London, December 2010

Capital Economics: Based on a plausible scenario for the evolution of the sustainable growth rate of the economy and the commodity-intensity of activity, China’s commodity demand in 2025 could be half the level that a simple extrapolation of the recent trends would suggest.

• In a recent Focus piece we set out a number of reasons why the prices of industrial commodities may already have risen to unsustainable levels. Just one of these was the observation that China’s GDP growth is likely to slow in the next few years to between 8% and 10%, compared to the 10% and 14% recorded from 2003 to 2007 during the last commodity boom.

• Admittedly, the larger size of China’s economy after years of rapid expansion means that even if growth does slow, the absolute increase in GDP in any given year will probably still be greater than it was in the past. For example, the IMF is forecasting that China’s real GDP will increase by RMB1355bn in 2011. This would be slightly larger than the RMB1329bn gain in 2007, despite a much lower forecast for GDP growth (9.6% in 2011 vs. 14.2% in 2007). What’s more, even if growth settles at around 9.5%, as the IMF expects, the size of the increases in GDP would continue to climb. (Chart 1.)

• However, we are not disputing that China’s economy – and its demand for commodities – is likely to continue to grow at a rapid pace. Instead our argument is that this story may already be reflected in the current level of prices and that future demand could now fall well short of what many anticipate.

• For a start, growth in China’s economy, although still strong, will slow. Real GDP growth has averaged close to 10% since the late 1970s, but this will not be sustained indefinitely. In particular, the pool of underemployed workers waiting to migrate from the countryside has nearly dried up and the number of young workers is falling. As a result, the easy productivity gains achieved by moving workers from farms to factories will be harder to achieve in the future.

• What’s more, the commodity-intensity of a given level of economic activity is likely to fall, probably much more so in China than in other rapidly developing countries. The quantity of commodities used for each unit of global GDP has been trending down (typically by about 1% a year) for at least the last fifty years. This reflects a mix of efficiency gains, technological progress and a shift towards lesscommodity- intensive activities, notably services. China’s extraordinary investment boom over the last decade means that it has bucked this trend, which is a key reason why commodity prices are high now, but rebalancing of the economy over the next decade is likely to see commodity-intensity drop sharply.

• The second chart illustrates both of these points. The first scenario assumes that China's economy continues to grow at 10% and that the commodity-intensity of activity is unchanged (many bullish forecasts actually assume that the intensity increases). The second scenario factors in a slowdown in trend growth to 6% within ten years. The third also incorporates a reduction of 2% a year in commodityintensity.

The upshot is that, by 2025, commodity demand in the third scenario (which we think is the most plausible) could be roughly half the levels in the first (which is what many seem to expect).

Ends --

Julian Jessop Chief International Economist.