As we begin the final quarter of the year, we are entering into forecasting season. Economists and other analysts will once again survey the landscape, and begin to formulate views for 2019 and beyond. No doubt this process will be rightly dominated by the risks of a still-intensifying global trade war, centered on but not limited to the U.S. and China. It will also include the expanding fallout, via capital flow volatility, to some emerging markets from risk aversion and a normalization of policy interest rates in the U.S. These two risks may intermingle. We will perhaps have geopolitics thrown into the mix as well.
But these risks are relative to a baseline. S&P Global Ratings believes there is an emerging, but not yet fully acknowledged, factor for this baseline. We have moved beyond China driving global growth; that was a narrative for the 2000s. Owing to steady rebalancing of the economy, Chinese consumers are now not only propelling Chinese growth, but also increasingly global growth. Moreover, as the middle class grows, they are increasingly tilting their country's imports of consumer goods westward. In short: we now know the global winners from China's rebalancing--Western consumer goods exporters. And this story has legs.
Chinese Consumption As A Global Growth Driver
It is well known that China contributes more to global GDP growth than any other country. Measured on a purchasing power parity (PPP) basis (following the "Law of One Price" for similar goods globally), China contributed 1.2 percentage points in 2017, one-third of the global total. This was more than the U.S. and European Union (EU) combined, and China has been leading the pack since the early 2000s. Measured at market exchange rates, which are generally more depreciated than PPP rates for emerging market economies, China still drives global growth with a contribution of 0.8 percentage point, more than one quarter of the 2017 total; it has been doing so since the mid-2000s.
More recently, consumption has been driving Chinese growth. This reflects the steady rebalancing of the economy away from investment and net exports as sources of growth and toward private consumption. This ongoing shift reflects two types of factors. First are demographic factors--namely the structural labor shortage reflecting continued high growth on the demand side and the legacy effects of the one-child policy on the supply side. Second, and more recent, are the authorities' efforts to deleverage the economy.(1) These efforts comprise slowing credit growth to the corporate sector (as a percentage of GDP, not the level), supported by supply-side reforms to weed out less efficient firms and allowing the market to play a somewhat larger (but still less than decisive) role in credit allocation via higher rates and a rise in default.
Putting these together, we conclude that Chinese consumption, owing to the steady rebalancing of the economy, is increasingly driving global growth. This steady rise stands in contrast to the volatile contribution of consumption from the U.S. and EU, reflecting in large part the impact of the global financial crisis. While the year-to-year numbers may show a differing mix in the consumption contribution to growth of China, the U.S. and the EU, the trend is clear (see chart 1). Chinese consumption will drive global growth for the medium term. But as the next section shows, this is only part of the story.
The Trade Dimension Of China's Rebalancing
As we have noted in previous research, China cannot unilaterally rebalance.(2) Changing the composition of domestic expenditure from investment to consumption will also change the composition of trade with the rest of the world (except in the unlikely case where domestic production exactly matches the changes in the composition of expenditures). And since global trade must balance, the changes in China's trade composition must be mirrored somewhere in rest of the world. Furthermore, since China is now the largest economy in the world (measured on a PPP basis), the rebalancing of its economy is likely to have material macro consequences for its trading partners.
The ongoing change in the composition of China's trade growth has featured a persistent difference in the performance of consumer goods and services versus capital and intermediate goods. We measure this as the wedge between export and import growth (see chart 2). Consumer goods have shown a negative trend in export minus import growth since the Global Financial Crisis (as well as before), consistent with the ongoing rebalancing of the economy toward consumption by a rising middle class. In contrast, capital and intermediate goods have seen export growth continue to outpace import growth.
The rise of services tells the story even more clearly. The wedge for services trade growth--negative 10.3% on average since the Global Financial Crisis period--has been larger than all of the goods trade categories discussed here by a wide margin. That mainly reflects the surge in services imports of travel (including education and tourism). The driver of this phenomenon is the rising Chinese middle class, which has begun to venture abroad as tourists and to send their children to university overseas. As chart 3 shows, Chinese services import growth--and the resulting surging services trade deficit--has been driven by travel, which has risen by 30% on average during 2010-2016 (the last year of available data), with the share of travel in the total rising by 30 percentage points to 58%. Owing to data constraints, we will confine our analysis for most of this report to the goods trade. For our recent, more detailed, research on services trade, see "How Well Do Services Trade Data Tell The Asia-Pacific Story?" published Sept. 26, 2016.
Which Countries Benefit Most?
All we have shown so far is that, because of China's rebalancing, its consumption is now driving global growth and that this has spilled over to the rest of the world via the trade channel. The next step is to look at the distributional consequences of this trade spillover at the country level. More specifically, who is benefitting from the rise in China's consumer goods imports?
The bottom line is that there have been material changes in the country composition of China's consumer goods imports. In our previous work on the global effects of China's rebalancing, we speculated that the preferences of the Middle Kingdom's rising middle class would tilt China's imports toward the advanced countries, which tend to produce and export higher-end consumer goods, as well as many services. That has indeed been the case.
