The next 15 years - China in 2025

Economy set to become the largest in the world

By William R Thomson

There is some dispute about whether it was Nils Bohr, the famous physicist who split the atom, or the equally famous but malapropism-prone New York Yankees manager Yogi Berra who first said 'it's risky to make predictions, especially about the future'. Whoever said it first, it is a fact, and they might also have added a caution about how these difficulties are amplified in times of dynamic change and turbulence that we are presently experiencing. If we have entered the Pacific century, as the writer has believed since he first stepped on the continent over 40 years ago, then the Asian renaissance is due to the region continuing barrelling along while changing the lives and expectations of the three billion people living there and affecting world geopolitics, possibly profoundly, at the same time. But the ride is unlikely to be completely smooth; rapid industrialisation is usually an upward passage interspersed with sometimes violent corrections as societies are forced to adjust to new realities.

Whilst predicting the next century is for professional futurologists, it has the advantage that no one presently living will be around to hold them to account when things go wrong; the next 15 years is a more accountable challenge. But before we start to examine where we could be going, it might be useful to examine where we have come from both in the longer-term and since the establishment of Asia Asset Management in 1995, a 15 year period in which the global map has begun to make some irrevocable changes.

The changes have been huge, powered by policy shifts in China and India that capitalised on globalisation brought on by sharply reduced transport and telecommunications charges, the internet, the end of the Cold War, the birth of the World Trade Organisation, two Western recessions and two significant wars that did not involve the major Asian players. Asia suffered from its own financial crisis from 1997-2000 but bounded back sharper and more competitive than ever and resolved, having ended colonialism, never again to be under the yoke of the IMF and Western organisations. This led to the huge reserve accumulations in the 'noughties' and the accompanying global imbalances.

Few Western leaders in private now argue against the observation that the economic pendulum is swinging from West to East. Their aim now is how to get a piece of the growth as we saw when David Cameron in July led the biggest UK trade mission to India since the East India Company first arrived 300 years ago.

Whilst a few sceptics or contrarians exist in the financial community, their concerns are mainly shorter-term, revolving around a possible bubble in the Chinese property market and its after effects and whether the economy can rebalance towards a more sustainable less export-driven and energy efficient model. There are also concerns about corruption and inconsistency in the application of the rule of law. Economic fluctuations are inevitable but they should be seen in the wider sweep of economic development and we believe that China is just following the industrialisation path previously set in the West - but on a greatly accelerated timescale.

Asia and the Rest of the World: 1000-1820.

Commentators in the West continually speak in awed tones at developments in Asia but there is still a tendency - albeit declining - in some circles to dismiss it as derivative and 'copying' a supposedly superior West. What these commentators miss is that China, and to a lesser degree India, are making up for a lost century-and-a-half and are re-establishing the sort of position in the world they had prior to the industrialisation of the West.

Rozman and de Vries show that the rate of urbanisation in China from the Tang to the Ching dynasty (762 AD - 1820) varied between 4.7 and 6.8%. Europe had zero percent urbanisation in 1000 AD and did not reach 5% till 1500 but had grown to 10% by 1800. (Table 1)


In terms of world GDP, China, India and Japan had over 50% in 1700 and 51.9% in 1820, double Europe's share of GDP at 24.9 and 26.6% respectively with the US coming in at 1.8% in 1820. (Table 2)


China's economic growth rate was more than double Europe's in the period 1700-1820 but only one-third of the US' rate.

In terms of per capita income, in 1700 China at US$600 exceeded the US and was below Europe on US$920. However, by 1820 China's per capita income remained at $600 compared to $1090 for Europe and $1257 for the US. These and following figures all use 1990 purchasing power parity dollars as used by the OECD. Whilst it is possible to quibble with the absolute level of all such numbers - as indeed most government statistics - they represent the best produced by economic historians and the trends they reveal are real and unarguable.

Stagnation and decline

The period 1820-1950 was the period of economic decline for much of Asia as a result of wars, internal uprisings, colonialism and poor economic policies. During this period Asia (as represented by China, India and Japan) fell from over 51% of world GDP to a mere 12.6%, Europe increased its share slightly to 29.3% whilst the main beneficiary of Asia's decline was the share of the US which grew from 1.8 to 27.5% of world GDP.

