Summary
Fathom’s China Model is a theoretically founded and econometrically grounded general equilibrium model of the huge and diverse Chinese economy, built to provide insights and forecasts independent of official statistics. It can explore the effect of domestic and external shocks, such as a domestic banking crisis. It can map the likely impact of Chinese policy choices, such as rebalancing the economy towards domestic consumption, and of external policy moves such as US ‘de-risking’.
We use this model as the foundation for our China forecasts, and also extend the opportunity for our clients to leverage this tool for their specific needs. Scenarios can be tailored according to what matters for each client, allowing them to make informed decisions.
Key facts
Client
Government, private sector
Brief
Forecasts and scenario analysis for China’s economy and financial markets
Timescale
Ongoing since 2009
Focus areas
China economics
Macroeconomic strategy
Our approach
Fathom applies the same rigorous, proven process to every piece of work; this process is the DNA that makes up our world-leading research.
With China now the world’s second largest economy when measured at market exchange rates, its economic and financial markets outlook matters greatly. In recent years, a number of clients have come to Fathom asking whether China’s economic ascendancy had passed its peak, and what the likely scenarios are for the Chinese economy over the next few years.
Having a bespoke China model is crucial to answer these questions, due to the Chinese economy’s unique characteristics and complexities. Unlike most advanced economies, China operates under distinct economic policies, with a dual-sector structure, and faces specific challenges related to its role in global supply chains. This demands a more tailored approach to accurately capture the dynamics at play, allowing a more comprehensive analysis of policy choices, external shocks and long-term trends that are specific to China’s economic context.
In the chart above, Fathom used the China Model to develop three scenarios. These scenarios included the US continuing to de-risk from China alone, a housing market slump, and a scenario in which China continues to acquire key technology that results in a better long-term outlook; but scenarios can be tailored to individual needs.
The model calculates the impact of these policy changes on the main macroeconomic and financial variables, almost 100 in total, with a horizon out to beyond 2040. It contains data at a quarterly frequency, and features the two sectors characteristic of the Chinese economy: urban and rural. The latter is important since it reflects the economic diversity and disparities between these two areas of China.
Delivery
Past consultancy examples include developing scenarios for the Chinese economy over a long-term horizon: for example, exploring how Chinese GDP and inflation will evolve by 2040 under different debt, demographic and de-risking scenarios. Fathom provided these together with a brief narrative exploring each outcome and its likely implications.
The model has also been used to answer important questions about China’s economic structure. In 2009, Fathom’s analysis concluded that China’s post-GFC, construction-driven model of growth was unsustainable. Back then, that call was out of consensus; but it ended up proving correct.
Recognising that the world is uncertain, Fathom typically delivers the results from its China Model in the form of fan charts that reflect not only the likeliest outcome, but also the uncertainty around that outcome. Essentially, we consider the ‘what ifs’. Point forecasts can also be provided.
The forecasts are accompanied by a write-up which explains the results and the assumptions underpinning the scenarios in a clear and jargon-free way.
Key calls
- Excess capacity. In 2012, using Fathom’s China Model, we demonstrated that the Chinese economy was suffering from excess capacity. Following the Global Financial Crisis in 2008-09 China undertook large amounts of fixed asset investment. The model demonstrated that this would result in excess capacity (through its contribution to the stock of fixed capital), coupled with a shortfall in aggregate demand in China in future years. We argued at the time that “investment only makes sense if there is some other source of aggregate demand that will mop up all that productive capacity…[otherwise it generates]…“problems of deflation, low or negative real returns on investment, and non-performing loans in the banking sector.” One expression of this excess capacity is China’s housing market, as evidence by the construction of vast quantities of unoccupied housing and ghost cities, which have been the subject of media exposés in recent years and led to bank defaults.
- As part of the same project, Fathom’s China Model also demonstrated that a solution to China’s excess capacity would have been a rebalancing of the economy towards the consumer. As we argued at the time, rebalancing is hard to do and was unlikely to occur. Twelve years later, China is still to meaningfully rebalance its economy.
- China’s growth dynamics. China has instead relied on increased fixed investment as its greatest source of growth over the long term, and the model predicts that this will continue to be the case, reflected in the contribution of capital stock in the bar chart. In contrast, the working-age population is expected to decline at an accelerating rate; and total factor productivity growth is set to slow to around 1.5% by 2030 (as shown in the chart), a rate that is lower than Japan, South Korea, and Taiwan experienced at similar levels of GDP per capita.
- De-risking. The model has found that a scenario in which only the US continues to ‘de-risk’ from China is likely to result in China continuing to catch up with the US in terms of GDP, challenging the global order. However, if US allies join in and a more global de-risking takes place, China’s economic catch-up is set to slow.
Get in touch
At Fathom we offer our clients unique insight into China, beyond the official statistics. For more information about our services or to discuss your needs and how we can help, please submit the form below: