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Can China Catch Up with Greece?

China’s leader Xi Jinping recently laid out the goal of reaching the per capita income of "a mid-level developed country by 2035." Is this goal likely…

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China’s leader Xi Jinping recently laid out the goal of reaching the per capita income of “a mid-level developed country by 2035.” Is this goal likely to be achieved? Not in our view. Continued rapid growth faces mounting headwinds from population aging and from diminishing returns to China’s investment-centered growth model. Additional impediments to growth appear to be building, including a turn    toward increased state management of the economy, the   crystallization of legacy credit issues in real estate and other sectors, and limits on access to key foreign technologies. Even given generous assumptions concerning future growth fundamentals, China appears likely to close only a fraction of the gap with high-income countries in the years ahead.

Some Unpleasant Growth Arithmetic

While it’s not clear exactly what peer group Xi had in mind in referring to developed countries, those classified as “Advanced Economies” by the IMF seem a natural choice. This group consists of thirty-two economies, with 2022 per capita incomes ranging from $36,900 at the bottom (Greece) to $127,600 at the top (Singapore) measured at purchasing power parity. (Converting dollar incomes to PPP terms corrects for cost-of-living differences across countries.) We define “mid-level” as beginning at the 25th percentile for this group, corresponding to a per capita income of $49,300.

China is currently a middle-income country, with a per capita income of $21,400, placing it just above the 60th percentile of the global income distribution. China has a long way to go to meet our income threshold. Per capita income would need to rise by a factor of 2.3, corresponding to an average growth rate of 6.6 percent to reach the threshold by 2035. Annual income growth would have to be 4.3 percent to match the current level in Greece by that year.

A look at history underscores the daunting nature of this task. Of the forty-three countries that had reached China’s current income level by 2009, not one managed to achieve the growth rate needed to push China to the Advanced Economy 25th percentile over the subsequent thirteen years (see chart below). Indeed, the median thirteen-year income growth rate for this group comes to 3.1 percent, with only five seeing growth above 4 percent. And for the twenty-four countries with incomes above $49,300, it took an average of thirty-two years to make the climb from China’s current income level. Only two did so in less than twenty years.

High-Income Status by 2035 Requires Unprecedented Growth

Sources: Penn World Table, version 10.01; IMF WEO database, April 2023; authors’ calculations.
Note: Per capita income growth is GDP growth less population growth.

A growth optimist will no doubt point to China’s robust growth trajectory since market reforms were initiated in the early 1980s. Per capita income growth came to 6.5 percent from 2009 to 2022 and was even faster during the two prior thirteen-year periods (9.4 percent during 1996-2009 and 8.8 percent during 1983—1996). Remarkably, China was the global income growth leader during all three periods.

China’s past growth performance is indeed impressive. Even so, the official data show trend income growth slowing since the mid-2000s (see the blue line in the chart below, which shows five-year growth rates). The authorities’ income goals involve reversing or at least arresting this trend.

Chinese Real Income Growth Has Been Slowing

Sources: China National Bureau of Statistics; Penn World Table, version 10.01; Total Economy Database (Conference Board).
Notes: Per capita income growth is GDP growth less population growth. *Growth data for 2020 through 2022 (as part of five-year averages) taken from Total Economy Database.

Moreover, these figures take China’s official growth statistics at face value. There has long been skepticism over the accuracy of China’s statistics, which we have discussed in earlier work, and many analysts believe that growth has been systematically overstated. Economist Harry Wu has given substance to the view, proposing a number of adjustments to the official data. These adjustments provide the basis for alternative series published in leading international datasets such as the Penn World Table and the Conference Board’s Total Economy Database. China’s income growth performance remains exceptional even given these adjustments, placing in the top decile of the global distribution during each of the three recent thirteen-year periods. But these data show growth already slowing to “only” at 4.4 percent from 2009 to 2022—barely fast enough to climb to the bottom of the Advanced Economy ranks by 2035—and to a still slower pace for the last five years (the red line in the chart above).

The debate over China’s true growth rate remains unsettled. Fortunately, we don’t need to settle it. As we’ll see, a look at the evolving sources of growth in China suggests that it will fall below our benchmarks even if the official data are correct.

Lessons from the Neoclassical Growth Model

The standard neoclassical growth model provides a useful framework for assessing China’s growth prospects. Under the model, economic growth comes from two basic sources: increases in labor and capital inputs, and improvements in technology. Growth contributions from labor and capital are equal to the growth rates of these inputs, weighted by their shares in the value of production. The growth contribution from technology (termed “total factor productivity” or TFP) is calculated as a residual, as the increase in output not explained by higher inputs.

