Dr. Marie Owens Thomsen, Chief Economist at Crédit Agricole Private Banking, comments on the concers over China’s slowing growth rate
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Confucius said "It does not matter how slowly you go as long as you do not stop." Perhaps some of the current confusion in the markets is related to a poor understanding of the strength of that quote. Financial markets today are behaving as if the world is in recession, or on the verge thereof. Market behaviour is close to that seen in 2011, although the macro-economic context is similar to that of last year when some 22 countries were in recession while in 2009 the number was as high as 95. World GDP growth is evolving around 3.5% (real, PPP), the average level of growth since 1980. Clearly, the global context is predominantly in expansion, and not about to stop.
Confusion is driven firstly by the over-focus on industry versus services. In terms of total value added, the service sector overtook industry in China in 2012. Services produced 48% of GDP in value added in 2014, more than twice the value added of the sector in 1976. Industry generated 43% of GDP at the end of 2014, down from 48% in 1980 but still up from some 30% in 1960. Clearly, the exciting story in these numbers is the doubling of the size of the service sector, unless we adhere to John Kenneth Galbraith’s cheeky quote that "… pessimism is a mark of superior intellect." China is now a service economy, a fact that few people seem to have noticed. An over-focus on industry is thus dangerous for policy makers, financial markets, and investors alike. For the sake of comparison, the service sector overtook industry in the US in 1960. It now represents 78% of US GD. Since the 1960s, US industry has enjoyed mostly uninterrupted growth, albeit below that in services. Since the 1960s, the US has also experienced a spectacular rise in incomes and living standards, vividly illustrating that there is nothing inferior about the quality of growth in services compared to industry.
Secondly, confusion abounds with respect the China’s slowing growth rate. It must be understood that China contributes as much to world GDP today as they did in the 1990s although the GDP growth rate has been cut by half. This is possible because in the interim period the size of the Chinese economy has doubled. At the time, China weighed 7% of world GDP and enjoyed (briefly) 15% growth, making a contribution to world GDP of one percentage point. Today the numbers are inverted: China weighs 15% in world GDP, grows at 7%, and thus makes an identical contribution. Should Chinese growth slow to 6%, it would subtract 0.1 percentage points from world GDP. Were GDP growth in the US and the Euro Zone accelerate by one percentage point, it would add 0.3 percentage points to world GDP. Few people expect China’s GDP growth to slow to 6%. The consensus forecast predicts 6.8% GDP growth in 2015, compared to 7.2% in 2014 (fourth quarter year-on-year evolution). That would subtract 0.04 percentage points from world GDP. The US and the Euro Zone will more than offset that drop this year, likely contributing an additional 0.25 percentage points to world GDP: a net gain to world growth of 0.2 percentage points. In essence, we need to recall that as the denominator grows, the resulting percentage growth rate falls by mathematical necessity. If we add a constant trillion yuan to China’s real GDP per year, the growth rate would fall to 2% around 2046, without any deterioration in the "top-line" wealth creation. This neatly illustrates Confucius message: as long as the country does not stop, there will still be wealth creation in yuan, in spite of the falling growth rate.
China is not about to stop. Fears in the markets are disconnected from macro-economic fundamentals. They might linger for a while, but reason usually prevails.
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