The constancy of change
20 minute read
The constancy of change
"In this world, nothing can be said to be certain, except death and taxes.” So said Benjamin Franklin in a letter written in 1789. Were he to be writing the same letter in 2021, some 230 years later, he would almost certainly be inclined to add a third phenomenon: 'change'.
Over periods of time, few things fail to undergo change, whether it be through an ongoing process of decay, evolution or, in some cases, revolution. Moreover, it is a widely held view amongst the political scientist community that the evolution of power develops cyclically, following a familiar pattern of rise and fall. Indeed, history is witness to the fact that, as a result of single or multiple factors, the global system regularly reshuffles its deck in terms of the hierarchy of power, diluting some and, in turn, elevating others.
These 'tectonic' shifts may not simply catalyse behavioural changes in the nature of inter-state relations but may also affect the fundamental power structures of the world's major nations. Historically, we have observed multi-polar, bi-polar, and uni-polar systems prevail at certain times: in 1991 for example, after the demise of the former Soviet Union, the world witnessed a uni-polar system with the emergence, and eventual dominance, of the United States – economically and militarily.
Recent trends are forcing a reshaping of that landscape, however. Whilst a number of new centres of power have emerged in Asia, Africa, and Latin America – a shift from 'West to Rest' – expert commentators are at the heart of the long-emerging consensus that the world is experiencing a profound – and inexorable – shift of power largely from West to East. Whilst this transition, in geo-strategic terms, is manifested across a number of Asian nations including Japan, the 10 countries in the Association of South East Nations (ASEAN), South Korea, India and some others, it is China that is playing the pivotal role.
This paper therefore focuses primarily on exploring the rising power of China – particularly its economic development – and its implications for the rest of the world. It goes on to examine how Henderson Far East Income, an investment company within the Janus Henderson range, is looking to capitalise on the opportunities presented by this fundamental macro-economic trend.
The beginning of the end
One need not delve too deeply into the annals of history to substantiate the fact that Asia has been the richest and most advanced of the world's regions throughout centuries. For many hundreds of years, the continent was the epicentre of civilisation, urbanisation, art, religious thought, resources, and empire, and thus feeding the rest of the world's burgeoning desire for knowledge and advancement – especially Europe.
For most of the past three centuries, however, the region has lagged behind its global peers and even today, in certain areas, human existence struggles for survival. Most historical authorities date the beginning of Western supremacy to the end of the 15th century with the arrival in Asia of the Portuguese explorer, Vasco da Gama. This heralded a 400-year period largely synonymous with European domination, the great empires being the British (across almost a quarter of the atlas), the French (in Indochina) and the Dutch (in Indonesia). This period begins to ebb in the early to mid-1900s, largely due to the post-war weakening of Europe, subsequent decolonisation – three dozen new states in Asia and Africa achieved autonomy or outright independence from their European colonial rulers between 1945 and 1960 – and the concomitant rise of the US.
In 2012, analysts at McKinsey, using data from the University of Groningen in the Netherlands, released a striking map showing how the global economic centre of gravity has shifted since AD1 – see below.1
The analysis represents a forceful wake-up call of how the West’s global supremacy is fast being eroded. As the map reveals, it took just one century, from 1820 to 1913, for the centre of gravity (as measured by 'weighing' the GDP of locations) to move from Asia to Europe. After the Second World War, that point moved further west, across the Atlantic, to the United States. In the 1960s, 70s, 80s and 90s, it remained in the western part of the northern hemisphere, but then a rapid and overwhelming acceleration occurred: between 2000 and 2010 – a single decade – the centre migrated back to Asia, overturning almost all the trends of the previous two millennia.
The path to post-war prosperity
Europe, at the end of the Second World War, was bloodied and severely weakened; the toll was the heaviest that mankind had ever known. Age-old trade links had been extinguished, any significant manufacturing capability that had not been destroyed was functioning well below capacity, and the continent was ill-prepared to deal with the 20 million or so rendered homeless by the conflict. As a result, Europe found itself relegated to playing second fiddle on the international stage, owing to the increased might of the United States and the Soviet Union and the growing rivalry between the two nations. Confronting the prospect of long-term obscurity, a divided Europe quickly came to terms with the fact that the retention of any semblance of global influence – and possibly the very survival of European civilisation – lay in the amalgamation of its economic resources and the integration of its institutions, with the financial, technical, and military support of the US.
