Comparing China and the West

There follows my Fund Strategy Polemic column for July.

For all the talk of a possible bubble in US technology stocks, the rise in the Nasdaq over the past year is dwarfed by the surge in the Shanghai and Shenzen stockmarket indices. Draw lines on the same graph representing percentage change over the past year or so and the American index’s rise seems ever so gentle. Of course things could change quickly.

At the time of writing there were already signs of wobbles in the Chinese markets. Sharp corrections have also happened before. The Shanghai Composite dropped precipitously in the months following its late 2007 peak. The problem is that comparisons between China and America, or indeed other developed economies, can be misleading. Although it is possible to use the same metrics in both China and the West, such as price-earnings ratios, the context is entirely different. The Chinese economy still works according to different dynamics than its western counterparts. Although most commentators pay lip service to these differences they tend to downplay their significance.

China is seen as in many respects similar to the western economies but with an oversized state and a different cultural context. As it happens the Chinese state is smaller than those of western economies, at least according to one widely accepted metric. The IMF estimates total government spending as a proportion of GDP at 29.6 per cent in China compared with 41.5 per cent for Britain and 36.8 per cent for America. This is a salutary reminder that, despite all the talk of free markets, the state plays a substantial role in western economies. 

Despite nearly four decades of economic reform it is misleading to describe China as a market economy. State-owned enterprises still play a substantial role and the leadership of the Chinese Communist Party (CCP) remains paramount. The ruling elite is focused more on maintaining order than in creating the conditions for profitable businesses. From this perspective the main purpose of promoting economic growth is to maintain the government’s legitimacy. Rising prosperity is a powerful incentive for the population to conform but the CCP offers relatively little else.

The recent focus on managing an orderly slowdown in growth is designed to maintain growing affluence while avoiding an economic crash. To be sure a consistent annual growth rate of even 6 per cent – that the IMF forecasts for China in the latter part of this decade – would be beyond the wildest dreams of the western economies. But expectations among the Chinese population are high and the official figures could well overstate the rate of expansion.

High expectations among the Chinese population point to a second important difference with the West. Amid all the talk of China as an economic giant it is often forgotten that it is still an emerging economy. Its huge population means that it can have a large GDP even when income per person is relatively low. Even on a purchasing power parity basis, that is taking into account lower prices, GDP per head in China is far lower than in the West. According to the latest figures from the IMF the US was on about $55,000 in 2014, the UK $39,000 and China $13,000. That puts China slightly below the likes of middle-income countries such as Colombia, Serbia and South Africa in terms of income per head.

The existence of a still sizeable rural sector also indicates that China still remains a developing economy. According to official figures from the World Bank just under half of the population is rural. In some respects this gives a misleading impression since many who live in the countryside work in services or industry. But the proportion of the labour force that still works in agriculture is many times that of America or Britain.

China’s massive scale represents another important difference between China and the West. In many respects the Asian giant is better seen as a continent rather than a country. Regional differences can therefore taken on more importance than might be expected The hukou system is one indication that the ties between the different regions are often different from what might be expected of a fully unified state. Essentially an individual’s access to education, healthcare and housing is tied to their hometown or village. In effect this amounts to an internal system of control on the huge numbers of migrants who travel from their homes to other regions of China to work. The movement of labour within China is far from free.

Just because it is possible to use the same economic and financial indicators it does not follow that China is essentially the same as the developed economies. Despite the extensive reform process set in motion in 1978 it should not be forgotten that fundamental differences remain.