Has China peaked?

Even if China's growth slows in the coming years, India faces the daunting task of achieving something extraordinary to catch up

These days, not a single week passes without encountering a research report or YouTube talk on why China has peaked both economically and geopolitically. With a very poor post-Covid economic rebound, poorly performing stock markets, a default-driven property sector, and political leadership less focused on growth, doubts about China are building.

The mood has totally swung on the country. As late as 2021, most experts felt that China was destined to overtake the US as the world’s largest economy by the mid-2030s. Many believed that its economic model — top-down, technocratic, with long-term planning and clear industrial policies — was the easier path to success. China was an economic miracle, with double-digit economic growth for multiple decades, and no country had ever lifted more people out of poverty faster than China had accomplished. Between 2006 and 2021, China delivered more incremental gross domestic product (GDP) in nominal dollar terms than the US almost every single year. It was thus the biggest driver of global economic growth over this period. China also moved from being about 20 per cent the size of the US economy to 76 per cent (the same level Japan peaked as a share of the US in 1995).

All this changed in 2022-2023, where a combination of a weak rebound in Chinese growth, currency depreciation, and a surprisingly strong US economy (especially in nominal US dollar terms) drove US outperformance. Over the past two years (2022/2023), the US has grown its nominal dollar GDP by $2 trillion more than China (source: Gavekal). This outperformance by the US reversed almost 40 per cent of the relative gains China had made over the past 15 years, when it was the principal driver of global growth. This level of US outperformance is unsustainable and was driven by an extremely strong US dollar, massive fiscal and monetary stimulus, as well as very high inflation driving above trend nominal GDP growth.

Irrespective of whether this trend is sustainable or not, the recent weak relative performance of China has caused everyone to doubt whether it will ever surpass the US economy. According to many forecasts, China will slowly settle into a 0-2 per cent growth path and is doomed to have a lost decade. Their arguments are based on the fact that China has a declining population, too much leverage across the economy, and a bust property sector, which used to account for almost 30 per cent of GDP. Combined with the above, multinational corporations have stopped investing in the country, and we are seeing trade barriers and tariffs against Chinese products across the world. US sanctions on technology transfer will also eventually hurt. The Chinese leadership, too, seems to be willing to sacrifice growth for stability, continuing to increase its intrusiveness in the economy.

While all of the above may be true, I believe China will manage growth of between 3 and 4 per cent in the coming decade. Far slower than what it used to grow at and definitely slower than what India will deliver.

The fact is that at its current level of GDP per capita other Asian miracle economies have continued to grow strongly. Even today, despite all the progress, China is less than one-fifth of the US when considering GDP per capita. At this income level, which is the same as Japan’s in 1980, South Korea and Taiwan were able to deliver growth of between 5 and 6 per cent for more than a decade. Even Japan, from these levels, kept growing at more than 4 per cent for over a decade. So, the current level of prosperity in China is not at a point where other countries have stalled and quickly slowed to OECD average levels. There is still scope for catch-up and productivity gains.

China has an ageing population, but still, the largest workforce in the world. The workforce participation rate drops off significantly after the age of 50, and even today, the education levels of the average Chinese worker are significantly behind those seen in the West. If China can get more workers to continue working past the age of 50, it can slow the shrinkage of the workforce. Improved education and training can lift productivity.

With a 30 per cent share of global manufacturing capacity and 20 per cent in exports of manufactured goods, China remains the manufacturing powerhouse of the world. It is also no longer true that multinational corporations (MNCs) drive the export engine of China. Today, more than 70 per cent of exports are made by local companies, up from only 50 per cent a decade ago. China also has the ability to innovate. In many of the technologies of the future, China has established leadership,whether it is electric vehicles, renewables, 5G, or high-speed trains. It has moved up the value chain and is capable of launching world-class products. China has now become the largest exporter of cars in the world, displacing Japan and Germany.

We see that Chinese companies have adjusted their manufacturing footprint and are now able to bypass tariffs and quotas. We observe waves of Chinese products entering markets but routed through Thailand, Turkey, Vietnam, and other countries. Trade barriers are not going to stop the China export machine beyond a certain point. Technology barriers are largely in high-end semiconductors, where China has narrowed the gap for all chips, barring the absolutely latest generation. Except for artificial intelligence (AI), most other manufacturing applications do not need high-end graphics processing units or 5-nanometer and below chips.

Also, when we talk about MNCs like Apple moving manufacturing out of China, do remember that even if Apple were to move 25 per cent of all iPhone production to India, the balance 75 per cent will remain in China. Additionally, even the 25 per cent shift is impossible without involving Chinese component manufacturers. The manufacturing ecosystem in China, with its heft and capability, is impossible to duplicate.

I remain of the view, as highlighted before in previous articles, that it is premature to assume that we have hit peak China. If anything, we have hit peak China pessimism.

China may grow slower in the coming decade, it may never cross the US in terms of absolute GDP, but it will remain the second-largest economy in the world, and a leader in many of the newer technologies. It remains a country that no one can ignore, be it an MNC or a global allocator. While we in India may wish otherwise, a time will come when investors will rush back into China. The markets are cheap, there are some world-class companies and the cyclical weaknesses in both leadership and the economy will reverse at some point. Even today, China has twice the weight of India in the emerging market indices.

Another interesting fact is how much time it may take for India to catch up with China. Today, India is about 20 per cent the size of China in terms of GDP. China was at the same level compared to the US in 2006. It took 15 years of extraordinary growth, a strong currency and weak US performance for China to get to 76 per cent of US GDP. This 15-year performance has never been achieved before and is widely seen as a Chinese economic miracle. We will need to pull off something equivalent to make up serious ground on China, even assuming its own growth falters to 3-4 per cent. Have we as a country done enough on the productivity side and ease of business to drive us to Chinese levels of growth? Can we let our currency appreciate the way China did between 2006 and 2021? These are questions worth asking as they will decide how quickly we can catch up.

The writer is with Amansa Capital