A new research report from HSBC Global Asset Management focuses on the just-beginning transition in the Chinese economy from a investment-led rapid growth model to a more stable consumer economy model. The report titled China’s Transition Marks a New Reality for Emerging Markets was authored by Binqi Liu and Olga Yangol.

Liu and Yangol explain their perspective in the introduction to the report: “…we argue that the urbanization trend in China will help smooth the transition of the economy from a largely investment to a more consumption-led growth. While recent woes in the property sector in China have further fueled fears about a collapse in investment and growth, in our view, the more likely outcome is stabilization in investment, accompanied by a gradual rise of consumption in China.”

China Urbanization

Korea and Japan as historical examples

The HSBC report argues that it is instructive to compare China today to historical examples of countries that went through a transition in their economic models such as Korea in the 1990s and Japan in the 1970s. Lui and Yangol note that the South Korean economy grew at the rate of over 8% per year on average from the 1960s until the 1980s. Overall investment peaked by the mid-1980s and then started to slow. Of interest, the major drop off in investment and growth in the late 1990s led to a decrease of from almost double-digit to low single digit growth. Japan followed a similar model. Following burgeoning economic growth in the 1960s, investment levels hit a peak and then tumbled in the early 1970s.

China Urbanization

Although it might seem that investment-fueled growth was unsustainable and the inevitable economic rebalancing meant that growth in both countries had to stabilize at lower levels of equilibrium, the situation today in China is quite different. Both Korea and Japan suffered major external economic shocks during their transition.

China Urbanization

For Korea, the Asian financial crisis led to significant capital flight, which choked off most funding for economic investment. For Japan, it was the collapse of the Bretton Woods system (dollar convertibility to gold) that led to a much stronger yen that hurt Japan’s competitiveness. In addition, the oil shock of 1973 caused energy prices to surge and put breaks on the energy-dependent economy. Lui and yangol argue that given the absence of a major external shock, “…the rebalancing process in China should proceed more smoothly.”

Urbanization is key to China’s economic transition

China Urbanization

China is somewhat of an anomaly globally with the large size of its population and its relatively low level of urbanization. That said, urban migration has increased a great deal over the past two decades, with the urban population increasing by around 1% per year.

Given historical evidence and the recent examples of Japan and China, this trend toward urbanization is likely to continue for at least two or more decades before stabilizing at somewhere around 70% or above. The Chinese government has recently announced an urbanization plan aiming for a 60% urban population by 2020. Of import, the rising urban population in China will continue to boost demand for housing, mass transit and infrastructure, and will also eventually lead to higher wages.

H/T Managed Funds Association