What’s Behind China’s Shift in Investment Strategy? All it took was for me to use this space last week to opine that Dow 13K was for real—at least from an economic point of view—for markets to fall back below this fundamentally meaningless level. In part, the retreat was a response to factors that will largely resolve themselves over the coming months, such as: Will higher gasoline prices weaken the remarkable resilience of the U.S. consumer? Will there be a last minute glitch with the Greek debt swap? Will increased hiring damage corporate profitability? But one part of the markets’ shudder, which factored in diminished prospects for Chinese growth, underscores an issue that we’ll return to not just for weeks and months, but for years.
Chinese GDP growth peaked at an annualized 12% growth rate during the first quarter of 2011. On March 5, Premier Wen Jiabao told the National People’s Congress that the government planned on 7.5% growth in 2012. Although actual Chinese growth has exceeded government plans for several years in a row, Mr. Wen’s projection carries more weight than, say, forecasts from the Fed or the Congressional Budget Office because China remains, to some considerable extent, a planned economy, and the premier’s government will largely determine how the capital needed for growth will be allocated. I believe the slowdown is more than a continuing effort to engineer a “soft landing” for the Chinese economy; it is part of a larger effort to shift the source of future growth. This shift—and the extent to which it occurs—should shape global economic prospects long after we’ve forgotten whose ox was gored in the Greek bond default.
Basically, the Chinese government is allowing growth to slow in order to redirect the economy from infrastructure and export-oriented investment toward accelerating domestic consumption. One of the reasons behind that shift is to try to maintain social stability in the wake of growing disparities in the standards of living across what is still a very poor country. Even after adjustments for purchasing power, China’s per capita GDP is less than one-sixth that of the U.S. Another reason— one that matters greatly for investors— is an effort to overcome what economists call the “middle income trap.” Numerous countries have emerged from poverty on the back of export growth (frequently of natural resources) only to stop growing as production cost advantages faded, and few countries (Japan in the 1960s, South Korea and Taiwan more recently) have successfully achieved the next leap to domestically sustained growth and prosperity. If China is to sustain growth, spread its benefits and (selfishly) create sales and investment opportunities for foreigners, the government’s effort to redirect investment toward what it calls the “people’s livelihood” will need to succeed. And if that effort demands a temporary slowdown in aggregate growth, markets should take the change in stride.