Much has been said about the slowdown in manufacturing in China which has caused stock markets in China to slump as well as fan worries about a worsening global economic picture. A structural slowdown has certainly taken hold, but most analyses have only focused on slowdowns in manufacturing and fixed asset activity, both based on yesterday’s news. The Chinese leaders preemptively announced policies months ago that would halt frothy real estate bubbles. Slowing manufacturing mostly reflects the slowing exports to slowing US and European economies. However, many China analysts ignore the services PMI which is more reflective of the health of the domestic Chinese economy, and that indicator has shown nothing but consistent continued expansion. Service PMI in August was 56.3, and July was over 55.
China’s leaders have been pressured by American policymakers to increase consumption so they have responded by implementing policies that would grow China’s middle class. Labor wages in China have been increasing in the double digits for years now, and the growth in consumption is also growing in the double digits. All this is great news for Americans and the rest of the world since a growing Chinese middle class means that private companies everywhere have a new source of revenue for all their goods and services. Just ask Hermes, Dior, McDonald’s or the high end French wine makers who their fastest growing customers are in the world. By creating another enormous middle class, the private sector in the rest of the world can sell to China and thus pull their own economies out of the doldrums.
There is another great reason to celebrate China’s structural rebalancing to the service sector. As China’s economy becomes less resource intensive, it will put less of a strain on the environment, and pollution levels from rapid industrialization should start to reverse trend.
Naturally, naysayers will say that Chinese Central bankers must do more to stimulate more growth. After all, the GDP is slowing so the growth in the services sector must not be large enough to offset the slowdown in manufacturing and construction. However, it is probable that the services sector is growing sufficiently to offset the contraction in other areas. Since China is still largely a cash society, most consumer transactions are difficult to track. Increased spending in restaurants, retail, and other consumer areas are more likely to go undetected than large industrial orders. Thus, the net change in economic activity could be zero while the official GDP number appears to be in decline.
China doomsayers also say that energy usage, another indicator of economic activity, has been declining as well. Energy usage certainly is a good leading indicator for a country if the structure of the economy remained the same. But as I pointed out earlier, China is moving away from infrastructure building and manufacturing—activities which are both highly energy intensive--to an economy that will become more consumer and service oriented like the developed countries. Producing more hamburgers and hair salons will require less energy than producing more airports and highways even if the economic activity remains equally robust.
Obviously, the fate of China’s economy in the end will also be influenced by other exogenous factors such as oil prices going through the roof if Israel strikes Iran. Even China’s leadership transition this fall could introduce reasons for caution about its economy since a 70% turnover in personnel is a significant change in leadership even under favorable conditions. Such major shifts in power could create greater volatility in policy directions which usually slow economic growth so it is not surprising that the leadership recently announced a preemptive move against a more serious slowdown by providing more stimulus for infrastructure investment. But barring unforeseen catastrophes, China’s ability to serve as a continued engine for world economic growth should continue for many years to come since the service sector is still nascent and has much room for improvement. This should be great news for investors scouting for bargains during times of depressed valuations and heightened uncertainty in the Chinese market. It should also be welcome news for citizens around the world who are looking for the next leg of global growth. That growth may come from another disruptive innovation discovery somewhere in the world --or it may simply come from China's obvious need to invest in its embryonic but booming service sector.
