Looking at the economy from the demand side

Source of this article: Li Xunlei Finance and Investment

Everyone is familiar with the old saying "it is easy to go up the mountain, but it is difficult to go down". I like to climb mountains, but I don't really agree with this sentence in my heart, because from the perspective of mechanics, climbing a mountain is obviously more tiring than going down, and the heavier the load, the greater the work done on the upstream. But once I went down the mountain because of carelessness, the downward speed was too fast, and I accidentally fell, and the consequences were serious, so I felt that the ancients had a certain truth. If you encounter steep hills, slippery roads, it is indeed more difficult to descend the mountain.

In economic terms, the downward phase of the economic cycle is divided into hard landing and soft landing, and there is no corresponding term in the upward stage. Of course, whether it is easy to go up or down is inconclusive, because it is not told whether the ascent and descent are the same path, and the slope is not known, not to mention that due to the different physical characteristics and foot skills of each climber, it is difficult to draw conclusions without assumptions. In fact, the analysis of the economy is the same, many people are Xi to linear derivation, but the real economy is not linear, or even flat, because the space we live in is three-dimensional, and we have to add the dimension of time.

More than 10 years ago, I pointed out that the biggest problem facing the mainland in the future may be "insufficient effective demand," because the investment-led and export-oriented economic growth model will lead to a decline in the proportion of income in the household sector, and at the same time, the internal income gap will widen, which will lead to a shortage of consumer demand with the ability to pay.

This article discusses the current real estate cycle and economic transformation that everyone is generally concerned about, and focuses on the analysis from the dimensions of effective demand. Does this dimension of analysis lead to conclusions that are different from ordinary logic?

When urbanization meets aging

- How long does it take for real estate to adjust?

If the urbanization rate increases by one percentage point every year in the future, then there will be 15 years to 80% to 80%, and the real estate industry will continue to prosper for a long time; or the urbanization rate of the mainland's registered population is only 46.7%, and the number of new citizens in the mainland is more than 300 million, and they have not yet bought a house, which means that the mainland's future demand for housing is huge?

A similar logic is common, for example, the fact that China's per capita consumption of dairy products is less than half of Japan's peak, suggesting that there is a lot of room for the dairy industry to grow. But China's pork consumption accounts for almost half of the world's total, does this mean that China's pig industry is in decline? Many African countries have a per capita GDP of less than 2,000 US dollars, does this mean that these countries have huge room for development?

Therefore, our spatial assessment of urbanization needs to be multi-dimensional, rather than simply adopting an "international comparison" approach. The mainland is currently facing an accelerated aging population. In 2021, the mainland has entered the stage of "deep aging" defined by the World Bank, which means that the scale of population migration has declined and the urbanization process has slowed down.

China's total population and proportion of the elderly

Source: WIND, Zhongtai Securities Research Institute

For example, in the five years from 2017 to 2021, the net outflow of migrant workers in the Pearl River Delta was more than 5 million, that is, as the average age of migrant workers continues to rise, the level of migrant workers returning to their hometowns will continue to rise, thus slowing down the urbanization process. For example, there is a net inflow of people over the age of 60 from urban to rural areas.

In the future, China's urbanization rate will not be characterized by the migration of migrant workers to the cities, as in the past, but in the context of the negative natural population growth rate, on the one hand, because the net decline in the rural population exceeds that of the urban areas, and on the other hand, the urbanization process in the local areas is also continuing, so China's urbanization rate will rise, but the growth rate will slow down significantly. In the case of South Korea, the urbanization rate has remained at 80%-81% for the past 20 years after entering an aging society.

Recently, everyone has been discussing when the property market will bottom out, and it seems that everyone is focusing on the three indicators of the annual sales area of commercial housing, the proportion of real estate development investment in GDP and the growth rate of new construction area. Optimists believe that the annual sales area of 900 million square meters is the bottom, or the proportion of real estate development investment in GDP is about 7%, or the growth rate of new construction area is the bottom. If this judgment is true, then the bottom of the property market is indeed at hand.

For example, the house-price-to-income ratio and rent-to-sale ratio should still be on the high side, that is, the valuation level of the house as an investment product is still relatively high compared with the United States, Japan, South Korea and other countries where housing prices are not cheap. But even if its valuation level is lower than the average of the world's developed countries, is it the bottom?

