Car sales in China decline, what does it mean for the overall economy?

How important is the automotive sector for China's economy? What does the contraction of sales in 2019 mean for the overall economy? What else can we read out of recent automotive trends in China? Here are some thoughts to these important questions:

According to World Bank data in 2018 all industry (second sector including infrastructure construction) contributed a bit over 40% to China’s GDP, down from 47% in 2008 after massive stimulus because of the global financial crisis. Manufacturing (second sector without construction) contributed a bit over 29%, down from 32%.

What this means is that the non-construction manufacturing grew almost as quickly as overall GDP, while construction grew substantially slowlier. In other words the Chinese economy became less dependent of government stimulus, which mostly was investment in infrastructure construction. It also means that the main driver of growth was the third sector (as the first sector was already small in 2008 and has since lost more in importance, from 10% down to 7% of GDP). The car industry is obviously an important part of manufacturing, but I couldn’t find a reliable number of its value. An unverified answer on Baidu Zhidao by an unknown user claims automotive manufacturing’s total value added makes up 9.7% of China’s GDP, slightly more than the complete agricultural sector, or the housing construction (8.1%) without real estate (6.4%).

The automotive sector is in a negative development in 2019, the sales numbers are in trend to decline by some 10% compared to 2018. This decline is in “number of vehicles sold” not in “sales in RMB”. As especially the local brand’s cheap vehicles and some lower-priced foreign brands like Ford or Peugeot are performing very weak, while luxury brands and new, higher-priced local brands like NIO or XPeng are seeing growth, I expect to be the financial contraction to be smaller than the contraction in unit numbers. For clarification: contraction – often called “negative growth” which I find an oximoron and try to avoid – is not the same as the frequently heard “slowing”. When we read about the “slowing Chinese economy” it means the Chinese economy is growing at incredible speed, which is just a bit slower than it used to be, but still much higher than any Western economy. Slowing economy is by no means a crisis, nor a stagnation or a recession, it is rapid growth.

The image shows a NIO mobile charging service truck charging a Tesla.

So if we assume the car industry makes up about 10% of China’s GDP, and expect a 10% contraction, it would lead to a total impact on GDP of -1% economic growth. That is of course substantial and has to be offset by other sectors.

What sectors could that be? A pessimistic view is government stimulus within China. That is pessimistic, because China’s policy is explicitly to get away from government-led investment-driven growth. Now some economists like John Ross, who I find very convincing, argue that all economic growth in the long-term to a large extent relies on investment in infrastructure and productive capital. But such investment doesn’t have to come from the government. The more complete a country’s basic infrastructure is, the more investment should come from innovative companies investing in new technologies, new manufacturing methods, and new types of productive capital.

A second option is infrastructure investment in Belt and Road Initiative’s supporting countries. This is an interesting option for China, as such investment usually is a combination of Chinese low-interest loans, preferrential or concessional loans from development banks such as the AIIB, and local financing from the recipient countries. It is again export-driven growth, but no longer in the low-cost, low-income sector, as most low-skilled, low-wage labor is sourced locally in those projects (counter to unsubstantiated claims by some observers) while China exports expertise, know-how, and machinery along with high-skilled project managers and experts labor.

A third option is of course the service sector, and within the service sector, I see mainly two massive growth potentials: one is the financial industry, especially insurance; the other is the IT sector, especially the online market from trading to entertainment. Let’s quickly look at those:

The insurance industry is typically a sector that grows fastest when people’s basic needs have all been covered. Once people have everything they need for a good life, they seem to start to spend money to prevent future risk, which makes sense. Chinese insurance coverage in many areas is very low, while the number of people belonging to the upper middle class or high incomes is steadily increasing. Some use their money to expatriate, but they are a small minority. In addition to the growing demand for insurance, there is a substantial opening up of the insurance supply, meaning foreign insurers are allowed to offer more and more products to Chinese customers in JVs or directly. This drives up competition, innovation, and variety of insurance product offers. So rapid growth is a very likely outcome.

