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The Oz trial

True, the data didn’t worry Donald Trump. On the contrary, they prompted the instinctive mercantilist to tweet that China will be more desperate than ever to avoid the tightening of US trade tariffs due on 1 March.

Actually, probably not. But that’s not the issue anyway. The question is whether China’s growth will be sufficient to add a noticeable shove to the developed world’s stuttering economies; either by demanding more of the west’s capital goods to help fulfil its own capital formation, or – as is increasingly the case – by grabbing more western consumer goods and services. Such stuff may now be old hat to the affluent of Shanghai and Beijing, but it’s still ‘must have’ for the aspiring middle classes of Bozhou, Xiangtan, Chengde or any one of 100 substantial Chinese cities that you and I have never heard of.

Put it this way, even if China’s growth fades to 6.2 per cent in 2019 – the rate that the International Monetary Fund (IMF) forecasts – then its additional output will run to amounts that would have had the developed world’s economists, business people and investors in paroxysms of ecstasy had they been generated in, say, 2008.

The point is that we put too much emphasis on the rate of China’s growth and not enough on the quantity of its output. Sure, assuming that output in 2019 runs out at the IMF’s forecast, that will mean for four years running China’s growth will be only ‘six point something’ (see Table 1). For those still trapped in the notion that double-digit growth in China is both a given and vital for the West’s happiness then that would, indeed, be a problem.


Table 1: China – output and growth
 Output ($bn)% change on year'Oz' multiple
*Output & 'Oz multiple' based on current US dollars; % change on year based on local currency at inflation-adjusted values
Source: World Bank


But the China of Xi Jinping (pictured) is a different beast from the one controlled by his predecessor, Hu Jintao. Apart from being much more assertive, it’s much bigger. When Mr Hu became general secretary of the communist party in 2002, China’s output was just short of $1.5 trillion. When he left office in 2012 it was $8.6 trillion and in the year just began it’s likely to chase $14 trillion.

Size brings constraints, but it has advantages. Let’s explain, beginning with some background. Using output based on local currencies expressed at constant rates – the best way to quantify a country’s performance – China’s output grew at 9.2 per cent a year from 2002 to 2019 where the rate peaked at 14.2 per cent in 2007 and was in double figures five years running, 2003-07. Now the rate of China’s expansion is slowing, but its bulk continues to grow, so the extra output that it dumps into the global pool makes an increasingly big splash. Arguably, the best way to illustrate this is to quantify the annual increase in China’s output in relation to the total annual output of another country.

The one chosen for comparison is Australia and in 2017 – the full set of data for 2018 isn’t yet available – the growth in China’s output was 0.8 Australia's, which was above its average of the past 18 years (see Table 2) and more than the US – the world’s biggest economy – managed.


Table 2: China compared
Annual growth in output as a fraction of Australia's total output
Source: World Bank


For clarity’s sake, let’s spell out what we’re doing. Measuring each country’s output in current US dollars, Australia’s GDP was $1,323bn in 2017. In that year China’s GDP rose from $11,191bn to $12,238bn, an increase of $1,047bn. And that increase alone was 0.8 times Australia’s total output. In other words, just the increase was all that all of Australia could manage bar, let’s say, the contribution of Queensland; that’s a guess, but you get the idea.

Hopefully, expressing China’s growth like this underlines the sheer quantity of it in a way that using annual growth rates cannot. Back in the early 2000s – when the west was very excited about China’s rise – the country only managed to grow by about 0.3 Australias a year. However, as Table 1 shows, the ‘Oz multiple’ in the second half of the period 2000 to 2017 is, on average, noticeably higher than in the first half despite the slowing growth rate – a proof, of sorts, that China continues to supply what the world so badly needs.

And it does so more effectively than any other nation. Sure, the US remains the world’s biggest economy, with output approaching $20 trillion in 2018. But its ability to supply additional Australias year after year is diminishing. Back in 2000, the $624bn increase in its GDP was 1.5 times Australia and right up to the 2008 global financial crisis, the US was averaging 1.1 Australias. Since then, however, the reversal has been marked. In the period 2008-17, on average the US has added just 0.4 Australias a year.

This says something about both the flaw in the statistics and Australia. The chief difficulty of assessing inter-country performance is that most nations use their own currency to measure economic stuff. True, this presents no problems with comparing growth rates between nations, but it makes for difficulties comparing the size of nations’ output. Using a common currency overcomes that, but at the cost of accepting that values will swing around depending on exchange rates between domestic currencies and the common comparator, which is usually – and in this case – the US dollar.

To get an idea of these swings, depending on the yuan’s value against the dollar, in the period 2000-17 China’s growth rate varied from 29 per cent (in 2007 and 2008) down to just 1 per cent (in 2016). This also affects the Oz multiple and chiefly explains why it was just 0.1 in 2016 as currencies throughout the developing world weakened against the dollar.

As for Australia, this was chosen because the lucky country is just that – fairly big (its output ranks just outside the world’s top 10), wealthy (per capita GDP is ahead of the US) and growing with an almost-spooky consistency; thanks in large part to its connection to China’s economy, Australia’s output has grown every year since 1991. These factors make it a demanding nation against which to pitch another’s performance and therefore a useful one.

The performance of the other countries shown in the table highlights the lack of growth in the developed world. The world’s third and fourth biggest economies – Japan and Germany – barely make a mark on Australia’s output. Partly that’s because these are just a distant third and fourth. In relation to China’s $12.2 trillion of output in 2017, Japan managed $4.9 trillion and Germany $3.7 trillion. In addition, it’s not unusual for their output to shrink. In dollar terms, Japan’s shrank in four of the five years 2013-17. And to find a year when either country’s growth was even half of Australia’s output you have to go back to 2007 for Germany and 2004 for Japan.

At least one can say about the UK’s performance that it is no worse than those two and the fact that sub-Saharan Africa (all of it) on average generates as much growth as Germany or the UK says something about the comparative success – and, perhaps, the potential – of this vast region.

If there is an investment moral to be gleaned from this, it is that UK investors must diversify globally. This especially applies to passive portfolios or to those parts of portfolios given to passive plans. This would include an appropriate share of capital going to emerging markets in general and to China in particular. ‘Appropriate’ might even mean weighting country and regional holdings according to their share of global output. In that case, Chinese equities would have a share approaching 20 per cent, which might seem outlandishly large.

Granted, for UK investors that would not have been a great tactic in the past 10 years. But that’s because the best plan by miles – and a feasible one to execute – would have been to be heavily overweight in US equities and underweight the rest. If nothing else, mean reversion could well sink such a plan in the coming few years.

Besides, the other investment lesson of the past 10 years is that it was right to be diversified pretty well anywhere outside the UK with the possible exception of mainland Europe. At worst that would have generated a performance on a par with the UK’s, as was the case with China; at best, it would have produced something better.