As I have covered here many times, the entire claim that the Chinese economy is growing at 7% and of a remotely successful rebalancing depends on the argument that the Chinese service sector is expanding rapidly enough to offset the widely recognized decline in manufacturing and industry. However, when people discuss the services sector, most especially with regards to China don’t understand one important service sector component and the implication of one component that is recognized as a service sector component. I should note I plan to do a much longer post on this with lots of data for comparison but for the moment just give a short sample.
The first mistake people in discussing the “service” sector is not realizing that real estate is included in the so called service sector. In must be emphasized that this is standard the world over and not in any way unique to China but many people do not realize that when they talk about the growth in the “service sector” they are including very hard production and the upstream industries in this classification.
The second mistake is in how we understand an industry that while recognized and appropriately classified as a service industry has a very large caveat due to “Chinese characteristics”. Financial services are widely recognized as a service but there are two important factors which imply we should at least recognize the unique nature of arguing for a healthy economy due to service sector expansion. First, financial services still derive the vast majority of employment, assets, and revenue from the major SOE commercial banks. Second, these banks give out the large majority of their loans, by some measures almost 90%, to old industry firms that are facing large declines in revenue. In other words, the financial services industry growth has come from the credit boom of traditional banks channeling money to old industry firms.
As the Financial Times EM Squared team notes, if we strip out financial services from the tertiary sector, services have actually declined since 2000 and relatively significantly by probably at least 5% of GDP. Even if we look at other services, service sector contribution to GDP excluding finance is near all time lows. In other words, any rebalancing has come from the service sector feeding capital to old industry declining firms not from the growth of new firms or organic growth in services.
The numbers bear this out. While listed A-share operating revenue for financial services and real estate has grown 17% and 31% annually for the last three years, wholesale and retail operating revenue grew at a mediocre 4% annually over the same time period. That is the complete opposite of rebalancing.
I want to strongly re-emphasize that there is nothing here out of the ordinary in how things are classified officially. What does need to be recognized are what exactly is considered a service sector industry and their dependence on old declining industries. If we account for that, the picture looks decidedly different.