China’s importance in global financial markets and geopolitics is undisputed. It has the world’s second-largest economy after the US at US$18.3 trillion in annual GDP, just under 20% of total global output. It has the world’s second-largest population after India, with about 1.4 billion people. It has the world’s third-largest landmass after Russia and Canada, with about 6.3% of the total dry land on Earth. It has the world’s third-largest nuclear arsenal after Russia and the US, with 350 nuclear weapons (although that’s a distant third since Russia has 6,257 nuclear weapons and the US has 5,550). By these and many other measures, China is one of the most powerful nations on Earth.
Chinese growth over the past 30 years has been unprecedented in world history. Here’s a sample of annual percentage growth in Chinese GDP in the new millennium:
2000 8.49%
2001 8.34%
2002 9.13%
2003 10.04%
2004 10.11%
2005 11.39%
2006 12.72%
2007 14.23%
The average annual growth rate in this eight-year time series is 10.55%. The compound growth rate over the same span is 123%. Put differently, the size of the Chinese economy more than doubled in eight years.
With growth like that, it’s a small wonder global analysts confidently predicted that China would surpass the US in total annual GDP by 2030, if not sooner. Other analysts said that just as the 20th century was the American century, the 21st century would be the Chinese century.
It was expected that by 2040, the Chinese would surpass the US in all meaningful ways, including output, technology, productivity, and even military prowess. Predictions were also being made about how soon the Chinese yuan would displace the US dollar as the world’s leading reserve currency. It was all just a matter of time.
In fact, none of these predictions have come true and most likely never will. Reality has hit China watchers like a bucket of cold water in the face.
Slow growth, or even no growth?
The more astute analysts always knew China would hit the wall economically in a bigger, more momentous version of what is known to economists as the middle-income trap. Even the China boosters, affectionally, if sarcastically, called ‘panda huggers’, are waking up to the fact that China is a desperately poor country despite a long list of paper billionaires. A 30-year hypnotic spell has been broken.
To see why China will come up short of expectations, simply compare the growth figures shown above with those from 2008 and later:
2008 9.65%
2009 9.40%
2010 10.64%
2011 9.55%
2012 7.86%
2013 7.77%
2014 7.43%
2015 7.04%
2016 6.85%
2017 6.95%
2018 7.75%
2019 5.95%
2020 2.24%
2021 5.87%
2022 3.00%
The average annual growth in this 15-year time series is 7.20%. That growth rate is 32% lower than the annual rate that prevailed from 2000–07. The compound growth rate over the same span is 182%. That’s substantial, but 182% in 15 years is not impressive compared to 123% in just eight years prior to 2008. For an apples-to-apples comparison, compound growth over the last eight years was just 56%, less than half the compound growth rate of the eight years from 2000–07.
This slowdown in recent years is striking, with growth between 9.40% and 10.70% in the first four years (2008–11) compared to growth of only 2.2% to 5.6% in the last four years (2019–2022). Of course, Chinese data is routinely skewed to the upside. It is entirely likely that China’s economy actually shrank in 2022, and there’s independent data available that suggests exactly that.
It’s not enough to blame this slowdown on the 2008 global financial crisis and the 2020 pandemic. China was barely affected by the global financial crisis and posted healthy growth of 9.65% in 2008. This growth was helped by China’s precautionary savings of hard currency reserves, which commenced in the aftermath of the 1998 global financial crisis. That said, there was a sharp break between the 14.23% growth of 2007 and the 9.65% growth in 2008. Something happened.
The something was that growth in the rest of the world slowed sharply, and there was less demand for Chinese exports even though China remained well-positioned to supply goods.
China also powered through the worst year of the pandemic with 2.24% growth in 2020 at a time when US growth was negative 2.8%. By 2021, China was back to a fairly robust 5.87% growth rate.
China’s weak performance in 2022 of 3.0% growth was partly explained by the zero-COVID policy of extreme lockdowns in Shanghai, Beijing, and other major cities. That policy has now been jettisoned for a ‘let it rip’ policy, allowing the SARS-CoV-2 virus to spread and trying to deal with the results.
Still, the slowdown in Chinese growth, which will continue, is due to even larger forces than financial panic (2008) and the pandemic (2020–23). China has fallen victim to what economists call the middle-income trap.