At this point, pro-European movements and supporters of federalism galvanised themselves and vigorously promoted the idea of European unification. In 1947, an International Committee of the Movements for European Unity was established, and, in the following year, the Hague Congress was convened from which emerged the European Movement on 25th October 1948. However, the end of the war did not herald the restoration of normality; rather, it resulted in another conflict which, despite being less brutal, was more protracted and insidious.
From its inception in the summer of 1947 to its demise in 1991, the Cold War – characterised by espionage, political subversion, and proxy wars – saw Europe, now divided into two blocs, at the centre of the battle between the world's two superpowers: the US and Russia. Pivotal events, including the Soviet blockade of Berlin and the explosion of its first atomic bomb in 1949, entrenched the USSR's status as a world force. Churchill had been right: there would be an 'Iron Curtain' dividing Europe into two. For the first time in its history, a divided Europe was largely dependent on the two undisputed victors in the Second World War.
Nevertheless, the continent determined to rise again from the ashes and to rebuild a harmonious, sustainable, and prosperous future. However, relations between France and Germany soured negotiations to the point of impasse. The breakthrough came in 1950 when the French Foreign Minister, Robert Schuman, proposed that the joint output of coal and steel in the two nations be placed within the framework of a supranational structure, thereby guarding against a future remilitarisation of Germany, and firmly anchoring the Federal Republic of Germany within the free, Western world. The suggestion, immediately welcomed by the German Chancellor, led to the signing of the Paris Treaty on 18th April 1951, and ultimately to the Treaty of Rome, which formally created the European Economic Community, or 'common market', in 1957. The Schuman plan, a major milestone in the history of European unification, is therefore seen by many as the 'birth certificate' of the community of Europe.
The solidity of economic recovery following the war varied throughout the world although, in general, it was robust. In Europe, West Germany, having weathered continuous economic decline during the early years of Allied occupation, thereafter, experienced an astonishing and pronounced recovery and had, by the end of the 1950s, doubled production from its pre-war levels. Italy exited the war in poor shape economically but, by the 1950s, its economy was marked by both healthy growth and stability. France bounced back rapidly and enjoyed almost immediate economic growth and modernisation.
Much of this new-found prosperity had, of course, been catalysed by the Marshall Plan: enacted in 1948 at the instigation of the then US Secretary of State, George C Marshall, and also known as the European Recovery Program, it had delivered over $15 billion of much-needed aid to help finance rebuilding efforts across Western Europe. Over a four-year period, it facilitated the rebirth of cities, industries and infrastructure devastated during the war, the removal of trade barriers between European neighbour states and the fostering of commerce between those countries and the United States. A less widely proclaimed goal was to stem the spread of communism across the content of Europe.
By contrast, the UK was, needless to say, in a state of economic ruin by the conclusion of the war and experienced relative economic decline for decades to follow. Studies now show that joining the EU played a major part in halting the UK's post-war economic decline relative to the EU6 (the six EU founding members: Belgium, France, West Germany, Italy, Luxembourg, and the Netherlands) and, set against four key economic measures – trade, foreign direct investment, finance, and Economic Monetary Union – the UK gained significantly from EU integration.
The United States, having been spared industrial and civilian devastation (the 300,000 combat deaths it suffered paled in comparison to any other major participant), found itself at the end of the war experiencing phenomenal growth and in better economic condition than any other country in the world, with American society enjoying more affluence than most of the population could ever have imagined, as more and more citizens considered themselves to be within the ranks of the middle classes. This growth had multiple contributory factors: a sharp rise in the number of automobiles produced annually (which quadrupled between 1946 and 1955), a housing boom (stimulated in part by easily affordable mortgages for returning servicemen), the rise in defence spending as the Cold War escalated, and the repurposing of sophisticated war-time technology into peacetime applications all played a part.
Corporate America was changing also. Major corporations grew larger still, franchise operators like McDonald's expanded rapidly, and a new form of entity emerged in the shape of the conglomerate: substantial firms with holdings in a variety of industries, some of which would be overseas in order to take advantage of lower labour costs. International Telephone and Telegraph, for example, bought Sheraton Hotels, Continental Baking, Hartford Fire Insurance, and Avis Rent-a-Car, amongst others. The result was an economic expansion unseen in human history. In 1945, the United States produced roughly half of the world's industrial output with a GDP of $228 billion; by 1975, 30 years later, this had grown to $1.7 trillion.
