As everyone already knows, the biggest real estate story of 2019 was the August debut of Small Talk in The Real Deal. But 2019 is over, and like all good real

Will China pass the US in GDP any time soon? Why or why not?

To make that type of prediction, you’d have to get some sense of China’s past GDP growth rates and whether they might decelerate in the future. Here is how reported China’s GDP growth has looked in the last few years[16]:

Note that growth was consistently around or in excess of 10% per year, and then dropped in the global financial crisis in 2008 and 2009, recovered in 2010, and then in 2011-2013 dropped below 8% per year.

China’s growth is projected to decelerate further in 2014.[17][30] Notice how the growth rate keeps declining.

What’s going on?

China grew rapidly in the past because of its low labor costs.

Now, labor costs in China have risen so much that in many cases labor from Mexico is cheaper than that of Chinese labor. Many countries now have lower labor costs than China.

Mexico’s hourly wages are about a fifth lower than China’s, a huge turnaround from just 10 years ago when they were nearly three times higher, according to new research by Bank of America Merrill Lynch.[4]


This suggests that China’s growth should ALREADY be starting to slow down, and this is the case.

“We cannot deny a downward pressure on economic growth,” Xu Shaoshi, minister in charge of the National Development and Reform Commission.[1]

Xu said the nation’s traditional growth pattern is challenged by rising labor and environmental costs, according to Xinhua.[1]

“Future economic growth may soften,” Zhang Liqun, a researcher with the Development Research Centre of the State Council, said in a statement.[19]


As China becomes more prosperous, it is starting to care about the environment and efforts to be more of an environmental steward increase China’s costs further.

Another point is that businesses in China do not pay the true cost of coal, oil, and electricity and other power costs[5], which makes their cost cheaper than would otherwise the case. If the government were to reduce its subsidies, growth would decline, because Chinese companies would lose a small portion of their pricing advantage. It’s possible that as it begins to care more about the environment these subsidies may wane.

Beyond rising productivity and rising wages in general, one other factor impacting wages is minimum wage laws. Minimum wage laws are common in developed countries like the United States. Because these laws raise the wages of those with the lowest incomes with less impact on those with higher incomes, their effect is that wages of those earning the least will rise more overall wage growth, which will further erode China’s labor cost advantage.

Minimum wages should rise until they reach at least 40 percent of average urban salaries by 2015, according to a guideline in a 35-point income-distribution plan issued by the State Council in February 2013 to tackle the country’s widening wealth gap.[27]

Another point is that China’s growth has been fueled by migration from rural areas to cities, but that’s slowing down too.

The urban population was growing at 3% a year early this century but this fell to 2.5% in 2010 and is projected to grow by only 1.5% at best as overall population growth hits zero by around 2020.[6]

This is important because productivity in rural areas is less than half that of urban areas[22-24] So urban migration will boost productivity growth less going forward. The urban population is currently over half the total population.[26]

Another point is that the percentage of the population over 60 will rise from 14% to 30% over the next 35 years or so.  The result will be that some portion of the population will gradually be leaving the workforce, as they get old.[7] If the working age population drops from 86% to 70% over 35 years, that’s a decline of 0.6% per year. This will reduce GDP growth.

In addition to the fact that China’s population is getting older, it’s also expected to shrink.

China … will peak at 1.4 billion people in 2025 and fall back to just over 1 billion by 2100.[25]

That’s a decline of about 0.45% per year from 2025 to 2100.

Further, unsustainable lending growth and a shadow banking system have bankrolled infrastructure and development projects which have inflated China’s GDP.[28] China has increased its debt to GDP levels in an effort to increase its growth. China is now making efforts to curtail its shadow banking system.

The central bank is walking a tightrope as it tries to rein in banks and check the dangerous surge in credit, now 220pc of GDP according to China Securities Journal.[2]

Growth in lending has been 20pc to 30pc a year since the Lehman crisis, when China ramped up credit to cushion the global trade shock. Rating agencies says this is far above the safe speed limit.[2]

China’s National Audit Office last estimated in 2010 that local-government debt stood at 10.72 trillion yuan ($1.75 trillion), or 27% of GDP. But, by all accounts, it has exploded since then, with some estimates suggesting that the load now accounts for 60% of the economy[11]

China’s local-government debts have climbed to 17.9 trillion yuan ($3 trillion) by mid-2013, latest official data showed, sparking further concerns about local governments’ fiscal conditions and risks in the country’s financial system.[20]

[12]

According to Standard & Poor’s, 80% of local government bonds are owned by Chinese investment firms, which manage money for individuals and insurance companies, and some of the bonds have ended up in wealth-management products sold by banks to individuals. Foreign investors have negligible access to the bond market at the moment.[12]

