We know the fact that China’s economy today is about 40 percent the size of the US. But such has been the fear here of rising China and the fact that China’s done so well that it’s sort of eaten away into the psychological confidence.

Ruchir Sharma: If you look at China’s growth pattern, it’s been absolutely remarkable, unprecedented in economic history almost, where the Chinese economy has grown for the last 20 years at an average pace of around 9 percent or so.  But the most important thing when it comes to economic growth, or one of the most important things, is their starting point, which is that when you are a very poor nation, you have a lot of unutilized resources, you’re able to sort of use those resources and grow very fast to catch up with the rest of the world.  

Today China’s per capita income is above $5,000.  It is no longer a poor country.  There are many poor people in China, but it is no longer a poor country.  Today China is a middle-income country.  At that level, what we tend to see is that economic growth tends to slow down because your base has become much higher, and we think that China now is at that critical juncture.  So if you look at the other big economic stars in history such as Japan, Korea, Taiwan, they all at a similar stage of economic development saw their economic growth rate slow down.

Now in economics there’s something really familiar called the middle-income trap, which suggests that a country sort of stops growing much and is not able to converge with the richer nations.  I’m not talking about that.  That’s a very loose concept, it’s a very crude concept, and it’s hard to know when to apply it.  What I’m saying is that in China’s case currently we are likely to see a middle-income deceleration in line with what Japan, Korea and Taiwan saw when they reached a similar per capita income level adjusting for exchange rates.  

So the fact is that today China is at a level where its economic growth rate is bound to slow down because its per capita income level is more than $5,000, and it is also an economy that now doesn’t have some of its traditional drivers working for it the way it did over the past few decades.  For one, its investment ratio is very high.  The fastest driver of economic growth in any economy which is growing quite robustly tends to be investment, but China’s investment, the GDP ratio now is quite high at nearly 50 percent.  Its export share of the global market now is very high at about 10 percent.  That’s similar to what Japan had when its economy also started to slow down.  

And China today is also dealing with wage pressures for the first time.  This was unheard of which is that in the past we thought China had an endless pool of labor that could keep coming to the global marketplace and producing goods at a very cheap rate.  But now Chinese wages are increasing quite rapidly, so that pool of labor is being exhausted.  And it’s partly because a lot of the Chinese now have moved to urban centers.  For the first time China’s organization ratio now is more than 50 percent, which means more than 50 percent of China’s population now lives in urban places.  So the scope for a productivity boost coming from rural to urban migration is also slowing down.  

So these are the factors I can show are coming together to argue why China’s growth rate now is likely to slow down to about 6, 7 percent at best, rather than the 8 to 9 percent that the world has gotten so used to over the past 30 years.

If China sort of glides to this path that I’m talking about of 6 to 7 percent, I think that it could be good for the United States at the margin.  The most important effect here will be two—one psychological and one real.  The real effect will be that if China slows down to 6 or 7 percent, I think a lot of the commodity prices today which are very high and hurt the US consumer, including oil, will cool off quite a bit.  And I think that that could be very good because the lower commodity prices from oil to other commodities essentially means that that’s an inflation, sort of—that’s a tax cut being passed on to the US consumer because it sort of helps their pocket with lower prices.  So I think the biggest real implication could be the lower commodity prices could help the purchasing power by lowering commodity inflation.

The other positive is the psychological effect.  Like there was this Gallup survey carried out like over a year ago which showed that more than 50 percent of Americans today believe that China is the world’s largest economy.  Now this is not true.  We know the fact that China’s economy today is about 40 percent the size of the US.  But such has been the fear here of rising China and the fact that China’s done so well that it’s sort of eaten away into the psychological confidence, I feel, of the US a bit.  And I think that if China slows down to a more reasonable base that will make them feel a bit better in terms of the fact that the US is still in the growth game and has not been beaten to dust by these outside countries such as China.

Directed / Produced by
Jonathan Fowler & Elizabeth Rodd