China’s entry into the second world war began in 1937, after a clash between Chinese and Japanese troops at the Marco Polo Bridge, just outside Beijing led to all-out war. As the war intensified, an unlikely alliance between sworn enemies Chiang Kai-shek and Mao Ze Dong was formed, and the country established a unified-front line and bravely fought the larger and better equipped Japanese army. By the time Britain declared war on Germany in 1939, China had already been fighting for two years and sustained heavy losses. Around 14 million Chinese died and up to 100 million became refugees during the eight years of Sino-Japanese conflict between 1939 to 1945. Still in recovery from the impact of the second world war, China would suffer more setbacks in the decades to come in the form of the ‘Great Leap Forward’ and the ‘Cultural Revolution’ – both plans of China’s Great Helmsman', Chairman Mao Zedong. The Great Leap Forward resulted in one of the largest famines in world history, while Cultural Revolution crippled the economy and thrust China into 10 years of turmoil, bloodshed, hunger, and stagnation.
A world in flux?
Much has changed in terms of the world economy in the 70 or so years since the post-war return to prosperity which took such a fervent hold on the West. European nations emerged for a lengthy period of time as a united force on the global stage by pursuing a course of economic and political integration and formulating common foreign and defence policies under the umbrella of the EU. This unfolding scenario generated the impression that the geo-political landscape would develop into a multi-polar system and that the EU would be capable of posing a serious challenge to the hegemony of the US. To a large extent, this has failed to materialise, with Europe beset by seemingly endless calamities: the collapse of the Exchange Rate Mechanism in 1993, the euro debt crisis which forced five out of 17 eurozone countries to seek financial help from other nations between 2009 and 2012, unprecedented levels of economic in-bound migration by those seeking work and – most recently – the potentially terminal derailing of wider European integration brought about by Brexit.
In the second half of the 20th century and beyond, the United States has acted as the anchor and guarantor of the Western liberal order and supported the transition of many states towards western liberal democracy, the election of Donald Trump as 45th President of the United States marked a turning point in the debate over global power relationships and the US's role in the world. The relative decline of its weight has featured prominently in debates regarding the consequences of global power shifts, particularly given the extent to which America's global reputation suffered in the light of failed military interventions in Iraq and Afghanistan, its part in triggering the 2008 world-wide recession and Congress's reluctance to grant more weight to emerging nations in international institutions.
After many years of ideological misgivings between the US and China, the world's two largest trading partners, policymakers on both sides need to adapt swiftly as trade and geopolitical relationships change. A new US administration may represent a de-escalation of tensions, but Biden's initial moves suggest the direction of travel will remain essentially the same, with a commitment to steadfastness. By way of example, in March the US joined Britain, Canada and the EU in a simultaneous declaration of sanctions against Chinese officials involved in the incarceration of more than 1m ethnic Uyghurs in Xinjiang. That being said, it’s important to recognise that more members of the UN support China’s actions in Xinjiang than those who oppose them. Most UN member states also support China as an irreplaceable source of loans, infrastructure, and affordable technology. Returning to the theme of the cyclical nature of shifts in economic power, it's illuminating to show the significant fluctuations that have taken place over the last six decades, as illustrated in the table below. It shows the top five economies by GDP at intervals from 1960 to 2019 (the latest year for which data are available).
Rather than simply delivering a static view, the table provides us with a lens through time, helping to show the rapid ascent of certain countries and the descent of others. Whilst there are a number of points of interest within the data, the two most noteworthy have been described as 'economic miracles'. The first relates to Japan and describes the record-setting GDP growth it experienced between the end of the Second World War and the end of the Cold War. In 1960, its economy was less than 10% the size of that of the United States; just a decade later, it was 20%, with the country achieving sustained real GDP growth – often in the double digits each year – that allowed it to accelerate past both the UK and France to become the world’s second-largest economy. It's a position it would retain every year between 1972 and 2010, until it was supplanted by another Asian economic miracle: China.
