The increase in the world’s China–dependence in the past few years suggests that the imminent rebalancing of the Chinese economy will have highly visible consequences for many countries. Perhaps the central defining feature of China’s economy is its dependence on investment spending. Last year the investment/GDP ratio reached 50%, a record not only for China but also, as far as we know, for any other major economy ever. However, this extraordinary investment-orientedness is about to end, and China’s rebalancing will shift the economy away from investment spending and towards consumer spending. That’s partly for ‘natural’ reasons, to do with the decline in the efficiency of China’s investment spending, the fall in the return on capital, and the changing dynamics of China’s labor market. But in addition, we think that Chinese policymaking will help to accelerate the rebalancing process, even though it’s true that in recent years Chinese governments have promised more re-balancing than they’ve delivered. Pension reform, price reform, interest rate liberalization and other measures are now helping to raise the disposable income of Chinese households and reduce their incentives to save heavily.
China’s investment-driven growth model has had a decisive impact on emerging economies in the past 10 years. It has defined the rapid growth of Asia’s regional integration: China has absorbed capital goods from Asia both as part of manufacturing production chains, as well as to satisfy China’s domestic demand. And it has helped to form a ‘China-commodities complex’, creating a high level of China-dependence for commodities exporters worldwide. The metals-intensity of China’s investment-driven growth has been particularly unique.
China’s rebalancing will certainly come along with weaker growth, and this could contain a number of threats for emerging markets, in particular . These will come in three forms: i) threats to the commodities-exporters who fail to benefit from the weaker growth of China’s commodities demand and its changing composition; ii) threats to countries who lose out in China’s pursuit of vertical integration, by which China replaces foreign-supplied inputs to the production process with its own; and iii) threats to a broader group of commodity-importing countries if it turns out that a weaker, more balanced Chinese growth has a bad effect on global risk appetite .
The threat to EM from a slower-growing, more consumer-driven China will depend largely on whether the rebalancing process is benign (more consumption) or not (less investment). The experiences of Japan in the 1970s and Korea in the 1990s are not encouraging in this respect: rebalancing in both these economies relied more on a fall in investment than a rise in consumption. In the longer term, the new shape of China’s links to EM will depend on i) which countries have a chance of supplying more consumer goods and services to China; ii) which countries have a chance of winning out as global production capacity relocates away from a more expensive China; and iii) which countries can withstand China’s emergence as a global competitor.
Our analysis of these trends suggest that Asia is by far the best-placed to take advantage of a new pattern of Chinese growth, even if it may also be the region most at risk of a fall in Chinese investment demand. South America, by contrast, will face an adjustment process that could be painful given the appreciation of real exchange rates that the region has seen in its membership of the ‘China-commodities complex’. Mexico, Turkey, Hungary, Romania, Poland, Israel, Czech, Egypt, Ukraine and others all have a chance of surviving well.