A neoclassical perspective reveals two fundamental constraints on China’s future growth performance. Labor inputs are set to decline under the weight of population aging. According to projections from the United Nations, China’s working age (20-64) population will fall by 6 percent by 2035. In principle, increases in labor force participation or hours per worker could offset some of the decline in the working age population. But China already ranks high on both these measures. At best, moves higher could offset only a fraction of the demographic drag.

China’s high share of investment spending in GDP—consistently above 40 percent since the mid 2000s—has supported a rapid buildup in the country’s capital stock. Indeed, China’s capital-output ratio is now among the highest in the world in PPP terms. But capital accumulation is subject to diminishing returns: A given increment makes a smaller contribution to growth when capital is abundant than it does when capital is scarce. Moreover, as the capital stock rises relative to output, a higher share of new investment must go to offset ongoing depreciation. The impact of diminishing returns is already in evidence. According to our estimates, increased capital inputs contributed an average of 3.4 percentage points to GDP growth in 2018-22, versus   4.3 percentage points for 2013-­17.

In earlier work based on the neoclassical framework, we found that the growth contribution from capital will continue to fade in the years ahead, even given favorable assumptions. Updated projections taking in new data reinforce this conclusion, implying a contribution of 1.4-1.9 percentage points for the period through 2035. (For details, see our appendix on China growth scenarios.) Taken together, we expect reduced contributions from labor and capital to hold income growth below 4 percent absent an offsetting acceleration in TFP growth.

A surge in TFP growth, however, seems unlikely, since productivity growth in China is already quite high, averaging 1.8 percent since 2009. Only five of the forty-three countries that reached China’s current income level in the past saw TFP growth that high over the subsequent thirteen years (see chart below). Not one managed to exceed this pace by more than a few tenths of a percentage point. In short, China will need to achieve TFP growth in excess of the fastest historical precedents to meet official income goals. Moreover, these estimates assume that the official growth figures are accurate. If the lower growth rates of Wu’s work are correct, TFP growth has already fallen to about zero.

Productivity Growth of 2 Percent Is Rare

Sources: Penn World Table, version 10.01; IMF WEO database, April 2023; authors’ calculations.
Notes: Country sample size: 42. The TFP growth spurt for the Netherlands covers 1964-77.

Structural Headwinds

In our view, however, a combination of longstanding and emerging structural headwinds will make it difficult for China to match its past productivity performance, let alone exceed it. The longstanding headwinds have been widely discussed elsewhere, including in our own work, and we will simply list them here:

  • Pervasive state and Communist Party management of the economy, a tendency that has grown more pronounced under President Xi’s tenure.
  • Lagging institutional development, reflected for example in low scores on survey-based measures such as the World Bank’s Worldwide Governance Indicators.
  • The need to rebalance the economy away from an excessive reliance on investment spending and toward consumption-led growth.
  • High private sector and government debt levels, built up in financing investment-led growth.

New headwinds have emerged alongside these longstanding ones. China’s growth has long been dependent on property sector activity. (By some measures, real estate accounts for one quarter of economic activity.) Chinese authorities have traditionally relied on relaxing or tightening credit and regulation for the sector to smooth out cycles in GDP growth. Over the last two years, however, real estate activity has gone into an extended decline, seemingly unresponsive to official efforts to support activity.

Current strains in the property sector serve as an example of the broader challenge of managing a rotation away from credit- and investment-centered growth. But these strains have their own dynamic. Shifting away from investment-led growth will entail a substantial reallocation of government expenditure from investment to consumption and household transfer payments. At the same time, though, overall government deficits and debt are already very large. Any such shift in expenditure priorities will be intertwined with the politically thorny issue of government debt restructuring.

A second emerging headwind involves the move by China’s trading partners toward onshoring and derisking. The pandemic revealed the fragility of countries’ global supply chains, many centered on China. In addition, geopolitical tensions between China and key trading partners have mounted in recent years. These forces have prompted moves to bring supply chains closer to home, and where they remain international in character, to locate them in countries with whom relations are less fraught—policies that U.S. and European officials have referred to as “derisking.”