In 1820, the world was a very different place: the Greeks had just begun to revolt against the Ottoman Empire, Brazil declared independence from Portugal, the world’s first modern railway opened in England, where the first industrial revolution was already underway, and China, where the Qing dynasty was approaching its third century of imperial rule, held the largest share of global GDP. Having fallen behind from the late 19th century as several industrial revolutions compounded in the western world, China embarked upon its unprecedented economic catch-up in 1978. Despite a disappearance from the upper echelons of the list by 1980, new and all-pervading economic reforms in the 1980s and '90s paved the way to the economic colossus we know as China today, not to mention the unparalleled achievement of lifting 800 million of its people out of a state of poverty (accounting for over three quarters of global poverty reduction between 1990 and 2005). By 1993, China was once again one of the world’s top 10 economies and, by 2010 – a mere 17 years later – had surpassed the UK, Germany, France and even Japan to entrench itself as the second largest in the world – two-thirds the size of the US – a status it continues to enjoy today.
Where are we now … and what does the future hold?
The importance of China as a nation has been recognised for centuries; Marco Polo was one of the first to do so when venturing there in the late 13th century at the time of the Yuan Dynasty and was astonished by the many considerable advancements being made. Living in the emperor's lands for 17 years, he witnessed a great many things that had previously been unknown to Europeans. Some may have forgotten, however, that China was the first country that gave humanity the four great inventions: the compass, gunpowder, papermaking, and printing.
The Chinese have proved to be as capable of great innovations now as they were then and, after decades of relative isolation, the country has emerged as a superpower. Whilst the rise in Asian prosperity and productivity started with Japan and South Korea, and then transitioned to South East Asia, the truly transformative event occurred when China joined the process of rapid industrialisation – because of its sheer size, it is that which triggers a shift in the axis of the entire global economy.
Indeed, since the last decade of the 20th century, China has become the workshop of the world. Consider the facts:
- it is the world’s largest exporter and the second largest importer of merchandise goods;
- it uses more steel and cement, and has more miles of high-speed railway lines, than any other nation;
- it manufactures nearly 70% of the world’s photocopiers, CD/DVD players and microwaves;
- it has overtaken the US as the largest exporter of IT including computers, mobile phones and digital cameras;
- it is one of the largest manufacturers of heavy machinery;
- it is the largest trading partner of the US, and the largest trading partner of 64 countries, against just 38 for the US;
- of the 10 cities that are forecast to experience the fastest GDP growth up to 2025, only New York is in a developed economy, the other nine being Chinese;3
- whilst being the greatest consumer of energy, it is at the same time spending billions of US dollars on the development of green technology and renewable sources of power.
All of this has a psychological impact too. Studies show that the populations of Asian economies tend to be far more optimistic than those in the west. The new Asian middle classes are confident their children will be better off financially. For them, the future's bright, whilst westerners find it harder to remain upbeat. In China, this sense of optimism also derives from the generally held view by the Chinese population that their government is doing a good job and the country is moving in the right direction. Therefore, the government enjoys the overwhelming support of ordinary Chinese and there is a sense of buoyancy and unity. Once unsure whether to join the G-8 of industrialised nations, the Chinese now talk of a 'G-2' – a group of just two nations, China, and the US – ruling the world.
A number of factors may combine to arrest China’s meteoric growth in the years to come. First, its population peaked in 2012 and its labour force is declining. Second, as it catches up economically with the rest of the world and approaches the innovation frontier, significant leaps in productivity will be less easily achieved, and can no longer stem from knowledge transfers but must be driven by domestic innovation. Healthy growth from a low base is normal – building basic infrastructure is a key driver – but becomes less sustainable as the basics are met. Catching up is easier than pushing the innovation frontier. Finally, China’s already high levels of investment, which have been in the region of 50% of GDP, will be difficult to maintain in light of its total debt.
Nevertheless, despite these obstacles, China's ascent to the top rung of the global productivity ladder within the next decade seems inexorable. PWC's most forecast of global productivity by country – The Long View: how will the global economic order change by 2050, published in 2017 – makes a number of stark predictions.
China attracted $163bn of fresh multi-national investment in 20205, more than any other country. The sheer size of the Chinese economy and its equity market gives investors access to an immense opportunity, offering both depth and liquidity. As the chart below show, the universe of quoted Chinese businesses is almost as large as that of the US and its market capitalisation is already the second largest in the world.
