- China continues to play a major role in the global economy, accounting for more than 18% of global GDP at the start of 2022
- Despite the European Union’s trade deficit with China, their interdependence emphasises the impact of globalisation on global trade
- China’s GDP growth outlook, policy goals and ensnaring geopolitical risks are potential flashpoints on your portfolio
China is a big deal: it singlehandedly accounts for more than 18% of the world’s GDP (gross domestic product). Across the world’s 10 biggest economies it is the top trading partner for eight and a top five partner for the remaining two. It has the world’s largest trade surplus at $676 billion, which is roughly equivalent to the GDP of Poland. And it is the leading import market for six out of 10 of the world’s largest economies (Figure 1). Within the emerging Asian economies, China is the largest export market for these nations, highlighting its importance regionally as well.
In recent decades China has been a major driver of globalisation. According to traditional economics, the enhanced trade associated with globalisation should allow all participating countries to benefit from lower cost goods and services. These lower costs have been deflationary – for example cheap textiles and electronics – and have helped foster the low inflationary environment seen since the start of the century.
Figure 1: China biggest trading partner
Source: Bloomberg, ECTR Trade Flow function, data covers year-end 2021. Highlighted countries indicate the six out of 10 of the world’s largest economies for whom China is the biggest import market.
Figure 2 shows the European Union’s net import and export balance for the most traded goods between it and China in 2021. In total the EU ran a $249 billion trade deficit, with only Germany, Ireland and Finland running a surplus. Automotives, the healthcare sector and aircraft trade were substantial net exporters, with the likes of Airbus and Europe’s automotive sector the benefices. Turning to net imports, Europe is clearly reliant on China for electronics, particularly telecommunications equipment, as well as textiles, plastics and base metals
Gathering storm clouds
This reliance on China for basic materials and lower-end manufacturing emphasises the impact of globalisation within trade. However, US Federal Reserve Chairman Jerome Powell said recently “there is a real possibility that globalisation will go into reverse1. His comment alludes to recent events that have caused countries to question the reliability of their overseas supply chains and think about creating domestic supply chains instead. Such events include competition for Covid-19 vaccines, and the breakdown of the once heralded just-in-time supply chains and subsequent bottlenecks.
Figure 2: the EU’s net import and export balance with China, 2021 (€ billions)
Source: Eurostat, 24 February 2022. Note: the data above denotes the net import and export balance for the EU with China for the top 20 most traded goods between the two (€ billions) in descending order. Underlying data from Eurostat
Furthermore, Russia’s invasion of Ukraine sparked an exodus of companies leaving Russia on principle, gas supplies became weaponised and we saw the emergence of global food security issues. In China, there were extended Covid-19 lockdowns which restricted industrial activity, as well as accusations of anti-competitive practices and human rights concerns around the treatment of the Uyghur Muslim population. Considering the magnitude of all these challenges, domestic supply is seen as increasingly attractive for countries. As an example of this phenomenon, Apple has begun shifting production to Vietnam and India from China, especially following its recent issues with Chinese supplier Foxconn2.
Given the predominance of China, then, its future trajectory matters in three main ways:
GDP growth outlook
The Bloomberg consensus is for 5.1% year-on-year GDP growth in 20233. This may have an outsized short-term impact on more cyclical industries such as autos and aircraft, or a longer-term impact if China is no longer the engine of growth it once was. It is no secret that GDP growth has declined in recent years, albeit from an elevated level, but China’s demographics are concerning. The country’s population growth has been consistently slower than the US in the 21st century and even contracted by 850,000 in 2022 a feat once thought unthinkable. The population is also ageing with those 65 and over climbing to 12% of the total population, versus 6.5% for India and 16.6% for the US. China has also struggled with youth unemployment, which currently sits at 17%, another factor reducing the labour force4.
Finally, the elephant in the room: China’s soured real estate sector that has spurred rapid growth since the financial crisis and accounts for around 25% of GDP5. Government policy towards the sector has improved in 2023 with loosening of leverage and liquidity constraints alongside mortgage rate cuts. However, with a high proportion of developers having either defaulted or in distress the sector remains challenged and constrained.
This includes themes such as self-sufficiency in areas such as science, technology, food and base metals – the last of which has implications for global commodity prices in the event of stockpiling. Another consideration is China’s pivot to high value manufacturing such as advanced semiconductors as the country advances and its lower wage advantage erodes. The increased focus on technology was evident at the 20th National Congress of the Chinese Communist Party in October 2022, with “technology” and “talent” (in a technology context) getting 55 and 34 mentions relative to 25 and 5 at the 19th congress6.
When BP exited its Rosneft stake in Russia in February 20227 due to the invasion of Ukraine it resulted in a loss of almost $25 billion. In a worst-case scenario of China invading Taiwan you could see similar styled exits. Such scenarios aside, the ongoing US/China semiconductor dispute has seen Dutch chips firm ASML restricted from selling advanced chip-making machines to China, which saw it lose around a quarter of its Chinese revenue8. Similarly, Huawei, following spying allegations from the US, was blacklisted and blocked from acquiring US technology for its smartphones. The action resulted in a 50% drop in revenues in its consumer division, turning Huawei into a shadow of its former self9
What is clear is that exposure to China is global and widespread. While there is no one-size-fits-all solution, each country, firm, sector and investor should consider their relationship with China and their exposure to its continually evolving economy. Key factors to consider include China’s growth trajectory , the Chinese Communist Party’s policy goals and the resultant headwinds and tailwinds, and finally the geopolitical risk that investments in China carry.