The IT sector in China is so huge that it is difficult to summarize it in a few sentences. I also don’t claim to be an expert in the IT industry. What I can say is that China definitely is a world leading nation in terms of IT innovation, especially in platform and application innovation. Anyone who has used weChat knows, that there is no Western app that can compete with the comprehensiveness of the service offer of weChat. For those who don’t know weChat: it is a chatting app like Whatsapp or FB Messenger, a phone and videochat app like Skype, a payment app like ApplePay (but in chats you can also make payments to friends or in group chats), a public service app where you can pay your phone bill, electricity, gas, buy train tickets, movie tickets, etc. (I don’t know a comparable app in Europe or the US). Facilitated by such payment apps (mainly weChat and Alipay) a huge range of online service offerings has become incredibly convenient, as one doesn’t need to have a credit card linked to any app or website where one wants to make payments. Anyone offering a service can simply provide a QR-code or let users directly link their weChat or Alipay account. This has sparked a plethora of innovative online services too big to describe here. As everything in China is huge, and time-consuming, there is still massive room for growth for any service offerings which make daily life more convenient. As everywhere there are always people and many spend a lot of time commuting and look for ways to not notice the world around them, there is also massive room in the online entertainment sector.

Fourth and last I want to mention again and again the fact, that more than 50% of Chinese people do not live in modern, well developed, rich, so-called tier-1 and tier-2 cities, but rather in smaller, poorer, less developed tier-3 to tier-5 cities, including rural villages where many basic services are still not available. All these areas are at a point of development, where people need higher incomes through better paying jobs, as well as more service offerings to spend their money in a meaningful way. It is definitely not easy to push economic growth in these areas, especially not from a central government which is very far away (both geographically and mentally). But it is the clear order to every Communist Party executive who is sent to such a place to find the local “main contradiction” preventing fast development and to solve it in order to trigger rapid growth. Some executives are more capable than others. Some really care for the place they govern, others try to get money out of their position in corrupt ways and/or only care about promoting their career to be reassigned somewhere else as soon as possible. This is difficult to prevent on a national level as well, since there are tenthousands of village level leaders and administrations. Oversight and control of local administration by the common people and the media are the suggested solution by proponents of Western democracy, and to some extent experiments in this direction are made. It would fill a research paper to describe all these experiments, but it would be completely wrong to claim the Chinese political system isn’t changing. On a local level many changes happen in many places.

The image shows an all-electric street cleaning vehicle: I've noticed this year in Beijing that most public service vehicles (street cleaner's tricycles, street cleaning trucks, garbage trucks etc.) are already switched to purely electric engines.

To wrap up, let’s go back to the car industry. In numbers the contribution to GDP growth in 2019 I expect to be around -1%, which can be offset by more than 10% growth in other sectors. A more important aspect of the developments in the car industry, is its function as indicator:

1.      The electric vehicle sub-market grows massively in high double digits. While still small compare to traditional cars, it is by far the largest NEV market in the world. Shenzhen has its complete bus fleet of 22’000 buses electrified, more and more cities announce plans to convert their complete taxi fleets to electric vehicles within the next years. So this trend is accelerating. I recently heard a broadcast about London's plans to electrify their complete bus fleet until some time in the 2030s, and the reporter commented, how ambitious this plan was, given that there are thousands of buses in London. This shows how far behind China we already are in Europe, how low our ambitions and our actual execution speed are, compared to China.

2.      The contraction in the overall market produces clear losers (some foreign brands and most low-cost, technologically weak Chinese brands) and clear winners (famous foreign brands and advanced, higher-value Chinese brands). This “cleaning out” of the car market can be seen as a healthy development for higher quality growth in the future – if the weak Chinese brands are allowed to die or be bought by competitors, as many of them are local government-owned.

3.      The number of Chinese cars exported abroad is growing, giving further proof of the increasing competitiveness of Chinese brands in the car industry. Especially BYD and Geely are to be watched.

4.      In terms of IT connectivity, internet of vehicles, and smart vehicles Chinese brands are increasingly world-leading, rather than imitating Western brands. This is the challenge that Germany, Japan and the US have to find an answer within the next years. As IT development cycles are much faster than automotive cycles, traditional car-makers have to find ways to handle agile, IT-focused new competitors which never got used to the rhythm of the traditional car industry (not only Chinese, clearly Tesla is also a good example of this new type car maker).

Thanks for reading and sharing. Looking forward to everyone’s opinions and feedbacks.