Why Is China, the World’s No. 2 Economy, Still Called an Emerging Market?
Art by Woshibai
Is China, the world’s second-largest economy, still an emerging market country? This is more than just an academic question. Billions in international trade and investments hinge on it.
The cold reality is that China likely will remain in the EM category for some time, despite all its money and its prominence on the world scene. “It’s a developing economy and it will stay that way,” said Phil Torres, global co-head of emerging market research at Aegon Asset Management.
The reason is that it suffers from several standard maladies of EMs at their worst, which appear to be endemic: clumsy government economic intervention, a turbulent currency, and a fenced-in, stop-and-go stock market. Even though China bestrides the MSCI emerging markets stock index like a colossus, commanding 30.4% of it, Chinese shares perform little better than those of other EMs, whose economies have far less economic heft.
To be sure, China’s vast and relentlessly enlarging wealth has given it some of the trappings of a developed economy. Namely, its economic reach extends far beyond its own shores. Chinese needs for raw materials to power economic expansion have been an incredible boon to other EMs in Asia, Latin America, and Africa. As such, “China’s massive economy is important to the rest of the world,” said Ed Lopez, head of ETF product at Van Eck.
In fact, Beijing’s ambitious $1 trillion campaign to build infrastructure for nations in what used to be called the Third World, a program called One Belt, One Road, is steadily enlarging its influence. As is its expensive military build-up.
Meanwhile, China readily exploits its ongoing classification as an EM, as designated by the World Trade Organization. Staying in the EM category gives China cover to restrict foreign investments and business ownership, among other things. Thus, Beijing has the best of both worlds.
And this has led directly to the ongoing tariff war between the Trump Administration and Beijing, and round after round of seemingly fruitless negotiations. Trump has bemoaned China’s continued designation as a developing nation, tweeting: “They therefore get tremendous perks and advantages, especially over the US. Does anybody think this is fair?”
In the eyes of the president and other critics, China’s system is inequitable in requiring foreign businesses to partner with a Chinese company, hand over intellectual property, and get slammed by punitive legal actions and kangaroo-court rulings. Selling Western-made goods there is a hit-or-miss proposition, at best. Xbox and PlayStation game consoles, for instance, were barred from the Chinese market in 2014.
Ian Bremmer, president of the Eurasia Group research firm, has a definition of EMs that is cheeky, and spot-on—particularly regarding China. Emerging markets, he said, are “those countries where politics matters at least as much as economics for market outcomes.”
From the Chinese regime’s standpoint, however, the impediments to outsiders are necessary for the nation’s advancement—the bans on foreign competitive products, the government subsidies for favored companies (state-owned ones get preference), and the politically controlled legal and regulatory apparatus. Not long ago, China was a primitive land under totalitarian Marxist sovereignty. Today, the Communist Party still rules with a heavy hand, but capitalist incentives have yielded mind-boggling economic growth. So Beijing is reluctant to surrender its EM advantages.
By a Forbes survey’s estimate, China has the second-biggest collection of the globe’s billionaires, with 251. That’s compared to 540 for the US. Beyond this count, China is rapidly closing the distance with America in terms of gross domestic product. Currently, US GDP is $19.4 trillion while China’s is $12.2 trillion.
Trouble is, the Chinese growth rate is more than twice that of the US: an estimated 6.6% in 2018, versus 2.9%. If that pace is maintained, China should achieve parity with the US in about a dozen years.
One aspect of China, though, remains firmly in emerging market territory, a still-enormous degree of poverty. While rapid industrialization and government efforts have reduced the Chinese poverty level—which now is about $300 in annual income—to 3.1% from 88% in 1982, some 43 million still live below the poverty line.
All the billionaires aside, China’s current GDP per capita is $19,560, according to the International Monetary Fund. That’s a dazzling 30-fold increase from four decades ago. But it is still way lower than in the US ($65,060).
Indeed, China retains certain worst elements of EM status, which probably won’t diminish anytime soon:
Ham-handed government meddling with the economy. China’s growth story has, for the most part, been upward since the 1990s, and rapid growth betokens an emerging nation. Another attribute does, too: governmental monkeying with the free market and an overweening debt. The Chinese leadership has sought to whittle down the nation’s gargantuan corporate and personal debt loads. It fears a rash of defaults and insolvencies.
Chinese debt in 2000 was $2.1 trillion. Nowadays, public and private debt stands at $34 trillion. This debt burden is projected to increase by around 300% of GDP by 2022, says the Borgen Project advocacy group.
The upshot is a steadily ebbing growth rate. Certainly, at 6.6%, this rate is nothing to scoff at. Yet it used to be in double digits, and one could argue that a retreat to mid single digits is a mark of a maturing economy.
But much of the slowing is government engineered, evoking comparisons to inconstant rulers in down-at-the-heels countries the world around, whose wobbly economic stewardship brought their populations to grief. Sure enough, recently Beijing started to spend again, to hell with consistency. “China is a first-world economy, behaving like a third-world economy,” National Economic Council Director Larry Kudlow said last year.
An erratic currency. The Chinese currency was cheap in the last decade, with a dollar able to buy more than 8 yuan. Since then, it has mostly strengthened, partly due to the intervention of the People’s Bank of China, its central bank, in a bid to become an acceptable denomination for international trading.
Until lately, that is. From last March, it weakened again, which UBS attributes to the softening Chinese economy. Now, the exchange rate is 6.75 yuan to the dollar.
Due to China’s latest semi-austerity campaign and to the trade war, China’s slowing economic growth will help it sell more goods abroad, because its exports are made cheaper. But the situation promises to further anger Trump, which likely will result in more Sino-American trade tensions. UBS believes that the exchange rate will climb well north of 7 yuan this year.
A weakening yuan also will be of no help to Chinese leader Xi Jinping’s plan for his nation’s currency to become a stalwart of the international exchange market, a role that the dollar dominates. It certainly will be in keeping with an emerging nation, however.
Funky stock markets. Investing directly in stock issued in China, known as A-shares, is next to impossible for most foreigners. They have to buy shares listed in Hong Kong, a semi-autonomous province. Some of the larger Chinese companies, like Alibaba and China Telecom, are listed on American exchanges.
Still, trustworthy accounting and financial reporting are disquietingly scarce among Chinese companies. Furthermore, in spite of its occupying almost one-third of the MSCI EM index, its stocks’ performance has been so underwhelming that its absence is barely noted. We know this because MSCI provides EM indexes both with and without China listed.
Over 10 years, the EM index with China averaged 8.02% yearly, while the benchmark excluding China wasn’t far behind at 7.93%. The main Chinese bourse, the Shanghai Stock Exchange, is only half of what it was at its peak in 2007. It retraced some of that lost ground in 2015, and has mostly skidded since. Chinese stocks are thinly traded, and heightened volatility is the norm. Most people plug their money into the real estate market, which many fear is a bubble waiting to pop.
“You know, a lot of emerging markets never emerged,” noted Crit Thomas, global market strategist at Touchstone Investments. “Look at Russia, Mexico, Argentina.”
Might one add: China?