Population, education and innovation: The long, medium and short-term drivers behind China’s future growth
China has been among the world’s fastest-growth economies over the past 40 years since the ‘reform and opening-up’, and is widely considered an economic miracle.
Looking forward, we believe China’s economic growth will continue over the long term, though the growth rate should slow down.
Education dividend: Fuelling long-term growth and innovation
High-quality labour supply has been a key contributor to China’s economic success. Since the higher education reform in the late 1970s, there has been substantial improvement in the capacity and quality of China’s tertiary education system.
Nowadays, China produces more than 8 million college graduates a year, compared to only 1 million 20 years ago and less than 20,000 four decades ago.
In addition, more than 600,000 graduates who study abroad return to China every year. This provides Chinese corporates with abundant supply of well-educated and highly productive young talent.
This is a notable improvement from just less than a decade ago when many young workers would typically try to get jobs at production lines in good factories.
Supported by the large supply of talents, Chinese corporates have been evolving and increasing their budget in research and development (R&D) rapidly. China’s R&D intensity has risen from 0.9% of GDP in 2000 to 2.2% in 2019, putting it on a par with the average OECD countries.
In dollar terms, China now spends more on R&D than any other countries in the world except the US, and is set to surpass the US in coming years.
We believe this virtuous dynamic will continue over the coming decades, helping Chinese corporates and talents improve their innovative capabilities.
Population ageing: A double-edged sword
Population ageing is another major long-term trend that poses both challenges and opportunities for China. China’s demographic is set to undergo significant changes in the decades ahead.
Currently, people in the 45-54 age group represent the biggest cohort at around 17% of the total population. Over the next decade, some of the workers in this age group will reach retirement age and leave the workforce gradually, leading to shrinking working-age population and potentially weighing on economic growth.
And yet we are optimistic that technological advancement in areas such as automation and machine learning can help boost labour productivity and therefore mitigate some of the negative impacts of population ageing.
Companies that are able to reap the benefits of the new technologies could continue to enjoy fast growth. Meanwhile, the ageing trend could be an opportunity for healthcare companies that provide services to the ageing population.
Companies in elderly care, nutrition food, tourism, or even the pet industry, could also benefit from this trend.
Medium-term challenges
Over the medium term, we do see some macro challenges for China. To start with, China has been aggressive in both fiscal and monetary stimuli since the US-China trade war started in 2018, in the form of significant tax cuts, fast credit growth, strong government spending and subsidies, and huge amount of shanty town redevelopment stimulus.
In particular, household borrowing has expanded rapidly over the past five years, rising from 36% of GDP at the end of 2014 to 56% of GDP at the end of 2019.
Meanwhile, micro lending to SMEs has also been boosted significantly in the past two years.
To put things in perspective, total household debt has gone from 23trn RMB to 55trn RMB between 2014 and 2019, a staggering increase of over 30trn RMB.
We think the fast growth in household debt has played an important role in boosting consumption expenditure in China, which grew from 26trn RMB in 2015, to 38.6trn RMB in 2019.
As the household debt level is now already high, while fiscal budget is strenuous, credit growth over the next few years will likely have to slow. Investors that are expecting the same pace of GDP growth as in the past decades could be disappointed.
Moreover, default rates for consumption loans, micro lending and other corporate and local government debt will likely surge in coming quarters, especially considering the economic impact of Covid-19.
Chinese regulators have again emphasised strengthening financial regulation and containing financial risks as top government priorities of late.
Having said that, given the size and depth of the Chinese economy, even at a slower overall growth rate, there will always be segments of the economy and companies that can enjoy decent growth opportunities.
Meanwhile, while it is no easy task to contain financial risks and balance growth with stability, we are optimistic on the Chinese government’s ability to address these challenges given its impressive track record on execution.
Stockmarket: Wide dispersion and long-term opportunities
In terms of the stockmarket, Chinese equities have had a wild ride over the past year. At this point, we think there is already euphoric sentiment in some segments of the market, fuelled largely by global central banks’ ultra-loose monetary policy to keep the global economy afloat.
Meanwhile, there has been wide dispersion in stock performance as the price rally has so far been concentrated in certain segments and styles of the market, likely driven by speculative fund flows. This leaves many good quality but unloved stocks at attractive valuations.
Therefore, while a part of the market is very expensive relative to fundamentals, we are still able to identify good companies that are trading at highly attractive valuations.
Investors can take advantage of this opportunity to invest in under-appreciated and under-valued Chinese stocks, which we believe can bring decent returns over time.
Gary Cheung is portfolio manager of the Morgan Stanley China A-share Equity Strategy