China 2.0 = Consumption + Productivity

Thomas Masi, CFA


Nuno Fernandes, CFA


The Past – China Has Experienced Dramatic Results

The Chinese economy has been through a period of unprecedented growth over the past 20 years. Hundreds of millions of people have been lifted out of poverty and per capita income has grown at a pace never before experienced in an economy of this size. Many doubted the success, and yet the economy delivered.

The first phase of China’s path to wealth was based on cheap labor, cheap credit, and an investment wave in infrastructure. The result was the largest rural-to-urban migration in history. Literally hundreds of millions of workers moved from barely earning a living wage in agriculture to jobs in low-cost manufacturing. As many countries around the world outsourced low-wage labor-intensive tasks, the Chinese economy was willing to fill the void with efficiently organized workers who appreciated wages that were low by developed market standards. This fueled a wave of growth that was, and continues to be, an important building block of the Chinese Miracle.

This success was achieved in many ways because of a methodical approach in the context of a planned economy increasingly embracing free markets, where private investments in manufacturing and housing were met with fast-paced changes in regulations and bold infrastructure investments. The result has been a rapid rise of GDP per capita in China, which now stands close to $10,000.

The Present – Where China Stands Relative to the U.S.

China’s GDP is approximately $14 trillion. This is approximately two-thirds the size of U.S. GDP at $21 trillion. China’s economy is approximately 53% consumption, while in the U.S. it is approximately 82% consumption.1 Up until now, China has been dependent on exports for growth. The next phase, China 2.0, will be driven by domestic consumption. The stage is set. The government, realizing developed markets were slowing, especially in the wake of the global financial crisis, focused on the next phase of growth—rising domestic consumption and productivity growth. Investments in healthcare, severance packages for workers in restructured industries, and an expanding life insurance industry are paving the way for a decline in the savings rate, facilitating domestic consumption. Investments in infrastructure along with research and development in the healthcare, technology, and manufacturing industries have set the stage for higher value added products. Investments in education are designed to ensure that worker skills improve. Combined, these initiatives put in place over the past several years set the stage for China 2.0.


Challenges, Concerns, Skeptics – A Fixed Mindset Is a Difficult Thing to Change

There is much that could be criticized about the Chinese economy and many have done so for decades: it was supposed to fail, success was financed with debt, money was wasted on ghost cities, bridges were built to nowhere, pollution is out of control, and, surely, communism is the wrong form of government. China’s success threatens so many of our Western beliefs about democracy, communism, human rights, and freedom of speech that it is easier for the critics to conclude it will fail than to consider the factors that have propelled its success. Many articles written about China are designed to provoke fear. Our sense is that the voices of the skeptics will be with us for years. Instead of allowing them to overwhelm our understanding of the progress made, we choose to focus on the evidence and elevate our own awareness.

The Future

The continued success of the Chinese economy has many components, but one of the most important is the rise in productivity. The government continues to reform by expanding healthcare and social security, deregulating as well as addressing the excesses of the past credit boom. Going forward, heavy investments in education, intellectual property, and in a digital economy are crucial to China’s goal of obtaining sustainable growth in per capita income.

Today, with an aging population and wages that have risen from extremely low levels, the next phase of growth in GDP per capita is dependent on sustainable productivity and the gradual shift into producing higher value added products and services. Strong investments in capital goods need to be matched with enough quantities of skilled workers to sustain productivity growth. 

The government seems to be prepared for this next wave with massive investments in education, alternative energy, infrastructure, technology, and healthcare that will continue transforming the economy. These investments will have two major impacts. The domestic economy will be less dependent on importing high value added goods from developed markets in several industries, and China expects to move up the value added curve in terms of exports. In the years ahead, low-end manufacturing will be outsourced primarily to Southeast Asian countries that have models similar to China’s.


We will continue to monitor developments in China from multiple sources—official data provided by the Chinese government, information from the IMF and the World Bank, company reports, and audited financial statements of Chinese as well as western companies, in addition to first-hand information of interviews with management teams and business people. In our view, we must be open to multiple inputs to determine if the progress we have witnessed so far continues. In the end, we want to continuously evaluate whether the mission to improve productivity, produce higher value added products, and increase domestic consumption progresses in the years ahead.


Tom Masi


Nuno Fernandes

This represents the views and opinions of GW&K Investment Management. It does not constitute investment advice or an offer or solicitation to purchase or sell any security and is subject to change at any time due to changes in market or economic conditions. The comments should not be construed as a recommendation of individual holdings or market sectors, but as an illustration of broader themes.

Investing in securities or investment strategies, including the markets and/or any GW&K’s Investment Strategies presented in this document, involves risk of loss that clients should be prepared to bear. No investment process is free of risk; no strategy or risk management technique can guarantee returns or eliminate risk in any market environment. There is no guarantee that GW&K’s investment processes will be profitable, and you therefore may lose money. Past performance is no guarantee of future results. The value of investments, as well as any investment income, is not guaranteed and can fluctuate based on market conditions. Diversification does not assure a profit or protect against loss. GW&K’s active management styles include equity and fixed income strategies that are subject to various risks, including those described in GW&K’s Form ADV Part 2A, Item 8. GW&K’s Form ADV Part 2A may be found at or is available from GW&K upon request.

© GW&K Investment Management, LLC. All rights reserved.

1 World Bank: Final consumption as a percent of GDP.



Thomas Masi, CFA



Nuno Fernandes, CFA


PUBLISHED: May 15th, 2019
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