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Why you should take a broader view of China’s economy

Shanghai
Jalvaran | Getty Images
Shanghai

Wild guesses from one economic indicator to the next are not providing relevant and useful analysis of China's economy. They are simply leads to equally wild trading bets.

The world's second-largest economy is underpinned by strong fundamentals and is reasonably well run. It deserves a broader look at its short-term (i.e., a one-year time horizon) and medium-term (i.e., a period of up to five years) outlook for growth and price stability.

If you want a short-cut, and a good point of departure in that kind of analysis, you may wish to think of China's widely shared medium-term growth forecast of about 6 percent.

But here is a warning: As a long-time practitioner of formal economic model building, I would advise not to get hung up on that or any particular point forecast without a probability range.

I would prefer a simple question: Do the Chinese have what it takes to stabilize and maintain demand and output on a relatively high-growth trajectory in the years to come?

The Chinese certainly have the money. With a savings rate of 49 percent of GDP, China has plenty of readily available internal sources of finance to support growing investments in its stock of physical capital.

And in the human capital, too, where, oddly, they may have a spot of a problem. The latest population surveys show that the active civilian labor force grew at an average annual rate of only 0.12 percent during the five years to 2015. That was down from 0.27 percent in the previous five-year period.

China's productivity challenge

The upshot is that China needs an average total factor (labor plus capital) productivity growth of 5.8-5.9 percent to maintain the economy's noninflationary growth potential of 6 percent over the medium term.

Is that possible? Here are some numbers. China's average annual GDP growth of 7.8 percent over the five years to 2015, and its average annual labor force growth of 0.12 percent (over the same period), clearly indicate that a total factor productivity growth of more than 6 percent was part of that story.

I know that there will be people screaming that the Chinese numbers are fabrications. I would stay out of that, and so should you, as long as these numbers have the imprimatur of official international organizations which examine the Chinese economy.

But quite apart from that, I believe that Beijing is fully aware of what they are up against. All of China's current structural changes (reforms) are aimed at enhancing the efficiency of its human capital (through education and vocational training) and at fostering technological innovation to raise the quality of its (physical) capital stock.

The test of these policies will be (a) the pace of future economic growth, (b) price stability and (3) (yes) the profitability of the corporate sector. All that will tell us how successful China's allegedly wholesale and wholehearted embrace of a genuine market economy will be.

These are the things to watch. Reductions of excess capacities in a number of sectors related to massive infrastructure investments and overestimated external demand are part of an adjustment process that should redirect resources to more productive (i.e. more profitable) uses that will set the stage for a steady and sustainable growth.

This process is currently under way (China's PM Li Keqiang says it's so painful that it feels like "slashing your own wrists") in parallel with a rapidly changing composition of China's economic growth toward private consumption and service industries.

That change is already there. In the first quarter, household expenditures accounted for nearly two-thirds of economic growth, while the 7.6 percent growth of the service sector outpaced by 1.8 percentage points the growth of traditional manufacturing.

I cannot remember when I saw Germans praising anybody's economic management. But, lo and behold, it did happen. One of Germany's prominent economists opined last week that the Chinese economy was on a "right track," pleading for greater opening so that Germans could sell to China "more advanced technology" that would "raise the level of productivity and innovation."

Last year, German president, chancellor and vice-chancellor (and economic minister) all visited China to push trade and investments. More of the same is on the cards for this year, too. Good luck to them, because China is now fiercely competitive along a broad range of industries.

Indeed, China is now a large supplier of products, services and investment projects to its Asian neighbors, to Europe, Africa and to the Arab world.

Beijing's trade and investment ties are being strengthened and upgraded with the Koreas, Vietnam, Laos and Indonesia. Japan is also eager to get a bigger slice of China business – if an understanding can be worked out to settle the territorial disputes.

Further afield, Beijing is actively promoting its Belt and Road Initiative with the Arab world. That was a key issue discussed last Thursday (May 12) during the ministerial meeting of the China-Arab States Cooperation Forum in Doha, Qatar. China and its Arab partners want to replace "camels and sailing boats" of the ancient Silk Road with high-speed trains, deep-sea ports, navigation satellite systems and nuclear power plants.

Egypt seems particularly interested in promoting its trade and investment ties with China. Morocco wants that, too. King Mohammed VI visited Beijing last week to discuss a broad range of trade and investment projects; he even granted a visa-free access to Chinese nationals.

China has also pledged $60 billion to the African Union last December for a program of investment projects over the next three years. At the end of last year, Beijing's bilateral trade with Africa reached $220 billion.

Investment thoughts

China's investment possibilities deserve a broader look and a time horizon beyond instant and high-frequency trading bets on economic and financial indicators.

The country's solid economic fundamentals and its sound monetary, fiscal and structural policies offer attractive short- and medium-term investment opportunities. The booming consumer and service sectors seem particularly interesting. Companies specializing in various infrastructure businesses and telecommunication products are world beaters

China may also surprise those who believe that they can easily capture Chinese market shares with their superior technology. They don't seem to realize that China has pushed its technological frontiers in areas as diverse as high-end consumer appliances and electronics, capital goods and space exploration. If you want to bet big, these are worth a closer look.

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