leadership change
China is currently in the process of its once a decade change in the top leadership of the Communist Party. Official nominees for the highest posts will be officially announced in about two weeks. They’ll be ratified in a pro forma vote next March.
New leaders often mean new policy directions. While the old leaders are on the way out and the new ones are waiting to be anointed, the most prudent stance for lower-level Party functionaries (read: basically everyone) is to do as little as possible that could conceivably be second-guessed later on.
During the six- or nine-month transition period, the Chinese economy slows. It reaccelerates as new leaders clarify what their priorities are.
I expect the same will happen this time around. But as I try to imagine what I would do if I were running China, I’m beginning to think that the character of China’s growth from this point on may differ substantially from what it has been to date.
How so?
is the developing country growth model broken?
The standard developing country growth model that helped the EU and Japan recover after WWII and which has been duplicated by every successful emerging economy since, is broken.
The model, which I’ve written about extensively, has two parts:
1. gear your economy toward exporting to the huge, healthy, fast-growing US, and to a lesser extent the EU, and
2. peg your currency to the US$ so foreign exchange movements won’t erode your labor cost advantage.
The breakdown has come in both areas:
1. aging of the Baby Boom is reducing the long-term growth rate of the US to around 2%. The need to repay immense government debt suggests to me that 2% will be a ceiling over the next few years, not a floor. And the EU, China’s largest export market, probably won’t show much life for the next half-decade.
2. keeping the currency peg means more or less mirroring US monetary policy, which is now calibrated for an economy in intensive care, not one in full bloom. Keeping the local currency in sync implies maintaining domestic monetary policy that’s much too loose.
In addition to this, there are signs in China that, at least on the more heavily industrialized east coast, it is running out of the cheap labor needed to fuel the export-oriented development model.
reorienting growth
For all these reasons, I think the new Chinese leadership is going to make a substantial effort to re-orient growth away from exports to the US and EU (where there’s little growth to be had). Exports will continue to go to other developing nations.
The two other areas for development are the domestic service economy and higher value-added manufacturing. In free-market economies, forces of the status quo (labor-intensive exports) typically use their substantial political clout to stifle progress here. And there are certain to be similar efforts made in China. But Party control of the Chinese economy suggests the status quo will be less successful.
investment implications
If this shift in priorities is underway, and is successful, the biggest winners will be suppliers of products and service for average Chinese consumers. Luxury goods will continue to do well, I think, but mass-market products will do better. The trick will be finding ways to play them.
On the other hand, suppliers of export-oriented industrial machinery–to some degree domestic, principally overseas-based–to Chinese firms seem to me to potentially be the biggest losers. (We may already be seeing this phenomenon in 3Q12 earnings results and in management guidance.