Several of my 2020 blog posts have explored China’s thriving innovation ecosystem and rapid transition to a digital economy — a hugely important investment theme for sure, but I’d like to shift gears this time to the subject of Chinese debt and domestic consumption.
Our internal investor dialogue around China has raised a number of provocative questions. One of the best ones asked recently was: Will rising debt ultimately derail Chinese consumption? The short answer, in my view, is no.
On the topic of debt, some of my colleagues have studied China’s consumer debt and concluded that the pace at which it is growing looks unsustainable in the long term. I tend to agree. While there is still some room for consumer leverage to expand, how much and how fast are uncertain at this point. Worst case, getting those answers wrong could result in a proper financial crisis.
What about consumption? In the medium term (five- to 10-year time horizon), I believe there is further space for Chinese consumers to ratchet up their buying if the national savings rate continues to go down (as I expect it will). However, the really pivotal question is whether or not the additional income will be there to support and drive that consumption growth. I say yes, in all likelihood.
Over the years, I have written extensively about China’s “engines of growth” and why I believe the country’s economic growth potential remains significant. One way to see that potential is to focus on relative productivity and efficiency. Figure 1 shows some possible paths I drew a decade ago. The purple line shows Japan’s “catchup” growth following World War II. The blue line shows China’s historical path until 2010. The dotted lines show relative per-capita GDP growth for the US and China under different assumptions, both measured in current dollars.
China’s growth trajectory to date has met or exceeded my 10-year-ago expectations. Keep in mind that China has four times the population of the US, so when its GDP per capita reaches 25% of America’s, the total size of the Chinese economy will equal that of the US. When China reaches 50% of US productivity (GDP per capita being a broad measure of productivity), its economy will be twice as large. GDP growth comes from both income and spending and will be fueled, in large part, by Chinese innovation (as I have discussed at length elsewhere).
Once we can be comfortable that the income will be there, then we can think about how China’s consumption might compound post-COVID-19. By my conservative reckoning, given its still-low base (just 10% of US per-capita consumption), Chinese consumption can easily more than double by the end of the next decade. By then, even at modest growth rates, the increase in China’s consumption each year will be roughly as big as Indonesia’s entire economy. (This assumes exchange-rate stability or appreciation over the 10-year period.)
Bottom line: If I am right, this rise in consumption should be the engine of growth for a variety of digital, personal, and physical goods and services and will provide a runway for many Chinese companies to compete and succeed in the future.