the workforce and the gender imbalance doesn’t help matters. The skewed social dynamics are affecting the birth rate which has dropped to 7.5 births per 1000 people, the lowest it’s been for decades.
And this picture may be even bleaker than it appears. Fuxian Yi, senior scientist in the obstetrics and gynaecology department at the University of Wisconsin, said he estimated that China’s 2020 population was 1.28 billion rather than the 1.41 billion census number reported and that fertility rates were lower than reported. The recent policy to promote three-child families may be too little too late.
What about the reshoring movement? Transferring a business operation that was moved overseas back to the country from which it was originally relocated can help rebalance an economy and create new jobs. With shorter lead times and control of the supply chain, manufacturing companies in the US that have adopted reshoring have reported enhanced product value, lower inventory costs, and greater product differentiation. China still holds the crown as the factory of the world for now but with all the reshoring taking place with companies of all sizes, will the superpower soon be knocked off its throne?
With all this in mind, should we be looking at China as an area of investment in a different light? Our comparator Japan has started to show signs of coming out of the period of deflation. Japan has offshored some manual work, embracing AI and modern production methods to improve productivity and China may adopt the same strategy. If China can capture the productivity of AI, the shrinking population may no longer be as problematic.
When it comes to the future of China and its investment potential, it’s worth taking the system of government into consideration and the real estate scenario. Earlier this year, China's giant real estate developer, the Evergrande Group, went into liquidation after the company was unable to restructure the $300 billion it owed investors. Just six years ago, Evergrande was riding high, preselling apartments, but like many major Chinese property developers, experienced financial stress in the wake of overbuilding and new regulations on debt limits. Real estate in China used to be a pillar of economic stability and growth but has now turned into a large-scale crisis, threatening domestic and global markets. When the crisis filters down through the Chinese population, what kind of social unrest might this cause in a people’s democratic dictatorship when they realise their savings have potentially gone up in smoke?
Is there an argument to say that investment risks associated with China are greater than Japan? With the difference in governance and the reliability of Chinese economic data a subject of debate, making informed investment decisions can become a grey area. Scepticism and analysis form part of a healthy approach to investing but can of course only be realised if the data is available and accurate.
China has been a major part of the emerging markets sector, and many personal investors have significant exposure to this area but is it time to reevaluate whether China remains a strong long-term investment? China's GDP grew by 5.3% year on year in the first quarter of 2024, above market expectations. There are still attractive valuations in China and over a longer timeframe, China is likely to remain an important cog in the global economy, but the economics, politics and demographics need to stabilise to restore the sector to its former glory and reinvigorate investor interest. Whether you choose to stay invested in the shorter term or jump ship for now, it’s worth doing your research and identifying fund managers who are making the investment choices that align with your own thoughts and conclusions.
Jon Lycett, Key Accounts Manager
Katie Sykes, Client Engagement & Marketing Manager
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