“Since many local governments use land as collateral for their debt, a potential fall in China’s property market will pose huge risks to them,” said Terry Gao, a senior analyst at Fitch Ratings. That puts Beijing in a difficult situation. If it continues to try to push down property prices, which have been climbing rapidly, it risks leaving itself saddled with more bad debt from local governments.[12]

The last big concern is that governments spent the proceeds of the bonds on unnecessary projects that are unlikely to boost local growth, which would make it harder to pay off the bonds.[12]

[13]

[14]

[15]

[15]

[15]

It’s clear this credit growth is unsustainable and has been artificially inflating China’s growth numbers, so reasonable forecasts would take this into account by making future projections that are considerably lower than recent growth.

It’s not clear whether this debt-fueled spending was economically optimal either, raising the possibility of future write-offs. If bad loans were made, lending may decline and debt to GDP ratios may decline, which would further eat into growth prospects.

One other issue is that China’s savings rate is very high — it may be the highest in the world — and exports have driven growth historically.

China’s economic growth has become increasingly dependent on increases in investment and net exports. The government has recognized the need to expand domestic consumption and rebalance its economic growth, but actual progress in that direction has been very limited.[3]

China has been talking about this issue since 2004[3] without much progress.

If China were to institute more of a social safety net (e.g. unemployment benefits) people might feel a need to save less.

China could also allow consumers to take on more debt when buying real estate. In China, the official minimum downpayment is 30% and interest rates are around 6.6%.[9] China’s residential mortgage debt is much lower than that of the U.S. In 2009, it was 15% of GDP vs. 84% in the U.S.[9] It would likely have to balance this by making there is enough construction to satisfy the resultant demand this would cause. This would also reduce upward pressure on the yuan.

As an alternative, China could allow the yuan to appreciate. That would increase the buying power of Chinese citizens, but its exports would become less competitive, causing growth to slow down further. The yuan appreciated for several years as China has pursued this course of action. Yuan appreciation helps mollify complaints from trading partners that the yuan is artificially low.

If growth starts to slow, and China begins to import more and export less, the yuan won’t appreciate indefinitely.

China’s current account surplus has been declining as a percentage of GDP. If it keeps declining, there will be less cause for the yuan to appreciate.

If people in China needed to save less money for housing, the savings rate in China may decline.

It’s worth looking at Chinese housing prices. Here is a graph[8] that shows how China’s cities compare to other international cities in terms of affordability:

These figures may overstate the expensiveness of Chinese cities because tax evasion efforts and the fact that grey income is not reported.[9] Still it’s worth noting that these ratios are typically lower in developing countries and China is the only developing country on this list.  Beijing for example has a per capita GDP that is 1/4 that of New York, yet its house price to wage ratio is 3.5x that of New York.

It’s true that there are a number of vacant houses built by developers who are unable to recoup their investment while those houses remain unsold. Normally developers with unsold real estate would have to dump them on the market at low prices or declare bankruptcy. However, in China because of laws that limit the incidence of bankruptcy there is not that sort of pressure.[29]

Price appreciation has been inconsistent in recent years.[10]


Clearly any deflation in housing prices would hurt lending and GDP growth, but it’s not clear if or when this would occur.

Beyond that rich Chinese people, sensing deflation may choose to sell real estate and other Chinese assets and park their money outside of China, which would likely cause the Chinese yuan to depreciate.

Any currency decline could be problematic as Chinese companies are beginning to be exposed to foreign debt.

Chinese corporations have taken on $1.5 trillion in foreign debt in the past year or so, where previously they had none.[31]


Another point is that a lot of people don’t trust China’s GDP figures and believe they may be overstated by 30% or more.

various economists, including some at the Conference Board, [believe] that actual Chinese GDP is probably a third lower than is officially reported. [31]

Other related figures may be inacccurate as well.

For a time we started to look at numbers like electric-power production and freight traffic to get a line on actual economic growth because no one believed the gross- domestic-product figures. It didn’t take long for Beijing to figure this out and start doctoring those numbers, too.[31]

If you put this all together, China is really in a more challenging position than is widely acknowledged.

If we assume export growth slows due to labor and environmental cost issues, urban migration slows, lending growth slows, and/or the yuan appreciates (which further reduces the growth of exports), a likely scenario to consider is that it’s possible China’s growth may slow down further.

The result is that it will take longer for China’s GDP to exceed the U.S.’s GDP than would be the case if its present rate of growth were to continue.

All this needs to be properly incorporated into forecasts.