China's per capita income fell slightly from its levels 200 years earlier to US$568 whilst Europe's grew four-fold and America's eight-fold to where it was 20 times that of China.

The bottom was reached at this time in Asia's relative position with the Korean War and Mao's ascension to power. Although China and India's share of world GDP continue to shrink slowly, first Japan entered is dynamic growth stage from 1950 to 1990 followed by Korea's strong upward push as economic development took hold after the ending of the Korean War.

The great resurgence

The turning point for China was Deng's policy changes in 1979 towards a market economy. For India the change was less dramatic, whilst Rajiv Gandhi had began some tentative liberalisation in 1984 it took the economic crisis of 1991 and the end of the Cold War for India to drop its 'license raj' mentality and adopt reform and pro-growth policies.

China's growth rate was virtually stagnant in the century up to 1950 but then grew at a 4.4% rate from 1950-78, accelerating at a compound 7.85% from 1978-2003. India accelerated from 3.8 to 5.3% during the same period whilst the US declined from 3.6 to 2.9% and Europe from 4.4 to 2%.

In 1978, China's share of world GDP had shrunk from 22.3% in 1700 to a mere 4.9% but by 2003 had grown back to 15.7%, a truly stunning turnaround, and by 2010 has become the second largest economy in the world with every prospect of being the largest by 2025. (Depending on the methodology chosen it could well happen this decade) (Table 2)

India, whose economy in 1700 was larger than China's, had fallen to a 3.3% share of world GDP and had recovered to 5.5% in 2003 by which time Japan had a share of 6.6%, down from a peak of close to 9% around 1990.

To put this in perspective, the US share of world GDP peaked in 1950 at 27.5% and had declined to 20.6% in 2003. The comparable figures for Europe were 29.3% in 1950 and 21.1% in 2003. Asia is now the largest economic bloc in the world, although it does not act as one the way the US and the EU act.

Transformation of the economy

In 1978, central government taxes amounted to 31% of GDP with large subsidies being directed to the wholly-owned and inefficient state enterprises. There was no foreign debt and no foreign direct investment. Essentially, the economy was autarchic and inefficient. The central government decentralised the control of these enterprises at the provincial level and at the same time gave peasants more freedom and incentives to produce in the agricultural sector. This rolling back of the state and the reduction in the 'iron rice bowl' of state provision in health, education and housing triggered increases in entrepreneurial activity that were the catalysts that spurred the economic revolution that has transformed the economy.

By 2005, the central government taxes had fallen to 17% and expenditure to 18.5% of GDP.

But it was the opening up to the rest of the world that had the largest impact. The opening up process allowed policies to be changed; they were gradual and consistent and the cumulative effect was both radical and transformative. These changes were aided in the early years after China joined the IMF and World Bank in 1980 and then the Asian Development Bank, later in 1986, after the sticky question of Taiwan's membership was eventually resolved under a unique compromise that allowed it to remain a member under the name of Taipei, China. Whilst Taiwan has never formally accepted the change of its name, it nevertheless remains a full and active member of the institution. In 2001, China joined the World Trade Organisation, which further fuelled foreign direct investment as China became the factory of the world.

From 1978 to 2003, China's exports grew almost 30 fold from 1.7% GDP to 7.1% of a far larger GDP and grew from 0.8% of world exports to 5.8%. Today's figures are of course even higher so that China is now the world's largest exporter.

China has been greatly aided in this process by holding its currency at a very competitive level allowing the foreign exchanges reserves to grow to over US$2.5 trillion. That policy is now leading to trade tensions with both the EU and the US. A seemingly inexhaustible supply of labour swelling in from the countryside to work in the new factories set up by foreign multinationals was another essential element in the story.

However, recent signs are that the inflow of workers is slowing and scattered shortages are being seen, especially in the south, accompanied by signs of unrest as workers demand a greater share of their product. In this respect, their reactions are no different than those experienced in the US, the UK and elsewhere as industrialisation matured and unionisation and real democracy were more honoured in the abstract than the reality. It may well be that the government is willing to go along with a certain contained degree of militancy as part of an effort to make the economy more domestically focussed. The share of labour in the economy has drastically shrunk as the economy has mushroomed in the last decade. A gradual rebalancing in favour of labour as an objective is more than likely when the next five year plan is announced in 2011.

