Chinese GDP numbers released yesterday indicate the world’s second largest economy has slowed yet again. I believe this trend is likely to continue…here’s why.
There are three primary sources of growth in any economy: (1) labor, (2) capital, and (3) productivity. Labor-driven growth originates from adding more workers to an economy. Capital-driven growth comes from deploying more equipment. And lastly, productivity-driven growth is the result of squeezing more output from existing labor and capital.
Labor in China is unlikely to be a meaningful source of growth for the economy because the one-child policy has created a demographic ripple. Sometime in the next few years, those leaving the labor pool will exceed those entering it. Labor may in fact emerge as a potential economic drag! It's not surprising to me that Beijing began last November to relax the one-child policy.
What about capital? China has been on debt-fueled capital expenditure binge that has mis-allocated capital and created significant excess capacities in support of a housing boom that appears to be busting. Might the dearth of home buyers be partially attributable to the one-child policy? China will need to spend at least the same amount this year as last simply not to shrink. But there are plenty of signs of excess in past allocations; investing in the face of overcapacity can lead to an even harder landing in the future.
As for productivity, surely a factory worker is more productive than a farmer and the ongoing urbanization can drive growth for many years to come, right? Not really. Urbanization is not as simple an 'answer' as it may seem either. While China's data indicates that there is a great deal of potential remaining for migration-fueled growth, much of this urbanization has already happened. First, China defines a region as “urban” if it has a population density of 1500 people per square kilometer…but by that definition, Houston (America’s fourth largest city) is rural! Second, the most likely age band to migrate is 16-24 year olds, and that age band is shrinking by 25% between 2010 and 2015. Another impact of the one-child policy? Third, China's hukou residency permit system (being reformed) classifies individuals according to where they live, not where they actually are (and we've already had lots of migration). Thus, there are those working in actual cities that are deemed rural, or working in factories but are listed as farmers, and there are fewer potential migrants!
So what? My interpretation of these facts implies that China will continue to slow for the foreseeable future. The world is underestimating Chinese urbanization, and there is a structural headwind that makes a low single-digit growth rate not just possible, but likely, and this has massive implications for asset prices, interest rates, commodity markets, and inflation rates. It may take a village to raise a child, but one child can create global economic ripples.