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Welcome to the Developed World – Turning the Chinese Consumer On

March 7, 2016

This week’s market action saw the DJIA back above 17,000 and the S&P 500 now down only 2% for the year. It is striking that the two largest sells-offs since last August are attributable to one issue: fear of a slowdown in the growth of China’s GDP.

China’s growth as a more open economy began in 1978. In the following decades, investors became used to staggering GDP growth which consistently produced around 10% expansion per year and as high as 14.2% as recently as 2007. More recently growth has slowed, with around 7% becoming the norm. As a result, the market now fears a massive slowdown – a worry exacerbated by skepticism about the Chinese government’s numbers. However, investors must ask themselves if these fears are really warranted?

China is currently at an inflection point. It is no longer an emerging nation and yet it is still short of being developed nation. Let’s look at some simple data for clarification.

Macroeconomists like to break down economic activity to help understand behaviors and prospects. At its simplest, GDP growth is derived from three major components: agriculture, industry, and services. Most emerging countries are characterized by the size of the agricultural component, the low cost of cheap labor, and an undeveloped infrastructure for manufacturing and industry. Historically, it is the shift away from reliance on the agricultural market that defines movement from an emerging to a developed economy. This shift is still underway in China. For example, the World Bank shows that between 2000 and 2014 the share of China’s economy accounted by agriculture fell from 15% to 9%. By contrast, the services sector grew from 40% to 48%.

Common among most of the developed world is the large share of GDP derived from the services sector. These are the economies where the consumer rules. We all are too familiar with our own economy: when the consumer slows their spending, the economy slows, but what about China where the consumer is only starting to contribute to growth? China’s past focus has been to develop the infrastructure to become a manufacturing powerhouse, which led to the 10%+ GDP numbers. So now that their roads, power plants, factories, and housing are in place. The question for China becomes “now what?”.

China is no longer an emerging country from the perspective of industry and manufacturing, but they are still emerging from the consumer services point of view. Many cultural issues must be addressed for the consumers in China to take that next bold step of spending money. Chinese save 30% of their disposable income, while the US consumer saves about 5%. Turning the switch on for the Chinese consumer will be the next transition for this economy and the world is watching and hoping. If China can turn consumerism on – look out.

Carl Gambrell

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