International | Sep 16 2009
By Chris Shaw
The popular view of the Chinese economy is that it is characterised by over-investment and under-consumption. However, Morgan Stanley points out the latter is a variable with two different dimensions, namely a domestic view and an international view.
The broker suggests the domestic dimension is based on underperformance of household consumption relative to the rest of the economy, as over the past ten or more years growth in household consumption in China has been outpaced by fixed investment growth and exports, meaning consumption as a proportion of GDP is low and has been falling.
In contrast the international dimension according to the broker is based on the fact China’s contribution to the global economy is much smaller as a consumer than as a producer, as evidenced by the fact personal consumption in the US stands at around US$10 trillion whereas in China the amount is more like US$1.6 trillion. In other words, if US consumers were to stop spending Chinese consumers couldn’t make up the difference, but if the reverse were to happen the impact on the global economy wouldn’t be as severe.
This is not how Morgan Stanley sees it. In its view China’s under-consumption on the international dimension is partly due to an underestimation of China’s consumption of services, which it estimates accounted for about 40% of GDP in 2008 and around 26% of total personal consumption.
This puts it at a much lower level relatively to the country’s peers. In nations such as the US and Japan consumption of services accounts for around 66% and 57% of total personal consumption respectively. Even among other Asian nations such as India, Korea and Taiwan the share of service consumption to total personal consumption is much higher than in China.
One reason service consumption in China is underestimated according to Morgan Stanley is consumption of housing is not adequately measured. Official statistics show it to be only about 3% of personal consumption. This is too low in its view as in the US the same measure is 16.6%, while even in India it is 6.6%. This reflects inappropriate accounting for the imputed rent of owner-occupied housing in its view, especially given the house ownership ratio in China stands at around 80%.
Personal spending on healthcare is another variable impacting on the numbers, as while in the US this measure accounts for 15-16% of total personal consumption expenditure, Morgan Stanley estimates it is only at around 6% in China, the difference again being at least partly down to poor data capture in official statistics.
So to more correctly assess the level of personal consumption in China, Morgan Stanley has attempted more of a like-for-like comparison by assessing consumption of the non-services, tradeable goods sector and here the gap is much smaller than headline data suggest with China at around 38% of US levels.
Looking at the two nations via a bottom up approach involving sales of autos, a big ticket item, and beer and milk-drink products, which are consumer staples, also shows the two countries are closer in terms of consumption than the official numbers indicate. For the former, China is at 69% of the US level and for the latter two items it is at 158% and 59% respectively.
Using other measures such as revenues for the financial and telecoms sectors also shows the two nations are closer in terms of overall personal consumption, confirming the view official data underestimate China’s consumption relative to that of the US.
Given Chinese policymakers have promoted domestic consumption as a policy priority, Morgan Stanley suggests it is reasonable to expect the incremental contribution of Chinese consumers to global consumption demand is probably not too far away from consistently exceeding that of US consumers.
Comparing the growth outlooks of the two nations supports such a view as assuming average nominal GDP growth of 5% in the US and 11% in China, an average annual rate of appreciation of the renminbi of 3.5% over the next decade and growth in personal consumption in line with GDP growth, then China’s incremental contribution to global consumption of tradeable goods and services will exceed that of the US by 2018.
This leads to the suggestion that those companies well positioned to ride both the consumption trend and demographic trends flowing from the one-child policy will be best placed to gain from the rise of the Chinese consumer.
Note that Morgan Stanley is of the view that the above assumptions are probably still favourably biased towards the US and that Chinese consumers could potentially overtake the number one global role from consumers in the US “well ahead” of 2018.
Also note that nominal GDP growth assumptions as mentioned above consist of 3% real GDP growth plus 2% GDP deflator for the US (which makes 5% per annum) and for China 7.5% real GDP growth plus 3.5% GDP deflator (which makes 11%).