In addition, increased geopolitical tensions have prompted the U.S. and its security partners to impose new limits on China’s access to critical foreign technologies. For example, last October the U.S. government issued major export controls that substantially blocked Chinese access to key technologies for manufacturing or acquiring cutting-edge integrated circuits, or even products containing such integrated circuits. This U.S. action was later joined by major security partners, notably including Japan and the Netherlands. These controls in essence are designed to roll back Chinese chipmaking technologies to pre-2014 levels. More recently, the U.S. issued an Executive Order that places targeted restrictions on certain outward investments in China by U.S. entities.

We do not know yet how severely property and derisking headwinds will crimp China’s future growth. But they clearly limit the prospects for maintaining past productivity performance.

Conclusion

China has many compelling strengths: a well-educated population, including half the world’s trained engineers; high-quality and still-improving infrastructure and an efficient distribution system; high if uneven state capacity; and clear leads in important new technologies, including solar power, battery production, and electric vehicles. China could surprise us and achieve Xi’s lofty income growth target. But that bet comes with stiff odds.

Hunter L. Clark is an international policy advisor in International Studies in the Federal Reserve Bank of New York’s Research and Statistics Group. 

Matthew Higgins is an economic research advisor in International Studies in the Federal Reserve Bank of New York’s Research and Statistics Group.

How to cite this post:
Hunter L. Clark and Matthew Higgins, “Can China Catch Up with Greece?,” Federal Reserve Bank of New York Liberty Street Economics, October 19, 2023, https://libertystreeteconomics.newyorkfed.org/2023/10/can-china-catch-up-with-greece/.


Disclaimer
The views expressed in this post are those of the author(s) and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the author(s).

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Four burning questions about the future of the $16.5B Novo-Catalent deal

To build or to buy? That’s a classic question for pharma boardrooms, and Novo Nordisk is going with both.
Beyond spending billions of dollars to expand…

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To build or to buy? That’s a classic question for pharma boardrooms, and Novo Nordisk is going with both.

Beyond spending billions of dollars to expand its own production capacity for its weight loss drugs, the Danish drugmaker said Monday it will pay $11 billion to acquire three manufacturing plants from Catalent. It’s part of a broader $16.5 billion deal with Novo Holdings, the investment arm of the pharma’s parent group, which agreed to acquire the contract manufacturer and take it private.

It’s a big deal for all parties, with potential ripple effects across the biotech ecosystem. Here’s a look at some of the most pressing questions to watch after Monday’s announcement.

Why did Novo do this?

Novo Holdings isn’t the most obvious buyer for Catalent, particularly after last year’s on-and-off M&A interest from the serial acquirer Danaher. But the deal could benefit both Novo Holdings and Novo Nordisk.

Novo Nordisk’s biggest challenge has been simply making enough of the weight loss drug Wegovy and diabetes therapy Ozempic. On last week’s earnings call, Novo Nordisk CEO Lars Fruergaard Jørgensen said the company isn’t constrained by capital in its efforts to boost manufacturing. Rather, the main challenge is the limited amount of capabilities out there, he said.

“Most pharmaceutical companies in the world would be shopping among the same manufacturers,” he said. “There’s not an unlimited amount of machinery and people to build it.”

While Novo was already one of Catalent’s major customers, the manufacturer has been hamstrung by its own balance sheet. With roughly $5 billion in debt on its books, it’s had to juggle paying down debt with sufficiently investing in its facilities. That’s been particularly challenging in keeping pace with soaring demand for GLP-1 drugs.

Novo, on the other hand, has the balance sheet to funnel as much money as needed into the plants in Italy, Belgium, and Indiana. It’s also struggled to make enough of its popular GLP-1 drugs to meet their soaring demand, with documented shortages of both Ozempic and Wegovy.

The impact won’t be immediate. The parties expect the deal to close near the end of 2024. Novo Nordisk said it expects the three new sites to “gradually increase Novo Nordisk’s filling capacity from 2026 and onwards.”

As for the rest of Catalent — nearly 50 other sites employing thousands of workers — Novo Holdings will take control. The group previously acquired Altasciences in 2021 and Ritedose in 2022, so the Catalent deal builds on a core investing interest in biopharma services, Novo Holdings CEO Kasim Kutay told Endpoints News.

Kasim Kutay

When asked about possible site closures or layoffs, Kutay said the team hasn’t thought about that.

“That’s not our track record. Our track record is to invest in quality businesses and help them grow,” he said. “There’s always stuff to do with any asset you own, but we haven’t bought this company to do some of the stuff you’re talking about.”

What does it mean for Catalent’s customers? 