The price-to-income ratio in mainland China is significantly higher than in developed economies (as of 2020)

Source: WIND, Zhongtai Securities Research Institute

The "price-to-earnings ratio" of residential properties in mainland China is still high

Source: WIND, Zhongtai Securities Research Institute

For example, the average price-to-earnings ratio of the CSI 300 index has fallen to more than 10 times, which is 5% of the average price-earnings ratio of the S&P 500 index, but why is it still falling? Forecasting is not science, so it can be difficult to find a scientific way to get accurate predictions. Just like the A-share market, it has been difficult to predict its tops and bottoms in the past 33 years through two dimensions: volume and price.

If we think that we and Japan can use the ratio of real estate development investment to GDP as a basis for bottoming out, then can Japan's housing prices fall for 16 years also be used as a basis for the required adjustment time? Moreover, Japan entered a deep aging society in 1994, and we will have a similar situation in 2021.

However, from the perspective of real estate demand, the current per capita GDP level of mainland residents is only about one-third of the Japanese per capita level in 1994, and Japan's Gini coefficient has been maintained in the safe range of 0.4, which is more conducive to consumption. As a developing country with a low income level, we are still facing the pressure of growing old before getting rich, so there may be a lack of effective demand for future home purchases.

The bull market in mainland real estate has lasted for more than 20 years, which should exceed most people's expectations. When the valuation level of the property market in Shenzhen or Shanghai 12 years ago had surpassed that of Tokyo and New York, the then Nobel laureate chairman Le predicted that the bubble in China's property market would burst, but in fact he predicted that it would rise for another 10 years. I remember that in 1995, the then chairman of the Federal Reserve, Alan Greenspan, proposed an "irrational exuberance" in the US stock market, but the bursting of the bubble did not happen until five years later. Therefore, we must have a sense of awe for the market.

In my opinion, it may be more reliable to use the cycle theory to predict the real estate cycle than the volume and price theory. For example, Kuznets, through his study of the economic development of the United States from the 19th century to the Second World War, found that there was a long cycle of about 20 years, which is also called the "construction cycle" because it is mainly marked by the cyclical fluctuation phenomenon of the boom and decline of the construction industry.

If the upward cycle of mainland real estate has lasted for more than 20 years since 2000, then how long will the corresponding downward cycle last?

Historically, people have generally hoped that happiness lasts as long as possible, that pain lasts as short as possible, or that bull markets last longer and bear markets last shorter. Therefore, human nature determines that forecasts are usually biased: for example, the forecast of the end of the epidemic is generally earlier than the actual end of the epidemic, and the forecast of economic growth after the end of the epidemic control in 2023 is generally higher than the actual growth rate. Market participants predict that the stock market will bottom much earlier than the actual bottom.

Therefore, I think that in the context of the acceleration of population aging, it may be necessary to look at the depth of this round of real estate adjustment from a longer-term perspective and take precautions.

Economic transformation from the demand side

- Long-term and tortuous nature

For a long time, everyone seems to be Xi to promoting economic restructuring through the supply side. For example, enterprises are the suppliers of goods and services, in the past 10 years, the policy has been to solve the problem of difficult and expensive financing for enterprises, this year has introduced four measures to support the private economy 106, inclusive finance, small and micro loans, etc. have long been used as KPI indicators to assess bank performance, and since 2019, preferential policies such as tax cuts and fee reductions and tax rebates have also been given to enterprises. Despite this, in the first 11 months of 2023, private investment in mainland China remained negative.

There are multiple reasons for the sluggish private investment, such as overcapacity, excessive leverage, and high financing costs, so we have promoted supply-side structural reform since 2015 and achieved remarkable results. However, after the epidemic, private investment did not rebound as expected, and the corresponding PPI continued to show negative year-on-year growth since October 2022.

Historically, every drop in the PPI fixed-base index has seen a corresponding decline in the growth rate of private investment. From 2012 to the present, the months with negative PPI year-on-year significantly exceeded the months with positive PPI, indicating that the phenomenon of overcapacity has not been solved, and if the production capacity continues to be compressed, private investment will continue to be sluggish, and the employment pressure will further increase.

The decline in the growth rate of private investment is related to the weakening of PPI

Set the PPI index in 2023 to 1, source: wind, Zhongtai Securities Research Institute

Comparing the CPI trend between China and the United States, it is found that the fluctuations of the CPI in the mainland in the past 10 years have generally converged and the trend has declined. On the other hand, the US CPI has soared since 2021, and although it has fallen significantly, it is still much higher than China.

Comparison of CPI between China and the United States

Source: Wind, Zhongtai Securities Research Institute

As of November 2023, the mainland CPI and PPI are still negative, with the decline in housing prices and the continuous decrease in the area of commercial housing sales leading to a further weakening of expectations, so increasing the income of low- and middle-income groups through various means is a key measure to boost consumer confidence.

