The Chinese economy: Still cautiously bullish

China’s national bureau of statistics recently revealed that in 2015 the country’s gross domestic product (GDP) grew at its slowest rate in the past 25 years. This headline added to nervousness and even panic in global markets. But the recent economic volatility may be a signal of an important social shift in China. This transition, like similar transitions over the past 20-30 years, could prove to be a key driver of China’s future growth.

Understanding this transition means understanding how China’s national balance sheet has evolved over time. One way to interpret the recent GDP figures out of China is to conclude that China’s economic assets have become less productive. This has happened before – in the decades after the founding of the People’s Republic of China productivity dropped because people saw less incentive to work more productively.

Leaders such as Deng Xiao Ping in the 1980s, and Zhu Rongji through the late 1990s, took steps to reverse that. They removed guarantees in employment, housing, and pensions for Chinese citizens, while simultaneously providing new economic rights and privileges to the people. That in turn led to the explosive economic growth China experienced in the following two decades.

Since 2008, however, expansion of credit has made assets more expensive – and less productive. The long standing assumption by Chinese citizens of a ‘government put’ means that the state is now faced with the problem of unaffordable capital guarantees for a large swath of assets held all across the country. To manage that, it’s again changing the social contract by removing implicit guarantees on the value of market assets. It’s compensating through plans to create a nationwide health insurance system and a pension scheme.

But it will take several years for the new social contract to gain traction – and until it does, we expect volatility. In time, however,  I believe that this type of inflection point will likely prove extremely positive for future growth of the Chinese economy. In fact, I would argue that this change in the social contract is a pre-requisite for a real, credible transition from a capital investment-led to a consumer-driven economy.