Until the deal closes, Catalent will operate as a standalone business. After it closes, Novo Nordisk said it will honor its customer obligations at the three sites, a spokesperson said. But they didn’t answer a question about what happens when those contracts expire.

The wrinkle is the long-term future of the three plants that Novo Nordisk is paying for. Those sites don’t exclusively pump out Wegovy, but that could be the logical long-term aim for the Danish drugmaker.

The ideal scenario is that pricing and timelines remain the same for customers, said Nicole Paulk, CEO of the gene therapy startup Siren Biotechnology.

Nicole Paulk

“The name of the group that you’re going to send your check to is now going to be Novo Holdings instead of Catalent, but otherwise everything remains the same,” Paulk told Endpoints. “That’s the best-case scenario.”

In a worst case, Paulk said she feared the new owners could wind up closing sites or laying off Catalent groups. That could create some uncertainty for customers looking for a long-term manufacturing partner.

Are shareholders and regulators happy? 

The pandemic was a wild ride for Catalent’s stock, with shares surging from about $40 to $140 and then crashing back to earth. The $63.50 share price for the takeover is a happy ending depending on the investor.

On that point, the investing giant Elliott Investment Management is satisfied. Marc Steinberg, a partner at Elliott, called the agreement “an outstanding outcome” that “clearly maximizes value for Catalent stockholders” in a statement.

Elliott helped kick off a strategic review last August that culminated in the sale agreement. Compared to Catalent’s stock price before that review started, the deal pays a nearly 40% premium.

Alessandro Maselli

But this is hardly a victory lap for CEO Alessandro Maselli, who took over in July 2022 when Catalent’s stock price was north of $100. Novo’s takeover is a tacit acknowledgment that Maselli could never fully right the ship, as operational problems plagued the company throughout 2023 while it was limited by its debt.

Additional regulatory filings in the next few weeks could give insight into just how competitive the sale process was. William Blair analysts said they don’t expect a competing bidder “given the organic investments already being pursued at other leading CDMOs and the breadth and scale of Catalent’s operations.”

The Blair analysts also noted the companies likely “expect to spend some time educating relevant government agencies” about the deal, given the lengthy closing timeline. Given Novo Nordisk’s ascent — it’s now one of Europe’s most valuable companies — paired with the limited number of large contract manufacturers, antitrust regulators could be interested in taking a close look.

Are Catalent’s problems finally a thing of the past?

Catalent ran into a mix of financial and operational problems over the past year that played no small part in attracting the interest of an activist like Elliott.

Now with a deal in place, how quickly can Novo rectify those problems? Some of the challenges were driven by the demands of being a publicly traded company, like failing to meet investors’ revenue expectations or even filing earnings reports on time.

But Catalent also struggled with its business at times, with a range of manufacturing delays, inspection reports and occasionally writing down acquisitions that didn’t pan out. Novo’s deep pockets will go a long way to a turnaround, but only the future will tell if all these issues are fixed.

Kutay said his team is excited by the opportunity and was satisfied with the due diligence it did on the company.

“We believe we’re buying a strong company with a good management team and good prospects,” Kutay said. “If that wasn’t the case, I don’t think we’d be here.”

Amber Tong and Reynald Castañeda contributed reporting.

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Petrina Kamya, Ph.D., Head of AI Platforms at Insilico Medicine, presents at BIO CEO & Investor Conference

Petrina Kamya, PhD, Head of AI Platforms and President of Insilico Medicine Canada, will present at the BIO CEO & Investor Conference happening Feb….

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Petrina Kamya, PhD, Head of AI Platforms and President of Insilico Medicine Canada, will present at the BIO CEO & Investor Conference happening Feb. 26-27 at the New York Marriott Marquis in New York City. Dr. Kamya will speak as part of the panel “AI within Biopharma: Separating Value from Hype,” on Feb. 27, 1pm ET along with Michael Nally, CEO of Generate: Biomedicines and Liz Schwarzbach, PhD, CBO of BigHat Biosciences.

Credit: Insilico Medicine

Petrina Kamya, PhD, Head of AI Platforms and President of Insilico Medicine Canada, will present at the BIO CEO & Investor Conference happening Feb. 26-27 at the New York Marriott Marquis in New York City. Dr. Kamya will speak as part of the panel “AI within Biopharma: Separating Value from Hype,” on Feb. 27, 1pm ET along with Michael Nally, CEO of Generate: Biomedicines and Liz Schwarzbach, PhD, CBO of BigHat Biosciences.