The materials of the Central Economic Work Conference at the end of this year, as official documents, for the first time put "insufficient effective demand" in the first place of all possible difficulties. In fact, we need to change the long-standing bias that "demand is not a problem", because most people in the country have inflation phobia, including the general belief that inflationary pressures will be higher this year at the end of last year. Moreover, we have always had a 3% inflation target in policy, but we have never set an anti-deflation target.

The added value of the mainland's manufacturing industry already accounts for 30% of the world's total, while the world's population accounts for 17.5%, and household consumption accounts for only about 13% of the world's total, which means that overcapacity may become the norm in the future. Moreover, the problem of insufficient effective demand has actually appeared since 2009 (this year the two-year investment plan of 4 trillion yuan was launched).

Therefore, the most effective means of expanding domestic demand is to expand consumption, not investment, which may create new production capacity. In fact, since 2009, the main way to expand domestic demand has been to stimulate investment, which has made it difficult to narrow the gap between supply and demand, and the problem is even more prominent when the export growth rate declines.

The problem of insufficient effective demand is first reflected in the low proportion of disposable income in GDP, which accounts for about 43 percent in the mainland, while the global average is about 60 percent, and secondly, in the low proportion of low- and middle-income groups, which are the main consumers, in the income and wealth of the whole society. Moreover, such an irrational income structure and wealth structure have been solidified.

The continuous decline in the number of births on the mainland is actually a reflection of the "weakening expectations" put forward twice by the Central Economic Work Conference. For example, the marriage data in mainland China began to decline year by year in 2014, with 13.4693 million couples in 2013, below the 10 million mark in 2019, and 7.636 million couples in 2021, falling below the 8 million mark in 2021. In 2022, the number of marriage registrations nationwide will be 6.833 million, a decrease of 803,000 couples or about 10.5% from the previous year. In the first half of 2023, that is, after the epidemic was relaxed, the number of marriages in mainland China will be 3.928 million, an increase of only 5.3% year-on-year. This means that the decline in the number of births will be a long-term trend in the future.

The abnormal decline in the mainland's total fertility rate (which began in 2017 and fell to 1.1% in 2021) is far lower than 2.1 (the internationally recognized replacement level of population replacement), and there is a saying that "China's fertility rate is the second lowest in the world". In order to raise expectations, it is necessary to increase the income of low- and middle-income residents and improve the level of social security. It is not enough to rely on promotional methods such as "home appliances to the countryside".

Therefore, the current economic transformation of the mainland should start more from the demand side, expand consumption, and increase the effective demand for housing purchases. Judging from the real estate policies in the past two years, most of them are starting from the supply side, such as ensuring the delivery of buildings, the transformation of urban villages, the construction of affordable housing, and providing liquidity support for real estate enterprises, etc., which will be conducive to the rebound of real estate development investment growth, but at the same time further expand the housing supply.

If the potential demand for real estate (such as improved housing purchases, 300 million new citizens buying houses, etc.) cannot be converted into effective demand, then the pattern of oversupply is difficult to change, and the downturn in the real estate market will exist for a long time.

Therefore, the core of expanding consumption is to increase residents' income, including property income, through multiple channels. Statistics show that property income accounts for about 16% of the disposable income of US residents, and the property income of mainland residents in 2022 will only account for 8.7%. However, in the current context of weak capital markets and declining corporate profit growth, it seems unrealistic to rely on the market's own strength to increase residents' income. The economy can only be stimulated through government policies that favor consumption and increase input.

High-quality development from the perspective of culture and system

- It can be more optimistic, but the structure needs to be improved

With the continuation of this round of real estate downward cycle, many people see that Japan has "lost 30 years" and worry about whether the mainland will enter the "middle-income trap". In my view, the "middle-income trap" is just a categorization of real cases in some countries, but it does not carry inevitability.

From the examples of countries and regions that have entered the "middle-income trap", there are Iran in the Middle East, South Africa in Africa, Argentina in South America, and Malaysia in Southeast Asia, most of which are rich in natural resources. East Asian countries and regions, with high population density and relatively scarce natural resources per capita, have not only not fallen into the "middle-income trap" in one place, but have mostly become developed economies.

This shows two points: first, countries or regions with abundant natural resources may not always become rich countries, and if their development model remains unchanged, they may collapse; second, countries or regions with scarce natural resources may have a greater sense of crisis, especially in regions that are greatly influenced by Confucian culture, are generally diligent and studious, and regard labor as the greatest resource endowment, and devote themselves to manufacturing and trade. The Confucian cultural circle should include Japan, South Korea, Chinese mainland, Hong Kong, Macao and Taiwan, Singapore, etc.

