Why “The World’s Factory” is Slowing Down, And What It Means For Hospitality
Over the last decade, the European hospitality industry has been a key beneficiary of China’s growing middle class. However, as China’s growth has slowed in recent years, what could this mean for investors in the sector?
In our latest research, Castleforge explores the challenges faced by China, the future of the global middle class and how this affects the hospitality industry in the UK and Europe.
Since the late 1970s, China has enjoyed a period of sustained economic growth, largely driven by structural reforms, large-scale government investment, and a fast-growing export-led manufacturing sector. Over the last two decades, China’s economic expansion has helped power the growth of the global middle class. Of the 1.8 billion people who entered the global middle class between 2009 and 2019, about 700 million (roughly 40%) were Chinese.
The European hospitality industry was a key beneficiary of that growth. As new members of China’s middle class increasingly looked abroad for their next holiday destination, international departures by Chinese residents tripled between 2009 and 2019.
This created a wealth of opportunities for investors in the UK hospitality market. However, there are signs that this particular source of growth may be beginning to slow.
China’s growth has slowed in recent years. For decades, government-directed investment has been a major component of the country’s growth strategy, with “local government financing vehicles” (LGFVs) responsible for funding and carrying out large-scale infrastructure and development projects. Back when China’s infrastructure and industrial capacity were underdeveloped, this programme worked well enough: it was relatively easy to deliver economic growth by investing in badly needed infrastructure.
As a result, these investment schemes were generally productive. However, as the country industrialised, opportunities for productive infrastructure investments became scarcer, and government investment became increasingly inefficient.
This led to a higher and higher debt burden, with China’s public debt now exceeding 300% of its GDP, more than twice the level 15 years ago. In particular, the market for LGFV bonds now totals about $7.8 trillion. To make matters worse, LGFVs face borrowing costs that generally exceed the returns on their investments, meaning that local governments have often ended up covering the difference out of pocket.
To raise those funds, local governments have looked to the country’s real estate and homebuilding sectors, most often by selling off public land. This strategy has left China’s investment programme at the mercy of the country’s property market, where prices have fallen sharply over the past couple of years. As a result, local governments are now feeling the pain: in July, local authorities’ income from land sales were down 33% year-on-year, calling into question their ability to continue funding infrastructure investments over the long term.
If government-led infrastructure investment stalls, China’s economic growth will probably slow in turn. This could imply a slower rate of growth for China’s middle class. Thus, the shot-in-the-arm that China’s middle class delivered to the UK and European hospitality industry over the last decade is not something that investors can take for granted going forward.
At the same time, however, the UK and European hospitality sector now stands to benefit from other tailwinds, including record levels of domestic tourism. With that in mind, our own hotel investment strategy targets assets located in markets most likely to capture these tailwinds—vibrant cities like Bath, Edinburgh, and Cardiff, which attract domestic visitors year-round. Should China’s middle class continue to grow as rapidly as it has in the recent past, that would provide a welcome bonus.