Many commentators and analysts of the Chinese economy are obsessed with manufacturing PMI, which measures the health of the industry. It is regarded, rightly so, as an important gauge of the world’s second largest economy.
However our obsession with PMI, which comes out every month, is causing us to miss a bigger story about the transformation of the Chinese economy from the world’s factory to a service-based economy.
If you look at China’s first quarter GDP data closely, the services sector now accounts for 49 per cent of the Chinese economy. On the other hand, the much talked about Chinese manufacturing industry is only 41 per cent of the economy.
HSBC Purchasing Managers’ Index has been consistently weak since January this year, hovering below the 50 level which indicates contraction. However if you look at service industry PMI it tells a different story -- it is consistently above the 50 level, which signals expansion.
In fact, in certain sectors like hotels, wholesaling, water transport and the internet, the PMI is actually in the highly expansionary region of the 60s. The Chinese services industry has been expanding faster than the manufacturing industry since August of 2012 and overtook manufacturing to become the most important pillar of the economy last year.
Though manufacturing will still be incredibly important to China for many years to come, it is important to bear in mind that the growth in the services industry is going to be the new engine for the Chinese economy.
The imbalance between consumption and investment is often described as the Achilles Heel of the Chinese economy. Investment accounts for nearly 50 per cent of the economy and that is higher than any other major economies, including Japan and South Korea during their boom years.
Consumption as a share of GDP has been declining and it has fallen 10 per cent in the last decade. But this does not mean that Chinese consumers are not spending money. In fact, China has been enjoying the strongest growth in consumer spending in the last three years, according to IMF data.
IMF’s chief representative in China, Steven Barnett, explains the big reason for the decline in consumption as a share of GDP is that economy has been growing fast, even faster than consumption. This is just arithmetic.
But in real terms, consumer spending has been increasing at 9 per cent every year for the last decade. That just happens to be slower than the double digit growth in the GDP over the same time. However, this relationship has changed in the last two years.
Chinese consumer spending has been growing at 10 per cent since the beginning of this year while GDP growth is decelerating. If this trend persists, we are going to a see a noticeable drop in investment as a proportion of the total GDP.
The strong growth in consumption is made possible in substantial increases in wages. Both urban and rural residents have been enjoying strong income growth for the past years. For example, the real wages increase for Chinese rural residents was 10.1 per cent during the first quarter of 2014 and urban residents’ income increased by 7.2 per cent.
Wage increases in China continue to outstrip economic growth and also signal the end of cheap labour in China.
On the investment front, Beijing is taking its feet off the accelerator slightly this year. Fixed asset investment, one of the most important engines for growth, is slowing down. Investment grew 17.6 per cent during the first quarter, a decrease of 3.3 per cent compared with the same period last year.
It is also important to see the private sector is doing most of the investing. It accounted for 64.8 per cent of total fixed asset investment in China during the first quarter. This is a far cry from a few years ago, when state-owned enterprises were leading the charge in investment.
There are positive signs that China’s once unbalanced economy is showing signs of re-balancing. We are likely to see the services industry and consumer spending becoming more and more important to China.
But don’t expect it to happen overnight. For an economy the size of China, it will take years if not decades to address the excess of the past. But the transformation process will not only bring benefits to Chinese consumers but also global suppliers who can satisfy their growing demands.