Challenges and uncertainties ahead

China's development story has huge momentum, much as the US had from 1865 to 1930. If America was built on external immigration and the opening of new lands, China is being rebuilt on the largest internal migration in history as upwards of 15 million people flood to the cities each year remaking the skylines in record times. That process seems inexorable and demands the record imports of commodities for factories, housing, shopping centres and power plants, to say nothing of the health and education needs of a swelling urban population that is becoming wealthier and has higher expectations.

Maddison (Table 3) has estimated that China's GDP will equal that of the US by 2015 and will be 138% of the US GDP by 2030. Again these figures use 1990 PPP dollars rather than current dollars but they have the imprimatur of the OECD. The World Bank would calculate a somewhat later date for the China-US crossover but again the direction and the destination are clear. (Shown graphically in Figure 1).




The recent travails of the US and EU economies may favour Maddison's estimates over the World Bank's because the economic growth differentials since 2007 have grown from 4 to 8% or more in China's favour. Indeed, it may well be that the US and the EU stagnate for longer than generally assumed - in the same manner that Japan has struggled since its bubble burst in 1990 - as they struggle to adapt and grow their economies with their ageing populations and over-indebtedness. (It is interesting that there are no major prior examples of rapidly ageing societies with declining populations (as is the case in Japan and parts of Europe) and growing economies. This seems to be an area ignored by academic).

It is important to note that even though China's economy will overtake the US in the next decade, the catch up process will be far from complete since the per capita income of its people is only projected at 34% of the US in 2030, albeit a sharp improvement on the 12% level of 1995 and today's estimate of about 21%.

The nature of China's growth

China's growth is inefficient, asset heavy and requiring extraordinary levels of capital to finance it. As times goes by it would be hoped that more of the economy becomes market-driven and service-oriented. Whilst China is and will remain an export giant, the economy should become more diversified to service an increasingly better-off population. With the EU and the US suffering lower growth and their populations unable to access the credit needed to support their old economic model, these governments will also be faced with the need for economic restructuring, another motivating factor for China's rebalancing of its export-driven economy.

China will therefore place increasing emphasis on developing the hinterland and the service sector whilst also spending vastly increased amounts on health, education and quite probably affordable urban housing in order that the benefits of development can be more widely spread and social peace be maintained.

At the same time, China will continue to expand its role as a global power since it has a need to obtain natural resources - oil, minerals and agriculture products - on a vast scale from around the world.


Geopolitically, we can expect China to steadily increase its voice and vote at the top table in international economic fora, such as the World Bank, the IMF, the WTO as well as regional organisations such as the Asian Development Bank. We saw this increased assertiveness in the G20 discussions in 2009 and at the Copenhagen Climate Change Summit. There will be continuing competition with Japan for regional economic leadership where China, already the larger economic power and one whose predominance will grow, is most likely to prevail.

It is quite possible that there will be increased efforts to develop regional equivalents of the EU and the ECB, depending how those succeed in the current crisis. Possible embryos are there in the ASEAN plus three and similar groupings. More formal cooperation amongst central banks seems inevitable with China, as the largest creditor, in the lead.

Whilst it is not in the remit of this article to comment on the broader geopolitical consequences of the rise of China, we have, of necessity, had to assume that the symbiotic relationship between China and the US continues over the period, despite there being many potential points of friction. Historically, the rise of new global powers has been ridden with conflict, whether it was the rise of Germany in the late 1800s or the rise of the US after World War I. China clearly has the potential and the objective to become a major naval power. But all indications are that the US will be reluctant to see its naval power and control of energy sources and trade routes seriously challenged. The potential for trouble between the two giants is obvious and could increase if the US is unable to get its domestic growth growing again and resorts to protectionist measures, but we place that in the nature of a caveat to the predicted path - a black swan if you like - rather than a prediction.

An ageing population

China's boom has been on the back of a seemingly inexhaustible fund of cheap labour from the inland rural areas. The labour pool has not only been cheap but the one child policy and the drop in Chinese fecundity has enabled the country to have an extraordinary high savings rate in the last 30 years.

