The Chinese ministry of Industry and Information Technology reported in September that industrial profits in the country dropped for the fifth month in August, with an overall year-on-year decline of 3.1% (see Fig. 1) for the first eight months of the year, and the August month alone reporting a year-on-year decline of 6.2%.
Among the national-scale industrial enterprises (those with annual revenues more than 20 million yuan), state-owned and state holding enterprises and overseas-invested private enterprises each reported a year-on-year decline of 12.7% cumulatively for the first eight months of the year (see Fig 2.). Fig. 2 below reveals overall year-to-date performance of the Chinese industrial sector. The latest figures from the Chinese Ministry of Industry also showed that out of the 41 industry sectors, 24 reported year-on-year increase, with 16 reporting profit drops and one reporting a loss.
The nosedive of the Chinese Industrial profits confirms the severe Chinese economic slow-down revealed by their other macroeconomic indicators including the purchasing managers' survey and the sharp decline in their tax revenues. With the dip in demand in Europe and the US, the declining business revenues is not a surprise, but the precipitous decline in profit margins is a surprise to some extent (see Fig.1 and Fig. 3)
But, one we look at the numbers with a fine-tooth comb, the complete picture comes together, as the center piece of the next phase of the Chinese growth emerge - the transition from an export-led growth to consumption-led growth; the Chinese government has begun the transition in right earnest. Ever since the paradigm shift was announced by the Chinese government in its economic blueprint, the 12th Five-year plan (2011-15), you can see in Fig. 1 and Fig. 3 there has been a significant increase in profit margin compression, primarily from rising wages.
Fostering wage (or income) growth would be one of the cornerstones of the transformation from an export-oriented economy to a consumption-oriented economy. To begin with, this paradigm shift was spurred by the realization that the export-oriented growth mode was not sustainable in the long-run primarily due to two reasons:
- The capital-intensive, export-oriented economy was yielding diminishing returns and was exacerbating the social inequality, which was slowly threatening the political legitimacy of the Chinese government. Also, the 2008 global financial crisis gave ample evidence that the Chinese economy was severely vulnerable to demand in the western economies.
- The declining working-age population, as a result of the one-child policy instituted in the early eighties, which is threatening to be a major demographic shift, made the Chinese policy makers to take note that it is imperative to rebalance the country's economy - as the earth under the world's largest workshop - the comparative advantage from abundant cheap labor - was slowly slipping away (see below the population charts of Chinese population projections for age groups 15-24 and 15-64 (see Fig. 4).
The compression of the profits in the industrial sector reflects the nascent, but slow and steady progression from an export economy to that of a consumption economy, wherein the income redistribution policies would elicit transfer of wealth from producers (the industries), in the form of wage hikes and contributions to social safety net programs, to the consumers (mainly the workers). This transfer of wealth should naturally expand consumption, which currently is about 25% of the economy, well below that of some of the other major emerging countries.
The fundamental economic policy shift outlined in the 12th Five-Year Plan is a policy in the right direction in the long run, as it would ameliorate the economic imbalances in the country as well as the global current-account imbalances that we have seen in the last decade or so. So, one can't help wonder if the apparent severity of the Chinese slowdown from the global slowdown has been aggravated by the fundamental change in the Chinese economic policy.
Those who have been writing off the Chinese economy in the recent days are jumping the gun, for the Chinese policy makers now are putting their economy on a sounder footing through a policy that stresses on all-inclusive economic growth. The severity of the current slow-down is nothing but growth pangs of a developing country shifting directions in order to put itself on a path of natural progression from a blue-chip developing economy to a truly developed economy. Of course, there is an impending demographic shift, as shown in the last chart above, in about 10 to 20 years down the road, but there is still definitely a lot of growth and prosperity in China between now and then. The fundamental demographic shift is definitely a bridge that needs to be crossed far out in the future.
Additional disclosure: I am long GXC - SPDR S&P China ETF.