Stuck in the middle with Xi
This slowdown was predicted as long ago as 1994 in an article in Foreign Affairs called ‘The Myth of Asia’s Miracle’ by Paul Krugman.
Economists consider a low-income country to have around US$5,000 annual income per capita. El Salvador (US$4,883), Ukraine (US$4,862), Egypt (US$4,504), and Bolivia (US$3,361) are all in that category. Middle-income countries have between US$8,000 and US$15,000 annual income per capita. Examples of middle-income countries are China (US$12,970), Russia (US$14,665), Mexico (US$10,948), and Turkey (US$9,961). High-income countries begin at around US$20,000 annual income per capita but have no ceiling. Examples include Greece (US$20,876), Estonia (US$29,344), Japan (US$34,358), and France (US$42,330). At the high end of high-income countries are the US (US$75,180) and Switzerland (US$92,434).
As an aside, comparison of China and the US on a per capita basis show that US income is six times greater than China. When nations are ranked based on per capita GDP rather than total GDP, China drops from number two in the rankings to number 65. That helps to put the China versus US GDP comparisons in perspective.
It’s also important to realise that China’s level of US$12,970 in annual per capita income is an average figure spread over 1.4 billion people. Due to China’s extreme income inequality, it’s more useful to think of China as having two populations. One population of about 500 million urban workers has an annual per capita income of about US$28,000, while a second population of about 900 million villagers has an annual per capita income of about US$5,000. That would put the 900 million villagers solidly in the lower income category, not even close to middle income.
And there’s extreme income inequality within the 500 million high-income group such that most of those would have a middle income of about US$12,000 per year, while a select few would be earning millions of dollars per year each.
Averages hide as much as they reveal. In fact, China is predominately a low-income country, with a significant middle-income cohort and a tiny slice of the super-rich. This income inequality makes China’s climb out of the middle-income ranks even more difficult. And the super-elite cohort is a potential source of social unrest among the less well-off.
Krugman’s thesis, which is widely agreed upon among development economists, if not Wall Street cheerleaders and talking heads, is that the rise from low- to middle-income status is fairly straightforward. You begin by moving tens of millions (or, in China’s case, hundreds of millions) of people from rural villages to cities. You provide decent, if spartan, housing, public transportation, and attract foreign direct investment to build manufacturing plants.
With some training, the city residents become adept at assembly-style manufacturing. Low labour costs allow goods to be assembled cheaply and exported at attractive prices. The cycle feeds on itself with more migration, more direct foreign investment, and expanded manufacturing capacity. Per capita income rises from the low- to middle-income range.
It’s important to note that this is not a high-tech production. It’s a low-tech assembly. China advocates seem impressed that 90% of our iPhones come from China. That’s true, but Chinese value-added is only about 6%. The value-added in iPhones comes from California technology, South Korean semiconductors, Japanese gorilla glass, and other inputs from 26 countries around the world. China has to import or license all of those inputs. Chinese workers then do the final assembly.
If an iPhone costs $1,000, only about $60 goes to China’s net of import costs and royalties. That’s still significant if you sell a billion iPhones in addition to textiles, pharmaceuticals, appliances, solar panels, rare earths, and much more. This assembly manufacturing model will get a country to middle-income status, but not beyond.
To make it to the big leagues of high-income status, you need high technology applied to high-value-added innovation and manufacturing. Very few countries (excluding OPEC members) have ever made this leap. The only examples in Asia are Japan, South Korea, Hong Kong, Taiwan, and Singapore.
We might exclude Japan from the list because it had achieved significant growth before the Second World War. Its performance since the Second World War is really a recovery story based on ample human capital rather than a transitional growth story. This list leaves many more countries (Malaysia, India, Turkey, Thailand, Brazil, Mexico, Argentina, Russia, Chile, and others) stuck in the middle-income trap with China.
Krugman’s point 30 years ago, which remains valid today, is that high low- to middle-income growth is not surprising and should be expected. It’s not a ‘miracle’. It’s just what happens when you squash corruption, build infrastructure, and move millions from country to city.
All the best,
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Jim Rickards,
Strategist, The Daily Reckoning Australia
This content was originally published by Jim Rickards’ Strategic Intelligence Australia, a financial advisory newsletter designed to help you protect your wealth and potentially profit from unseen world events. Learn more here.