The best of those days may be coming to a close. The numbers of potential workers aged 15-30 years is about to drop sharply and the age profile of the workforce about to become significantly older; and an older workforce is less mobile. However, China still has a rural population of about 650 million and that should still provide a significant reserve army for industrialisation. If China were to reduce its rural population gradually at a rate of 15 million per annum, the recent figure, to 10% of the total of 1,300 million - the conventionally accepted figure for China's population but one that may well be too low since regular censuses have not been taken for several decades - then China has many years of population in reserve that can be mobilised for industry and modernisation.

However, policy changes on residency rights in urban areas and higher wages may be needed to attract them in the quantities needed and a greater emphasis on developing the inland provinces - something that is happening now - will put the factories closer to where the population lives.

China, like other Asia countries before it, has to continue moving up the value chain as labour becomes more expensive. That is already happening as we see Chinese cars and other sophisticated manufactures being made for export to developed economies. Brand names are being developed in the same manner that first Sony and Toyota in Japan then Samsung and Hyundai in Korea were developed as their factories became more than screwdriver assembly plants. That process should accelerate and deepen in the coming 15 years creating more profits for Chinese companies to accelerate further their development. It is possible in the projected period that Chinese banks and oil companies become household names globally. The Bank of China has already been rumoured as a possible buyer for the largely state-owned Royal Bank of Scotland in the UK and CNOOC is on the lookout globally for deals.

China will have to remain open to foreign direct investment for the technology it transfers even as China itself rapidly ascends the research and development ladder with its huge output of scientists and engineers. Some real concerns are being raised at the present time by foreign multinationals about how welcoming China is becoming to foreign capital as it becomes more assertive about the transfer of proprietary intellectual property and raises security concerns in situations such as Google. That, of course, must be balanced by the xenophobia Chinese capital faces abroad, especially in the United States and to a lesser extent Australia. Given these concerns and the lower growth projected for the OECD countries, China will follow its comparative advantage and become an investment powerhouse in the emerging world. It is already the most significant investor in Africa and is important in Latin America and Asia.


The Eastern Seaboard of China has been transformed by the modernisation of the past 30 years with the development of motorways, modern high speed railways, airports and communications to the point where they are at and often exceed first world standards. Inland China has lagged in this development but the catch-up process for the lagging regions is now underway and will accelerate over the next 15 years as industry relocates there and modern transport communications are enhanced.

This will continue to drive the need for China to import huge quantities of raw materials from around the world regardless of dips in its growth rate. Hopefully, the investment will be increasingly energy efficient and environmentally sounder than has been the case to date. One can detect positive signs; the development of nuclear energy, world class wind and solar power companies and technologies but existing alongside dirty coal plants and environmentally contentious dam projects. These, however, are the inevitable growing pains of the development process that can be expected to be corrected as the country grows wealthier. That is what has happened elsewhere.

Reform of the financial sector

The financial sector has come a long way in the past 20 years since the Shanghai Stock Exchange, originally established in 1880, was reopened in 1990.

The banking system has also been through a series of reforms and restructurings and is still a work in progress. The sector will be critical going forward in financing China's growth, modernisation and social security system. If it succeeds, China should have the largest financial system in the world come 2025.

Alongside the smaller Shenzhen Stock Exchanges, the two exchanges had a combined market capitalisation of US$2.88 trillion on June 30, 2010, giving China the third largest equity market in the world after New York and Tokyo and ahead of Hong Kong at US$2.2 trillion. Adding Hong Kong to Shanghai and Shenzhen would place China's market capitalisation at over US$5 trillion, about 45% of New York.

At present levels, Shanghai and Shenzhen's market capitalisation totals about 55% of China's GDP in nominal dollars and about 31% GDP in PPP dollars. This compares with a market cap/GDP ratio of 84% for the New York Stock Exchange (and above 100% including the NASDAQ).

However, China is still only 6.5% of global market capitalisation. With the expected growth in China's GDP by 2025, the scope for growth in market is obvious. If China's share of GDP exceeds that of the US by 2025 then its market cap should exceed that of the US thereby placing it at least US$15 trillion in 2010 dollars. If China were to be 20% or more of world GDP in 2025, then China could represent the same proportion of world market capitalisation. Any moves towards foreign ownership and currency liberalisation should facilitate such a transformation as China is seen as an integral part of global portfolios reinforcing the growing mobilisation of domestic savings for the funding of pensions and insurance.

