How long until China becomes the largest economy in the world? There was a degree of inevitability about China overtaking the United States for the economic top spot. But China’s response to the Covid-19 pandemic appears to have accelerated its progress.
According to the UK-based think tank the Centre for Economics and Business Research, China could overtake the US in 2028. That’s five years earlier than the expectation from only a year ago and it’s because China is weathering the pandemic better than Western countries.
But what does this change around in the world economic order mean for your investment portfolio? In this video, I’m taking a look at the findings of the CEBR World Economic League Table, and explaining what all of this means for how we invest our money.
The latest World Economic League Table from the CEBR shows that the US and China will trade places, in dollar terms, by the end of this decade. It also shows that China is on course to become a high-income economy by 2023. That means it is on track to pass the per capita threshold of $12,536.
Despite strong economic growth, the average person in China will still be poorer in financial terms than the average person in the United States. That’s because China has a population four times larger than the US.
Also performing well in economic terms in the East, India looks set to move into third place in the global economy league table by the end of this decade. That’s eye-opening, because the size of India’s economy currently sits in sixth place in the world, one spot behind the UK.
What’s driving such strong economic growth in China? Only last month, Chinese President Xi Jinping said it was “entirely possible” for the Chinese economy to double in size by 2035. This forms part of his government’s new Five Year Plan, aiming to achieve “modern socialism” within 15 years.
In terms of the pandemic, China took the economic hit first. But it has recovered quickly from Covid, according at least to official government data. The CEBR says that Western governments should pay more attention to Covid recovery in Asia. The report says, “Typically, we compare ourselves with other Western economies and miss out on what often is best practice, especially in the rapidly growing economies in Asia.”
In fact, CEBR referred to China’s management of Covid-19 as “skillful”, and attributed its pandemic response to a boost in relative growth compared to the US and Europe over the coming years.
When we look at how China handled the pandemic, it went in hard in the early weeks and months, but avoided the subsequent and disruptive lockdowns experienced in the West. As a result, it a) avoided economic recession this year, and b) is on track to grow by 2%.
Compare and contrast that with the US, currently the largest economy in the world, and home to the worst death rate from Covid at more than 330,000 dead and counting. In the US, there has been huge economic damage, softened to some extent by significant monetary and fiscal stimulus. Despite government and Federal Reserve intervention, the US economy is expected to shrink in size by 5% this year.
CEBR says in its report, “For some time, an overarching theme of global economics has been the economic and soft power struggle between the United States and China. The Covid-19 pandemic and corresponding economic fallout have certainly tipped this rivalry in China’s favour.”
Another factor accelerating growth in China is its aggressive policymaking targeting industries like advanced manufacturing. CEBR deputy chairman Douglas McWilliams, speaking to the BBC, said “They seem to be trying to have centralised control at one level, but quite a free market economy in other areas. And it’s the free market bit that’s helping them move forward particularly in areas like tech.”
In terms of forecasts, the CEBR is expecting to see a “strong post-pandemic rebound in 2021” in the US, followed by annual growth of 1.9% between 2022 and 2024, and then slowing to 1.6% a year afterwards.
The Chinese economy is forecast to grow by 5.7% a year until 2025, and then 4.5% a year between 2026 and 2030.
Between the year 2000 and now, China’s share of the global economy has risen by 3.6% to 17.8%.
Turning our attention to the UK, the CEBR thinks that the UK economy will grow by 4% a year between 2021 and 2025, and then growth will slow to 1.8% a year from 2026 to 2030.
The UK is currently the fifth largest economy in the world. It was pushed down into sixth place by India, but impact of the pandemic means that India is one place behind the UK again, and it’s not forecast to overtake until 2024. After that, India is on course to overtake the size of the German economy (currently in fourth place) in 2027, and then Japan (currently in third place) in 2030.
The size of the UK economy, measured in US dollars, is on track to be 40% larger than that of France by 2035.
On a global basis, environmental factors could start to have a serious impact on the shape of the world economy during the next 15 years, according to the CEBR. They said: “Sea levels are expected to have risen by 45cm from the 2000 base by 2035. This compares with the smaller 20cm rise by 2030 predicted two years ago.”
One consequence of transition to a net carbon zero economy in the coming years is weaker demand for fossil fuels and lower oil prices. The CEBR forecasts the price of benchmark Brent Crude to fall below $30 a barrel by 2035.
There is a lot to digest in these forecasts, as we think about what they might mean for investment strategies in the years to come. I think it’s important to keep in mind that the relative size of different economies is always shifting. This shifting order is one reason why investors need to take care not to invest blindly.
For example, take a closer look at Japan. Once the second largest economy in the world, Japanese equities previously formed a significant part of global equity allocations. In the late 1980s, Japan dominated the MSCI World Index – a popular investment index forming the basis of global equity index tracker funds. At its peak, the Japanese market was 44% of the MSCI index. That was more than double Japan’s share of the global economy at the time, but reflective of the market capitalisation of its equity market.
Roll forward to today, and Japan is now 7.87% of the MSCI World index, with the US at 66.1% weighting – again, around double its share of the global economy. Right now, the United States dominates global investment markets. When Tesla entered the S&P 500 index last week, I joked on Twitter that it had turned the index from the S&P 5 into the S&P 6, by virtue of the massive market cap of Tesla plus Facebook, Apple, Amazon, Netflix and Alphabet/Google.
There’s another critical issue at stake when we think about China’s role in global equity allocations, and that’s because China gets a tiny weighting to the MSCI World Index because its A-Shares are mainly owned by domestic investors, and are therefore excluded by MSCI.
There’s a disconnect between the size of a country’s economy and the size of its stock market capitalization. That’s because profits are often earned overseas; for example, the FTSE 100 index of leading UK company shares earn around 70% of revenues from overseas. That’s why the FTSE typically does well when Pound Sterling falls in value, because those revenues from overseas suddenly become more profitable.
As the world economic order continues to shift, be prepared as an investor to demonstrate some flexibility. Take care not to get stuck in outdated beliefs about the US and Japan dominating, or indeed about oil stocks being the most valuable part of your portfolio. As always when it comes to investing, diversification – spreading your risks – is key to success.
UK resident investors have a habit of weighting their portfolios to UK stocks. This ‘home bias’ is common across the world; we tend to stick with more familiar holdings, as well as finding it easier to trade in local companies. But we can reduce risk as investors by investing in overseas companies too, as any changes to domestic markets (Brexit, anyone?) are less likely to be felt in every country across the globe.
Now, I’m not encouraging you to start buying up Chinese and Indian stocks, or overweighting these countries in your equity portfolio; even if you wanted too, it’s not that easy as a UK based investor to buy into the same Chinese stocks that Chinese investors are buying. But please do recognise that things change over time. The next decade or two is looking increasingly likely to favour Asia, to see the dominance of the US economy shrink slightly on the global stage, and to see the European Union’s share of the world economy shrink too.
What worked in the past won’t necessarily work in the same way in the future. If 2020 has taught us anything, it’s the need to challenge our preconceptions when it comes to the path of economic growth, investment markets and government policies.