The session will look at how the latest artificial intelligence (AI) tools – including generative AI and large language models – are currently being used to advance the discovery and design of new drugs, and which technologies are still in development. 

The BIO CEO & Investor Conference brings together over 1,000 attendees and more than 700 companies across industry and institutional investment to discuss the future investment landscape of biotechnology. Sessions focus on topics such as therapeutic advancements, market outlook, and policy priorities.

Insilico Medicine is a leading, clinical stage AI-driven drug discovery company that has raised over $400m in investments since it was founded in 2014. Dr. Kamya leads the development of the Company’s end-to-end generative AI platform, Pharma.AI from Insilico’s AI R&D Center in Montreal. Using modern machine learning techniques in the context of chemistry and biology, the platform has driven the discovery and design of 30+ new therapies, with five in clinical stages – for cancer, fibrosis, inflammatory bowel disease (IBD), and COVID-19. The Company’s lead drug, for the chronic, rare lung condition idiopathic pulmonary fibrosis, is the first AI-designed drug for an AI-discovered target to reach Phase II clinical trials with patients. Nine of the top 20 pharmaceutical companies have used Insilico’s AI platform to advance their programs, and the Company has a number of major strategic licensing deals around its AI-designed therapeutic assets, including with Sanofi, Exelixis and Menarini. 

 

About Insilico Medicine

Insilico Medicine, a global clinical stage biotechnology company powered by generative AI, is connecting biology, chemistry, and clinical trials analysis using next-generation AI systems. The company has developed AI platforms that utilize deep generative models, reinforcement learning, transformers, and other modern machine learning techniques for novel target discovery and the generation of novel molecular structures with desired properties. Insilico Medicine is developing breakthrough solutions to discover and develop innovative drugs for cancer, fibrosis, immunity, central nervous system diseases, infectious diseases, autoimmune diseases, and aging-related diseases. www.insilico.com 


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Another country is getting ready to launch a visa for digital nomads

Early reports are saying Japan will soon have a digital nomad visa for high-earning foreigners.

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Over the last decade, the explosion of remote work that came as a result of improved technology and the pandemic has allowed an increasing number of people to become digital nomads. 

When looked at more broadly as anyone not required to come into a fixed office but instead moves between different locations such as the home and the coffee shop, the latest estimate shows that there were more than 35 million such workers in the world by the end of 2023 while over half of those come from the United States.

Related: There is a new list of cities that are best for digital nomads

While remote work has also allowed many to move to cheaper places and travel around the world while still bringing in income, working outside of one's home country requires either dual citizenship or work authorization — the global shift toward remote work has pushed many countries to launch specific digital nomad visas to boost their economies and bring in new residents.

Japan is a very popular destination for U.S. tourists. 

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This popular vacation destination will soon have a nomad visa

Spain, Portugal, Indonesia, Malaysia, Costa Rica, Brazil, Latvia and Malta are some of the countries currently offering specific visas for foreigners who want to live there while bringing in income from abroad.

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With the exception of a few, Asian countries generally have stricter immigration laws and were much slower to launch these types of visas that some of the countries with weaker economies had as far back as 2015. As first reported by the Japan Times, the country's Immigration Services Agency ended up making the leap toward a visa for those who can earn more than ¥10 million ($68,300 USD) with income from another country.

The Japanese government has not yet worked out the specifics of how long the visa will be valid for or how much it will cost — public comment on the proposal is being accepted throughout next week. 

That said, early reports say the visa will be shorter than the typical digital nomad option that allows foreigners to live in a country for several years. The visa will reportedly be valid for six months or slightly longer but still no more than a year — along with the ability to work, this allows some to stay beyond the 90-day tourist period typically afforded to those from countries with visa-free agreements.

'Not be given a residence card of residence certificate'

While one will be able to reapply for the visa after the time runs out, this can only be done by exiting the country and being away for six months before coming back again — becoming a permanent resident on the pathway to citizenship is an entirely different process with much more strict requirements.

"Those living in Japan with the digital nomad visa will not be given a residence card or a residence certificate, which provide access to certain government benefits," reports the news outlet. "The visa cannot be renewed and must be reapplied for, with this only possible six months after leaving the countr

The visa will reportedly start in March and also allow holders to bring their spouses and families with them. To start using the visa, holders will also need to purchase private health insurance from their home country while taxes on any money one earns will also need to be paid through one's home country.

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