China urbanization is far behind that of the US, Japan, Germany, and South Korea. In fact, according to a new report from analysts at Goldman Sachs, by 2050 (37 years from now) China will still be lagging behind all three countries (see chart below). China Urbanization rate will increase rapidly, but it will not be enough to catch up with more ‘developed’ countries. This will have a profound impact on the global economy and investing in China. Whether China will catch up to the US in terms of GDP is a far different question. Below is an excerpt from the Goldman Sachs report on China Urbanization followed by the full report in scribd.
China Urbanization and economic development
China’s new leadership has identified China urbanization as ‘a huge engine’ of China’s future economic development. In this report, we explain how upcoming ‘new’ urbanization (not yet well understood by investors, in our view) may differ from the earlier urbanization model of yester years, identify the key policy variables to look for in the coming months, and in turn, analyze how sectors and stock impacts may shift in the China equities space over the medium term.
First, we study what might be different for ‘new China urbanization’, and where investors may have oversimplified impressions Based on our investor interaction in the past couple of quarters, we found that investors broadly assume that focusing on urbanization as the engine of growth will mean continuing a predominantly FAI-reliant approach, unchanged from the past. We disagree. In our view, the objective is to shift to a ‘new’ urbanization model that may be quite different from the old version in various respects, recognizing a multitude of new constraints. This will likely spell more targeted/selective FAI investments than before, and the incremental benefits may accrue more to consumption/safety net areas instead.
Four common investor misconceptions, which we address, are that new China urbanization:
- Will mainly focus on accelerating the quantity of people moving into cities (quantity targets do not imply acceleration; focus is more on quality than quantity).
- Must involve significant city building (Premier Li Keqiang clarified that urbanization is not about building more cities; we see more selective/targeted investment in previously under-invested areas as a higher/earlier priority).
- Will follow the same economic model as the past few years but at a faster pace (the old model cannot sustain for long; policymakers will want to refocus and realign government officials’ KPIs in order to drive reforms).
- Will unilaterally benefit all affected sectors in accelerating demand (we see some likely shifts in winners and losers, favoring consumption areas more than before and resource-intensive / polluting areas less than before).
Second, we identify the policy variables that should be monitored in the coming months. Specifically, Premier Li Keqiang laid out five areas of policy deliberation: geographic strategy, land reform, hukou reform, natural resource support, and environmental issues. These are meant to address and reverse accumulating problems from the old urbanization model, like widening wealth disparity, depletion of resources and other side effects. In addition, we think funding sources remain a big unknown that needs to be resolved through policy/reforms. We may see more specific reforms / policy decisions on these fronts in the coming months to firm up the new urbanization path and priorities.
Finally, we identify medium-term directional impacts on sectors and stocks under our coverage. Clearly, many policy uncertainties abound, and the timeline/prioritization to achieve such targets remains unclear. Vested interests and structural obstacles may also hinder progress in the near term. However, we think the broader direction of new urbanization is clearer – to focus more on safety nets, going green, lifting standards for rural residents, etc. Compared to the ‘old’ China urbanization impacts of past years, we see greater benefits for mass market consumption, and a more selective list of investment sector beneficiaries than before. Some key sub-sectors that may benefit include mass market consumption, low-end auto, generic medicine, concrete machinery, railway and subway construction, etc. We identify a group of stocks that may be levered towards each potential policy direction, and isolate Buy rated names that look positioned to benefit medium term.
The investment community has been intensely focused on the theme of urbanization in recent quarters. Premier Li Keqiang had identified urbanization as a ‘huge engine’ of China’s future economic development1, and the NDRC has promised to unveil an urbanization blueprint by the middle of 20132. With many details of the new urbanization still to be determined, we find that many investors we speak to have already formed broad assumptions about urbanization – based largely on how things have been developing in the recent past (what we call ‘old urbanization’). We identify several misconceptions and believe that what will ultimately be unveiled will be different as the new leadership targets a ‘new urbanization’ path. In short, to a greater extent than before, quality has to take priority over quantity, with new constraints and structural objectives. We expect the incremental benefits to accrue more to safety net and consumption areas going forward. In
contrast, demand lift for investment, which has been prominent in the past and assumed to be the main beneficiary going forward, may actually be more selective / targeted than before.
How does China urbanization drive growth?
Our economics team looks at the economic benefits of China urbanization on growth in general in two ways:
1) A shift in resources from primary to secondary and tertiary industries, as the latter have higher productivity, which helps to enhance overall factor productivity. Such benefits have been experienced in many developing countries, and have been China’s primary channel of urbanization driving growth in the recent past. Our economics team estimates population migration into urban areas as being responsible for more than 2ppts of total factor productivity gains over 2004-07, but a diminishing benefit post the financial crisis at only around 1ppt per year.
2) In addition to the first and more obvious route, through city agglomeration, there is also evidence that urban population tends to be more productive through technology spillover and knowledge sharing permitted by close proximity. Such effects may help business productivity as well as create more consumption demands via positive income effects, for example. Our economics team feels that such benefits have been largely absent in China in the past, but will need to play a bigger role going forward given easy productivity gains are declining in scope. For more details on our economics team’s growth quantification analysis by various scenarios, please see their latest report titled, Global Economics Paper: 218 – China: More efficient cities key to a brighter growth path, dated May 21, 2013.
Broadly, we think the shift from mainly focusing on population migration towards the previously absent areas is what will underscore the differences for new China urbanization.
But what precisely is to come with the new leadership’s new urbanization agenda? A lot is still to be determined and we are not certain how fast or how dramatically things may progress. However, based on the information and broad framework provided so far, we see a number of misconceptions already forming in the investment community.
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