INSIGHT: Countering the conventional China view

01 February 2007 16:33  [Source: ICIS news]

By John Richardson

China marching to tune?Conventional wisdom was a concept invented by the economist, John Kenneth Galbraith.

“We associate truth with convenience, with what most closely accords with self-interest and personal well-being or promises best to avoid awkward effort or unwelcome dislocation of life,’’ he wrote.

Galbraith concluded that, as a result, conventional wisdom was usually untrue.

The supposed truths about China, touted at so many conferences and seminars to the point where one can end up with post-PowerPoint traumatic stress disorder, include:

  • The state-owned enterprises (SOEs) will continue to be successfully reformed. This will ensure that capital is much more efficiently allocated into either higher value innovative industry, or to lower value sectors where China still has competitive advantage.
  • The pragmatic and wonderfully efficient Chinese government will be successful in tackling corruption and in closing the gap between incomes in the east and west, thereby controlling social unrest.
  • China will continue to import huge amounts of petrochemicals for the foreseeable future

Fantastic then, we can all go home, full of conference food and booze, happy in the knowledge that the huge investments being made in China will pay off.

No, of course not, which is why Galbraith got all worked up about conventional wisdom in the first place; it is so often so drastically wrong because an ever-growing herd of economists, journalists, companies, bankers and consultants ignore counter-arguments for the sake of an easy life.

Here are some counter-arguments which could, equally, be wrong.

Another economist, Will Hutton, in his new book, The Writing On The Wall: China and the 21st Century, writes of the crippling effects of corruption on the economy, the result of the obscene opportunities for graft created by the one-party system.

According to local economist Hu Angang, corruption cost between 13 and 16% of GDP (gross domestic product) in the late 1990s.

Hutton argues that political interference by the Communist Party hinders the efficiency of the SOEs and the 57 sectors of the economy, including energy and chemicals, which are still state-controlled.

He adds that one in three SOE employees are structurally idle, and that it would take only a slight upward movement in interest rates or a decline in sales to force the supposedly reformed SOEs into bankruptcy.

The resulting surge in non-performing loans could bring the banking system down.

Hutton argues that, despite the popular perception of China at first copying and then sometimes improving on what the West does, innovation is stifled by the one-party state. Half of the country’s patents are still sourced from overseas.

He adds that capital will continue to be badly allocated without political reform. Reform would lead to genuine improvements in the way SOEs are managed and greater innovation through a more open and therefore creative environment.

China has to spend $5.40 to produce an extra $1 of output making the economy less efficient than during the Mao era because of this chronically inefficient use of capital, according to Hutton. Twenty years ago, it took only $4 to produce $1 of additional output.

China’s government might fail to tackle the corruption that’s placing such a big strain on the economy because it’s in the vested interest of party members to keep things as they are.

Economic stimulus packages are being used to try and close the east-west income gap. But it can be argued that the earnings gulf will continue to widen unless rural communities are given the right to own land. Urban incomes have exploded because of the decision in the late 1990s to allow private-property ownership.

The upshot is that GDP could fall below the often-forecasted 8-10% level.

Lower growth GDP and therefore petrochemical demand growth could combine with local petrochemical capacity additions to drive imports down to negligible levels.

In addition, you could even argue that China’s petrochemical self-sufficiency drive might eventually extend to it becoming a major exporter.

The big build-up in acetylene-based polyvinyl chloride (PVC) capacity has already led to a surge in exports with China set to become a net exporter of PVC by 2011-12.

But what if the coal-to-chemicals process proves a huge success, allowing China to leverage on an abundant and extremely competitive feedstock supply? Might it one day end up exporting polyethylene and polypropylene?

If the pessimists are only halfway right and you are the last person leaving the room, please turn off the lights.

By: John Richardson
+65 6780 4359

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