In terms of weekly working hours, according to the National Bureau of Statistics, by September 2023, the average weekly working hours of employees in mainland enterprises will be 48.4 hours, which should be among the best in the world. In terms of female labor force participation rate, the mainland is also ahead of most developed economies and developing countries.

Global comparison of labour force participation rates of women over 15 years of age (%)

Source: Wind, Zhongtai Securities Research Institute

Although the mainland's female labor force participation rate has declined significantly over the past 30 years, it still significantly exceeds India's female labor force participation rate. Overall, India's labor force participation rate of the working-age population is only 51 percent, 25 percentage points behind China. Today, India's total population surpasses that of China, and the working-age population greatly exceeds that of China, but the number of employed people is only 430 million, compared with China's 734 million. In terms of literacy, China is 97 per cent and India is only 74 per cent.

Therefore, the rise of India today is certainly worth paying attention to, but China, whose per capita GDP is already 5.5 times that of India, still has obvious advantages such as diligence and professionalism. Generally speaking, as income levels rise, working hours will decrease accordingly, but the average weekly working hours of employees in Chinese enterprises have not decreased significantly. For example, according to Penn World Tables (2023), from 1970 to 2019, the number of working hours generally decreased globally, such as Denmark, where the average weekly working hours fell from 35 hours in 1970 to 27 hours in 2019, but we still surpassed India.

Therefore, although China's population Lewis inflection point has already appeared, and it is currently facing the pressure of accelerating aging and economic contraction, the traditional cultural genes and the leadership of promising governments in the field of scientific and technological innovation should be able to maintain rapid economic growth, such as the medium-term goal of doubling GDP by 2035, the average annual growth rate should be maintained at around 4.7%.

However, as a large country with a population of 1.4 billion, it is very difficult to enter the top 25% of the world's per capita GDP economy, also known as a high-income economy. As I've mentioned in the past, the World Bank continues to raise the bar for high-income economies, and early July this year, the World Bank released updated standards for "low-income, lower-middle-income, upper-middle-income, and high-income" countries around the world. High-income economies must have a per capita national income (roughly equal to GDP) of more than $13,845, which is estimated to rise to more than $20,000 by 2035.

From the current point of view, the total population of the world's high-income economies is less than 1.3 billion, that is, the proportion of the total population is only about 15%, which shows that it is very difficult to become a high-income economy, because the total population of the mainland is more than 1.4 billion, but the population of high-income economies will not exceed 2 billion in the future, that is, 25% of the total population, which is basic mathematical knowledge.

Therefore, as long as China's economy continues to grow healthily, it does not matter whether the so-called high-income economy standard can be met, and the so-called middle-income trap does not actually explain why the world's middle-income economies will always have the highest proportion of people – the classification criteria.

However, as a large country with a population of 1.4 billion, the issue of income distribution is the most difficult to deal with. I've done statistics that most countries with populations of more than 100 million people have a Gini coefficient of 0.4 or higher. This shows that the larger the size of the population, the "variance" of income distribution also increases. According to survey data released by the China Institute of Income Distribution at Beijing Normal University in 2021, the population of households with a monthly per capita income of less than 2,000 yuan in mainland China is about 964 million. Therefore, the Central Economic Work Conference also emphasized the need to expand the size of the middle-income group.

I believe that the core difficulty among these difficulties is the lack of effective demand, that is, although China is the world's largest populous country, it has the world's largest consumer market and 30% of the world's manufacturing industry However, due to the lack of demand with the ability to pay, consumption growth has slowed down, and then there has been overcapacity in some industries, and the PPI has been negative for most of the past 10 years, and social expectations are weak.

The lack of effective demand includes both the lack of effective demand for consumption and the lack of effective demand for investment, and the reason for the lack of effective demand for investment may be related to overcapacity and low return on investment, so the key is to expand consumer demand, not to expand supply. The path to expand consumer demand, as stated by the Central Economic Work Conference, is to increase the income of urban and rural residents.

If household income can continue to increase faster than GDP growth by expanding fiscal spending in the field of people's livelihood and promoting fiscal and taxation reforms, and at the same time the income distribution structure can be improved, then the problems of overcapacity, external environment, and weak expectations will be easily solved.

The Central Economic Work Conference should coordinate and resolve the risks of real estate, local debt, and small and medium-sized financial institutions, which are actually the three hidden dangers on the road to high-quality development. Just like on the way down after successfully climbing Mount Everest, the team members must be allowed to absorb oxygen and replenish energy, and with sufficient physical fitness, they can ensure a safe return.