June 17, 2022

News in Charts: The US and China – looking to the future

by Fathom Consulting.

The views expressed in this article are the views of the author, not necessarily those of Refinitiv Lipper or LSEG.

The massive hit to living standards from soaring energy and food prices, and the looming threat of recession as central banks try to rein in inflation, are dominating public debate at present. In this note, we seek to go beyond these immediate issues and examine the longer-run prospects for growth in the US and China. Here too, the outlook for both countries appears more pessimistic than it has for some years — particularly for China.

China’s economy benefited hugely from its admission to the World Trade Organization in 2001, and in the last two decades the global economy has transitioned from a unipolar world to a multipolar one. While the US remains the world’s largest economy when measured at market exchange rates, China’s real GDP is larger when measured on a purchasing power parity basis (which takes into account the differences in price levels in the two countries).

That said, the tag of the ‘world’s largest economy’ is of symbolic importance only as, broadly speaking, the two economies are currently of comparable size. A far more interesting question is how the relative size of each economy, and the standard of living of their citizens, are likely to evolve in the future.

Long-run trends in economic growth depend on two factors: how rapidly a country’s workforce will grow and how productive that workforce is. The abundance of Chinese labour has been key to its emergence as a global manufacturing powerhouse. Its working-age population surged from around 350 million people in 1950 to more than one billion people now. In contrast, the US’s working-age population only increased by around 100 million over the same period.

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However, projections from the United Nations suggest a very different picture going forward. China’s working-age population appears to have peaked and is expected to roughly halve by the end of the 21st Century. Meanwhile, the US’s working-age population is expected to continue to rise, albeit at a slower rate than before. Collapsing birth rates and a lack of immigration account for China’s particularly poor demographic outlook versus the US. The easing of restrictions around the ‘One-child’ policy has had little impact on Chinese fertility rates, while very high costs of housing, childcare and education are major deterrents to having larger families.

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Although China’s working-age population is already in decline, this is not immediately a problem for the country as it does have two sources of underutilised labour that it can draw on – the rural population and underemployed workers. The effects of China’s demographics on growth will not be fully seen until both sources of slack have been fully eroded. Based on current trends, this could be within the next 20 years.

Productivity is the other major driver of long-run growth. In China, labour productivity has grown much faster than in the US in recent years. This is to be expected — economic theory suggests that productivity in poorer countries will converge towards levels in richer ones as ideas and knowhow created at the technological frontier spill over to, and are adopted by, the rest of the world.

However, there comes a point where convergence tends to stall. This point typically comes when per capita incomes (in PPP terms) are between 25% and 50% of those enjoyed by US citizens. The only countries to break through this ‘middle-income trap’ are either democracies (with good standards of governance) or commodity producers. China is neither, and it is therefore unsurprising to see that labour productivity growth has slowed dramatically over the past ten years. In short, China is now at the stage of development where it will benefit less from others’ knowledge and must rely more on its own ability to innovate, particularly in key emerging sectors.

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There are also question marks over the outlook for US productivity. Having grown by an average of more than 1.5% per year between 1960 and 2007, it has averaged only around 1% per year since the global financial crisis of 2008/9. Previous Fathom studies have identified a link between persistently low interest rates and weak productivity outturns. If the USA does not break out of the current low-interest rate environment (and Fathom’s most probable scenario is that it will not) then it is unlikely that the economy will see a notable pickup in productivity growth.

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All in all, in terms of both the growth of the labour force and increases in productivity, the outlook for the US and Chinese economies is less bright than in recent decades. China’s demographics look particularly challenging, and its trends in productivity are perhaps more worrying. There are, however, two main upside risks to this pessimistic long-term view — automation and innovation. Automation could relax the constraint on labour; and the fact that R&D expenditure is around all-time highs relative to GDP in the US and at all-time highs in China, suggests some cause for optimism about the prospects for innovation, and hence for future productivity growth.

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