Some people use China’s PPP GDP in their forecasts. This is misleading. PPP is a calculation that assumes the yuan is undervalued and attempts to compensate for that. That’s not necessarily a fair assumption. When you look at China’s GDP on a nominal basis, it’s smaller than if you look at it on a PPP basis.

On a nominal basis China’s GDP was around half that of the U.S. in 2012, but it has over four times the population, so it should be able to overtake the U.S. eventually.

If you wanted to model an average of 6% GDP growth for China vs. 2.3% for the U.S. and 2.3% yuan appreciation per year, then you’re looking at China’s GDP surpassing that of the U.S. in the early 2020s.

If you go with China’s pattern of lowering growth targets on a yearly basis, you might model 8% in 2013, 7.5% in 2014, 7% in 2015 and so on. The real question is what the terminal growth should be.

If you wanted to model 5% GDP growth for China in 2017 and after, and 2.3% growth for the U.S., and limited yuan appreciation, then China surpasses the U.S. in the mid 2030s.

If we assume growth in China slows, to say 7% in 2014, 6% in 2015, 5% in 2016, and 4% thereafter, and the yuan appreciates 3% per year from 2013-2016 and doesn’t appreciate thereafter, and the U.S. grows by 2.3% per year, then you’re looking at China’s GDP surpassing that of the U.S. some time in the 2040s.

Keep in mind that China’s working age population will be declining, as outlined above. Productivity growth in the U.S. has been 1.8%, historically. If we assume 2% higher productivity growth in China long term, that’s 3.8%. If you assume a reduction of 0.6% because the population is aging that’s as low as 3.2% GDP growth in China — which is downright scary. You might raise that number by 0.25%-0.5% to account for urban migration for 10 years or more from 2020 to 2030 or more — so 3.45%-3.7% GDP growth or so during that time. If China allows its citizens to borrow more than they currently do, and domestic demand picks up, maybe prices in China rise, and the yuan appears less undervalued on a PPP basis, and there is much less pressure on the yuan to rise — so you could even assume the yuan stays relatively flat. That would work out to China passing the U.S. in the 2060s.

If you factor in a declining population for China of 0.45% per year from 2025 to 2100, and a population that doesn’t get older or younger on a percentage basis after 2050, that would push the date out further. However, you could just easily push the date forward by assuming faster productivity growth.

We really don’t know how much productivity growth will be in China now that its labor cost advantage has eroded. China could keep growing at a reduced rate or it could slow down a lot.

The point I’m trying to make here is that China’s economy is likely going to slow down and it’s very difficult to predict how much it will slow. There is a dearth of data and there is a lot of government control that will determine how things play out. The best you can do is assemble some relevant facts to guide predictions.

[1] China Estimates 2013 Growth at 7.6% as Challenges Seen Ahead
[2] China’s cash crunch threatens Shadow Banking shock – Telegraph
[3] Page on Csis
[4] UPDATE 1-Mexico hourly wages now lower than China’s-study
[5] Developing Countries Subsidize Fossil Fuels, Artificially Lowering Prices
[6] China’s Urban Slowdown: fewer Chinese are moving to cities, threatening Beijing’s plan to raise GDP through urbanization.
[7] China’s Demographic Collapse
[8] China’s Housing Market Is In Recovery Mode, But Is That Good News?
[9] Re-Examining The Chinese Property Market: Deflating Bubble Fear
[10] Rapidly rising house prices support fragile Chinese growth
[11]   Has China’s Debt Crisis Moment Arrived? – MoneyBeat – WSJ
[12] China’s local governments have piled up a mountain of debt, worrying economists
[13] DEBT: The US Vs. China
[14] China ‘Addicted’ to Debt, at 205% of GDP: CLSA
[15] China’s credit-to-GDP ratio, updated (and why it matters)
[16] China GDP Annual Growth Rate
[17] China May Cut 2014 Growth Target to 7%, State Economist Fan Says
[18] China’s savings rate world’s highest
[19] China Manufacturing Gauge Slips in Sign of Challenges for Xi
[20] China’s local debt surges, sparking concerns
[21] Year in Review: Developed economies retake growth-engine role.
[22] Page on Worldbank
[23] Urban-rural income gap gets bigger: report
[24] Urban-rural income gap narrowing in China
[25] Japan is rapidly losing population—and half the world is about to join it
[26] China’s Urban Population Exceeds Countryside for First Time
[27] China Wages Seen Jumping in 2014 Amid Shift to Services
[28] Shadow Banking Risks Exposed by Local Debt Audit: China Credit
[29] Your Best Investment In China In 2014
[30] China Provinces Set Lower Growth Goals for 2014
[31] Why Beijing’s Troubles Could Get a Lot Worse