The phenomena identified above relating to China's accelerating progress have not escaped the attentions of the asset management community, including Mike Kerley, portfolio manager since 2007 of Henderson Far East Income Limited, an investment trust within the Janus Henderson stable. Mike has long recognised the market potential of China and, unsurprisingly, given the trust's income mandate, regards corporate dividend payouts as of paramount importance. As identified in the Asia Pacific Dividend Index 2021, whilst the Asia Pacific region as a whole has become a global profit powerhouse – making up 36% of the global total in 2020, up from just 23% a decade earlier – China has proved to be the primary growth driver. By the end of 2020, its profits had soared to a record £430bn, up 141% since 2010, outpacing every other country within the analysis. Over the decade, profits rose seven times faster than the global average. Even if we stop the clock in 2019, i.e., prior to the arrival of the pandemic which caused so much disruption around the world, but left China relatively unscathed, Chinese profits had grown over three times faster than the global average since 2010. Growth in 2020 was 2.2% – one of the few countries where profits actually expanded.6 As at the most recent financial year end in August 2020, the trust's geographical exposure to China was 25.5% and the income contribution of that region 36.1%.7 Just five years previously, for the financial year ending 2015, the percentages were 20.9% and 25.0%, 18% and 31% lower respectively.8
There is no doubt, that the recent regulatory crackdown in China has unnerved investors. However, they shouldn’t be a huge surprise considering the well documented goals of the Chinese government. Perhaps what may have caught some investors off guard is the scale and the timing of the regulation. While some investors have interpreted the crackdown as a clash between the government and private business, the reality is more complicated. China's government is looking to level the playing field and reduce widespread inequality, which is reflected in the areas that have seen increased levels of regulation.
China has turned its focus towards “common prosperity”, as a result there has been increased regulation in areas with crucial social welfare implications, such as health care, education, and property. Therefore, the recent ban on tutoring and compulsory education, intensified regulation in the real estate market, and the broader coverage of social security and the health care system are all trying to address the top concerns of the average family in China. The government is also looking to level the playing field within its business arena. The Chinese internet platforms have grown rapidly over the last few years, partly due to the lax regulatory environment. This has resulted in some businesses gaining unfair competitive advantages, and we have even seen some exhibit monopolistic characteristics. Therefore, the new regulation aims to address the regulatory loopholes that some businesses have exploited to promote fair competition, sustainable growth and ultimately level the playing field.
In Mike Kerley’s view, these measures do not impact the number of opportunities in China – it’s just that the opportunity set is now different. Paying high multiples for structural sectors with high margins and strict regulatory oversight is fraught with danger, but there are other opportunities in areas that fit in with government aims and goals at much more attractive valuation points. The latest five-year plan clearly outlines areas where the government is focusing and investing around these themes makes the most sense. Clear targets have been set in terms of localisation (avoiding reliance on US imports) and improvements to the environment while a focus on reducing inequality should be good for trends in low to middle income consumption. An ageing population and shrinking workforce will prompt innovation around working practices involving greater automation, while industrial innovation will be encouraged and supported.
Taking a longer-term view, the outlook for China remains positive as the long-term structural trends remain intact. China will continue to have much stronger growth than the west over the next 20 to 30 years, driven by its huge population and emerging middle class which is becoming an ever-larger local market for goods and services. China is also experiencing rapid infrastructure development, technology advancement (much of it homegrown), and rapid adoption and integration into the wider Asian region with a combined population of 4.5 billion, which is estimated to contain 66% of the world's middle class in 10 years.6 The shift in global economic power from west to east would seem to be well-established, therefore. Indeed, many would argue that it is now unstoppable, with China well on its way to reclaiming its position as the world’s largest economy amid the Fourth, not the First, Industrial Revolution.
Source: Business Insider and McKinsey Global Institute analysis using data from Angus Maddison; University of Groningen, as at 29th June 2012
Source: World Bank – World Development Indicator, 1960-2019, as at January 2020
Source: McKinsey, urban world: mapping the economic power of cities, as at March 2011
Source: PWC, The Long View: how will the global economic order change by 2050, published in 2017
Source: BBC News, China takes new foreign investment top spot from US, as at 25th January 2021
Source: Janus Henderson, Asia Pacific Dividend Index 2021
Source: Henderson Far East Income Limited, Annual Report 2020
Source: Henderson Far East Income Limited, Annual Report 2015
These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. Any securities, funds, sectors and indices mentioned within this article do not constitute or form part of any offer or solicitation to buy or sell them.
Past performance does not predict future returns. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.
The information in this article does not qualify as an investment recommendation.
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