This week, the US reported record growth for the 3rd quarter — 33.1% on an annualized basis. However, due to the record decline, GDP is still 3.5% lower than it was at the beginning of the year. Somewhat in contrast, China’s reported GDP makes it the first major economy to return to its pre-pandemic growth path. While official figures have to be taken with a grain of salt and the exact the number is always questionable, the strength of the recovery seems legitimate. China was the first country to feel the effects of the virus and is well ahead in the recovery. Its economic rebound is as close to V-shaped as could be hoped and is due to mainly three factors.
First, China took dramatic steps to stop the spread of COVID-19. As a result of its quarantine policies, use of mandatory testing, and city-wide lockdowns, China has seen only small outbreaks as opposed to many other countries that are experiencing peak infection rates. This has allowed China to reopen earlier and more completely than the rest of the globe. China has used this difference to its advantage by extolling the virtues of its authoritarian government over more open democracies. Needless to say, stress between the US and China has only increased as a result. Regardless, the government’s ability to contain the virus and direct businesses to reopen has allowed China to get back to work.
Second, to spur economic growth, China — like the rest of the world — provided economic stimulus. Different from most countries, however, China focused its stimulus on infrastructure spending rather than focusing on household incomes. This is a tried and true method for China. During the Financial Recession of 2008, the global economic downturn could have had an enormous impact on China due to its reliance on exporting. But, to keep the economy growing, China began to rapidly increase infrastructure spending. This spending kept people employed and the country stable. No doubt, China’s infrastructure needed modernization, but the build-out was well beyond the needs. As a result, new “ghost” towns began springing up in many municipalities. More importantly, China’s total debt to GDP ratio has gone from 150% in 2008 to an estimate of 317% in the first quarter of 2020. For a developed country, this level of debt is not out of line, and through this pandemic we have seen national debt skyrocket. However, for a developing country this level of debt is high, and more concerning is the amount of bad debt.
China has stated that the stimulus is concentrated on new hi-tech infrastructure build-out, like 5G, artificial intelligence, big data centers, etc., but despite this focus, policymakers are still depending on traditional infrastructure construction. Given that China’s physical infrastructure is already well developed, the near-term returns on these projects is likely to be low. In the short-run this spending will allow China to recover quicker than the rest of the globe, but in the long-term it will dampen economic growth.
Third, China’s exports have been shored up by strong demand for medical supplies and “stay-at-home” goods. As a result, China’s global trade surplus has grown. So between its exports and infrastructure spending, China’s manufacturing sector has recovered very quickly. Because manufacturing is a larger percentage of China’s economy than it is in the US, the quick recovery in manufacturing plays a greater role in China’s recovery than it would here. The US economy relies more heavily on services, and these industries have been slower to recover.
Although the rebound has been led by construction and industry to date, services should contribute to further growth as the slack in the labour market declines. The initial spike in joblessness earlier this year has, for the most part, been reversed. This increase in employment, coupled with easing fears of a domestic spread of the virus, should bolster consumer spending. So, it should come as no surprise if China continues to be the key outperformer. Unfortunately for the US and the rest of the globe, its recovery is doing little to boost growth outside of its borders.
Washington Trust Bank believes that the information used in this study was obtained from reliable sources, but we do not guarantee its accuracy. Neither the information nor any opinion expressed constitutes a solicitation for business or a recommendation of the purchase or sale of securities or commodities.
Washington Trust Bank.