We suggest a very intuitive approach to quantify the GDP growth for #China using the Supply side economics framework.
What is the Supply-side economics? It is the opposite of the currently prevailing Keynesian theory, which states that demand is the primary driving force. Supply-side economics states that the supply of money, labor, and goods or services, creates demand. Fittingly, Supply-side #economics becomes very handy in explaining the outlook for Chinese economy given it being unquestionably heavily influenced by the Central Planning.
The Supply Side Economics states that the Growth in #GDP is equal to the sum of: 1) the Growth in Labor Force (Demographics), 2) Capital Accumulation and Total Factor Productivity (TFP).
The first two (the growth in Labor Force and Capital) are directly measurable while the growth in the Total Factor Productivity (TFP) is a residual and could be only estimated. It is less critical that these important drivers of potential growth are intertwined to a certain extent.
THESE THREE FACTORS DETERMINE STRUCTURAL SLOWDOWN IN GROWTH OF GDP TO ~ 5%:
1. Labor force started declining: (will shrink by -0.2%)
- Rapidly aging demographics (see our Article “Why Interest Rates Would Stay Low Matter What FED Says”)
- Urban migration is largely over
- Disappearing labor cost advantage for exports (China is more expensive than Mexico, Philippines, Indonesia, Vietnam, India)
2. Loss of capital productivity: torrid pace of investments led to excess capacity
- China is over-levered, which limits responsiveness to monetary easing or credit infusions
- Investment share of GDP is unsustainable: 10% points higher other countries’ peaks
- Shift away from Investment, towards Consumption takes decades. (Japan, Korea – were classic examples of these long-lasting transitions. We will write more on that later)
3. Productivity (TFP) Growth is predictably descending toward more realistic 2-3.5% rate
- After $10-15k real GDP/capita (in 2015 China surpassed $15K GDP/Capita in PPP), productivity drops uniformly for all countries. See the Figure 1.
Summing all these 3 Factors up is presented in the Figure 2 below. It would be really hard for China to grow in excess of 5% next few years.
Near-term though, the GDP growth might dip below 5%, correcting for cyclical imbalances:
- Chinese banks facing deteriorating liquidity and growing costs of forbearance
- Slowing data for oil, electricity, PMI’s, railroad cargo shipments and the ugly SHIBOR #yield curve indicate broadening cool-down
Based on the presented supply side economics models, China is not supposed to grow above 5%, even at the most optimistic scenario. Funny, that #Central Bankers and policy makers are still having this simplified nostalgia about the 7% growth. And, yes, we do have strong reasons to believe that the official GDP data for 2014-2015 is overstated. This week’s discussions at #Davos are full of those sentimental conjectures. Any growth above that rate of 5% is effectively borrowed from the future – using, among other things, a widely acknowledged credit (over)expansion. Therefore, in the short term, the growth rate might dip down to 1-2% – you need time to correct at least partially some excesses. And this cool-down is much needed, seriously.