PILARSKI SAYS… China – From Saviour to Bogeyman

PILARSKI SAYS…

China – From Saviour to Bogeyman

The country’s slowdown, like its growth, should not have come as a surprise, writes Adam Pilarski, Senior Vice-President at AVITAS.

As featured in Airfinance Journal Column PILARSKI SAYS

China’s economic growth over the past almost four decades has been quite exceptional. From a very underdeveloped country, it has evolved into a major producer and consumer worldwide. Because of its population size and high growth rates, China has become a major player in the world, including in aviation.

Three decades ago China had only seven million passengers versus 51 million in Japan and 372 million in the US. In 2013, the same numbers were 353 million for China, 106 million for Japan and 743 million for the US.

China is the second-largest air traffic market in the world, and every business person involved in aviation sees the country as a critically important market. One-fifth of all Airbus and Boeing aircraft delivered last year went to China. Hence, the country became the perceived saviour of many businesses which were enamoured with the huge potential it offers.

Recently, China has been in the news in a much less positive manner. The slowdown of economic activity and a major stock value price bubble burst caused ripple effects on many stock markets worldwide. The adage of “when the US economy sneezes the world catches a cold” can now be applied to China, with a slowdown there negatively affecting exports in many countries. Declines in raw material prices and bankruptcies of companies selling investment goods worldwide are tied to the slowdown in the Chinese economy.

What is interesting is that many people were caught by surprise both with the tremendous growth that China experienced over the many decades and by the slowdown it faces now. Both of these developments were perfectly predictable and could be quantified.

Let us start with history. Thirty years ago I was predicting the tremendous future growth in Chinese aviation, and my forecasts were met with almost universal scorn. My rationale was quite simple. The Chinese economy was expected to grow at very high rates and its traffic was way below the level that could have been expected based on population, country size and future economy. The fact that Chinese traffic grew from 1985 until today by an average of 12.4% annually should not have come as a surprise.

Similarly, the slowdown in the Chinese economy should not catch anybody by surprise because the signs have been around for a long time. First is the population structure. The policy of restricting families to one child caused tremendous distortions in China. The proportion of working to retired people has been inevitably shrinking. Older people work less and save less, affecting the economy significantly.

Two, the structure of the Chinese economy has been out of kilter with world averages in regard to savings, investment, consumption and exports. The phenomenal growth of the Chinese economy was accomplished via high production and exports. Abnormally high savings rates in part because of the lack of a social safety net led to equally abnormally high (40%) rates of investment. As a consequence, consumption is at ridiculously low levels of below 40% against about 70% in the US. This model could work with excess farm labour from inside China moving to the rapidly growing coastal areas where exports are produced. As the stream of excess labour is getting weaker, wages go up and China is losing its competitive advantage.

The obvious way forward, pushed by virtually all inside and outside experts, is to change the composition of Chinese GDP from export to consumption based. As these developments occur, China’s trade will stop growing at breakneck speed.  Exports relied on imports of raw materials, while consumption has many elements that have no foreign component. An increasing part of consumption (haircuts, entertainment, psychologist’s visit, etc) is purely domestic in nature compared with buying raw materials from abroad for production purposes.  This is the reason why Chinese developments are having a negative impact on the world economy.

Finally, high growth rates cannot continue forever. China experienced average annual growth of 9.8% for 37 years from 1978 until today. Singapore had an average growth rate of 9.3% for 28 years from 1966-94; South Korea grew for 29 years by 9.5% annually (1966-95); and Taiwan grew for 30 years by 9.7% from 1962-92. Japan grew in the 1960s by an average rate of more than 10.4%. And what happened to all those countries in the long run? None of them have experienced anything close to the numbers of previous decades. From 2000 until 2014, Japan, South Korea, Singapore and Taiwan experienced average annual growth rates of 0.7%, 4%, 5.4% and 3.7% respectively.

Chinese aircraft manufacturer Comac’s latest forecast calls for a long-term traffic growth in China of 6.8% annually based on a 5.8% economic growth rate, a far cry from the recent heydays of double-digit growth. This is a multiple of less than 1.2 versus a multiple of over two, used when I started to do such analysis more than three decades ago. Not bad, but not the salvation of manufacturers in the future – and a totally expected and rational development.

As featured in Airfinance Journal Column PILARSKI SAYS