Alternative investments, including hedge funds, private equity and venture capital, can all be expected to grow proportionally in this period from their present small bases.

China's banks, being state-owned, are used to meet governmental objectives rather than being governed by strictly financial criteria. Savers get a poor deal. The banks made the finance available for the US$600 billion stimulus programmes in 2009, most of it finding its way into infrastructure and property. Fast growth was successfully reignited but at the cost of soaring property prices in Shanghai and Beijing and an inflationary 25% growth in the money supply. We still have to see how long-lasting the effects will be of the popping of this bubble. Inevitably large losses will accrue to the banks from this programme reducing future lending growth. In prior busts, the central government has always come to the aid of the banks as indeed has happened in the West.

Reduced state-ownership and the development of a credit culture should be hastened but in reality will only happen slowly. The temptation for the government to use the institutions for political ends has been too powerful. However, as the banks expand internationally and list their shares overseas, they should gain greater degrees of operational independence.

Development of social safety net

An improved social safety net for health insurance, pensions and education is needed to finance improved mobility and the skills of an ageing population. The old 'iron rice bowl' social security model became ineffective a couple of decades ago with the restructuring of the state-owned enterprises. China is faced with the long term effects of the one child policy. The nightmare scenario is one child supporting two ageing parents and four ancient grandparents in their old age. An effective safety net would allow consumers to reduce their precautionary savings and facilitate the restructuring of the economy towards a greater role for the service sector.

The National Social Security Fund (NSSF) was established in 2000 to help bridge annuity gaps created by the demise of the legacy SOE funds. Starting with 20 billion yuan (US$2.4 billion) in 2000 it had grown to 776.5 billion yuan (US$114 billion) by year end 2009. Its asset allocation was 40.7% fixed income, 25.9% domestic equity, 6.5% global equity, other equity assets 20.5% and 6.3% cash. The first domestic shares were bought in 2004 and first international assets in 2007. Asset growth is on a fast track although that can be expected to slow as the baby boomers start retiring after 2015. If it grows at 15% annually, it would have assets under management in excess of US$1 trillion by 2025. Since up to 10% can be invested internationally it can be expected to be another significant global player, alongside the sovereign wealth fund China Investment Corporation (CIC), in coming years.

What could go wrong?

We have attempted to put the next 15 years in the context of the broad sweep of history, not attempting to predict the near-term or the inevitable busts that briefly interrupt and cleanse over-exuberance on the way to the next growth phase. One only has to look at the examples of the UK in the period 1815-1914, the US from 1865-2000 and Japan from 1868-1990; times of enormous growth and industrialisation interrupted by recessions, panics, depressions and war; none of which could have been properly predicted in advance.

If the view presented is regarded as overly Panglossian, it is because we have taken the longer view and it is not that we are unaware of the possible downsides from, say, a banking crisis arising from a property bust or external events - such as Western protectionism or global instability affecting energy supplies - turning adverse or even the dangers from domestic instability developing from adverse events. To a degree, we share those concerns but they are essentially unpredictable. The other great industrialisations have extended over a century or more. China is only a few decades into this latest episode in its history. Adverse events, should they happen, are more likely to delay the growth outcome than negate it.


As the old developed world struggles with its most challenging economic environment in almost 80 years; Asia, led by India and China, shrugged off the credit crisis with considerable aplomb. The fast rebound from the initial slowdown is now cooling off and the immediate outlook is for more moderate growth. The asset heavy, energy inefficient and export driven model is undergoing adaptation to one that is more service-oriented and sustainable. How smooth this adaptation will be is uncertain, but we are reasonably confident that authorities will succeed and that China will become the largest economy in the world, with the largest financial sector, before 2025. For Western investors looking for superior returns, we would turn Horace Greeley's statement made during the great expansion of the United States on its head to 'Go East, young man.'

* This Commentary piece represents the opinion of the author. It does not necessarily reflect the views of Asia Asset Management.