Global chief executive officers should stop praying for a miracle in China. As the investment- and export-driven boom of the last 15 years comes to an end, the days of double-digit annual growth in gross domestic product are over. Depending on the pace and nature of economic and institutional reforms, the new normal for GDP growth will be somewhere in the 6 percent to 7 percent range. For an economy of China’s size, this will still be very robust and will make China the world’s largest economy by 2025. For companies, however, a China that is growing at 6 percent to 7 percent will be very different from one that’s been growing at a 10 percent to 11 percent rate.
In China’s new era of slower growth, big infrastructure projects won’t play as important a role in the economy. Fixed-asset investment in China grew from 34 percent of GDP in 2000 to over 44 percent in 2011—an average annual growth of 12.7 percent, relative to a 10.4 percent rate of growth in GDP during this period. In 2012, however, there probably won’t be any growth, with fixed-asset investment likely to be the same as last year’s. Looking ahead, we predict not more than a mid-single-digit growth rate for this decade and beyond.
The question is not whether China still needs many new airports, highways, high-speed rail links, power plants, and so forth. It most certainly does. The real question is: Given the infrastructure China has already built, how much additional investment is needed to address unmet needs?
Look at aviation and the need for airports. Even though air traffic in China has grown robustly, annual growth slowed from 17.2 percent during 2000-2005 to 14.4 percent during 2005-2010. Just as trees don’t grow to the sky, the growth rate during 2010-2015 is likely to slow further. (Boeing (BA)predicts 6.9 percent annual growth for the 2011-2031 period. China has already built most of the big airports it will need during the current decade. New capacity additions will come largely in the form of feeder airports and the periodic expansion of existing airports. Combined with slower growth in air travel as noted above, this translates into a much slower pace of investment growth in new and existing airports than that of the last decade.
The same arguments apply to investment needs in such other areas as highways, ports, and power plants, as well as real estate. According to the UN Population Division, China’s urbanization has grown from 20 percent in 1980 to 51 percent in 2011. Since it is now beyond the halfway inflection point, future urbanization will occur at a somewhat slower pace than in the past. Consistent with this global pattern, the UN Population Division predicts that China’s urbanization will reach 73.4 percent in 2040.
Note also that the next 50 million units of new housing (including over 25 million units of “social”—that is, affordable—rental housing being built by local governments) will, by necessity, spring up in lower-tier cities, catering to lower-income families than was the case for the last 50 million units, which were constructed in bigger cities for richer people. These lower-income apartments will require fewer and less-expensive appliances. To put these numbers into context, note that the total number of urban households in China currently stands at about 235 million. All these realities imply a sharp slowdown in the growth of investment in real estate, as well as in factories to build home appliances.
Look also at the auto sector, one of the biggest drivers of manufacturing investment, both directly and indirectly (subsystems, parts, and raw materials). From 2000 to 2010, the passenger vehicle market in China grew at over 36.8 percent per year. At 14 million cars sold annually, it is now the largest in the world. What will its future trajectory look like?
Given China’s much higher population density, its auto penetration is unlikely ever to reach today’s 70 percent average for the G7 developed countries. It currently stands at 5 percent. An optimistic projection would be 30 percent to 40 percent auto penetration by 2030 and 50 percent by 2040—a point at which China’s per capita income would still be lower than that of the G7 nations. Translated into annual sales, these projections imply that China’s car market will peak at about 50 to 55 million units by 2040, four times that of 2010. These numbers suggest it is unrealistic to expect China’s car market to grow at more than a 5 percent to 6 percent annual rate during the current decade and beyond.
Further, China’s export machine is already facing structural limits. China’s share of world exports grew explosively from 3.9 percent in 2000 to 10.4 percent in 2011. During this period, the country’s exports grew at twice the pace of world exports—20 percent annually vs. 10 percent annual growth in world exports. However, China’s wages are rising and its inflation rate is higher than in the big developed economies. Thus, in labor-intensive goods, China has already started to lose share to lower-cost countries such as Bangladesh, Cambodia, Vietnam, and India. In more capital- and technology-intensive goods, rising costs in China imply that companies serving the U.S. and European markets will find it increasingly attractive to rely on near-shore manufacturing in places such as Mexico and Eastern Europe.
Even if China were to remain extremely competitive or become even more competitive, a big increase in export share could happen only via far greater shipments to the world’s big economies such as the U.S., Europe, Japan, Brazil, and India. It is hard to believe that leaders of any of these big economies will choose to commit economic suicide. Even on political grounds, we thus deem it impossible for China to increase its market share much beyond the current level. In short, we should expect China’s exports to grow at half the pace of that in the last decade.
To be sure, even a slower-growth China will provide plenty of opportunities for Western companies. If China were to increase fixed-asset investment at a mere 5 percent annual rate over what it spent in 2011, that would still result in a hefty 55 percent increase in real fixed-asset investment during the 12th five-year plan, relative to the 11th five-year plan. We see this as far more likely than a bolder scenario.
During the last 30 years, China has demonstrated the power of a top-down investment- and export-driven approach to achieve record growth on a sustained basis. Over the next decade, it will remain one of the world’s faster-growing economies. However, investors and corporate leaders would be wise to plan for a significantly slower Chinese growth rate than they have become accustomed to.