To study the changing composition of China's consumer goods trading partners, for simplicity, we grouped the main regional trading partners into the "Asia 5" comprising Japan, South Korea, Malaysia, Singapore, and Thailand. We then compared this group with Western trading partners defined as the EU plus the U.S. These two groupings account for two-thirds of China's consumer goods imports.
As we expected, China's imports of consumer goods have moved steadily toward the Western, advanced countries. This group of countries saw its share of China's consumer goods imports double during 2000 to 2017, rising to 44% from 22%. In contrast, the Asia 5 group saw its share decline to 24% from 44% over the same period (see chart 4). Drilling down a bit into the groups, China's consumer goods import share rose for the U.S. and all major EU countries, and declined for every country in the Asia 5 over the period.
We can tell the same story using data from the exporters' side. Here, we focus on the share of trading partners' exports of consumption goods to China as a share of their total exports to China. From this perspective, the picture looks particularly good for Europe, although the U.S. is benefitting as well; in contrast, the Asia story looks flat (see chart 5).
In general, the share of consumption goods in total exports to China has increased since the global financial crisis. For the EU, where this share was rising slowly before the crisis, the pace has picked up over the past decade. Indeed, the share of consumption goods exports in all exports from the EU to China doubled to 28% from 14% between 2007 and 2017. Italy and the U.K. led the pack with shares of about 40% at the latest reading, with Italy's share almost tripling in the 10 years to 2017 and the U.K.'s doubling. The rise in the share of U.S. consumer goods exports to China was more modest; it was flat from 2000 to 2009, but then climbed to 18% in 2017 from 9% in 2009. Consistent with the import side data above, the Asia 5 countries showed almost no change in their share of consumption goods exports to China. In the parlance of the trade literature, the Western, advanced economies demonstrate a rising "revealed comparative advantage" in consumption goods exports to China over their Asian counterparts. In plain words: the rising Chinese middle class buys its consumer goods from the West, not the rest of Asia.
The composition changes and growth rates above show that consumer goods trade with China is on the rise. But what about the levels? Just how important is China as a trading partner? Specifically, is China rising in the consumer goods export league tables as well?
China's rising prominence as an export market for the EU, the U.S., and the Asia 5 lines up well with what we discussed earlier, including its rising share of global income and consumption (see table 1). Between 2007 and 2017, China's rank as an overall export market continued to climb. It moved up two spots to the number 2 position for the EU for total exports, but moved up five spots to number 3 in consumer goods exports. For the U.S., China held its number 3 position in total exports but moved up four spots to number 3 in consumer goods exports. And for the Asia 5, China moved up by just over one notch on average to 1.6th position and by one and one-half notches on average to 3.2.
Does The Story Have Legs?
We now return to where we began this paper: the issue of forecasting. What needs to happen for the trends identified to persist? These trends are likely to persist as long as GDP and wage growth remain strong in China owing to continued urbanization and a structural labor shortage, rebalancing toward consumption-led growth continues, and deleveraging proceeds smoothly with modest increases in credit to households.
The first issue involves growth. In terms of simple arithmetic, if China continues to grow faster than the global average, its share of global GDP will rise and, even for a static share of consumption in its expenditure composition (no further rebalancing), the contribution of both its GDP and consumption to global growth will continue to rise. This will be true at least for the "longer-term" PPP exchange rate.
But continued robust growth, even at a more moderate pace, implies a successful (smooth) deleveraging of the economy. China's credit-to-GDP ratio remains high, particularly for its level of development. Although progress in reining in debt has slowed in recent quarters and there is still work to be done, the conditions are in place for continued, reasonably steady progress.(1) The economy remains largely self-financed, meaning that if domestic confidence remains high, the savings necessary for investment and growth will remain on-shore and largely insulated from global developments. Moreover, market forces are being allowed to play a somewhat larger role in the economy--for example, an increase in defaults, wider spreads between borrowers of differing quality--and the recent move to allow foreign rating agencies on shore improve credit discipline and resource allocation.
A continuation of Chinese consumption driving global growth and Western exports will depend on continued rebalancing. Here there is cause for optimism. The share of the Chinese economy pie going to private consumption remains one of the lowest in the world, and easily the lowest among major economies. In other words, there is some upside. The low level has been justified by precautionary savings following the elimination of parts of the social safety net in the early reform period. This was compounded by the excess labor problem related to absorbing the large agricultural workforce into the modern economy. But with the latter completed more than a decade ago (when many trends described in this paper began) and with labor demand now consistently outstripping labor supply (as the main cohort of the labor force shrinks), the implication is that wage growth will exceed nominal GDP growth for the foreseeable future. This will drive consumption higher as a share of GDP and spur rebalancing forward.
Finally, what can go wrong? Up front, we would acknowledge the graveyard of China "hard landing" scenarios. None of the doom-and-gloom forecasts made by some analysts has come to pass and the authorities' record of maintaining growth through both calm and turbulent times remains impressive. The most vulnerable link in our view is confidence. It is the loop of wages to saving in the domestic banking sector that keeps funds flowing, interest rates low and the economy humming. Should that break down, then growth would slide and even fiscal stimulus in an economy that is still state directed would struggle to restore the pace of activity. But, as we have hopefully shown, if this happens, more than China will be affected.