INSIGHT: China's economy needs radical restructure

05 November 2012 12:30  [Source: ICIS news]

By John Richardson

PERTH (ICIS)--China's once-in-a-decade leadership transition is due to begin on Thursday this week (8 November), when some 2,270 delegates will gather in Beijing for the 18th Party Congress.

Political and economic experts are queuing up to warn that unless the new leaders are successful in radically restructuring China’s economy, the country faces major-long term problems.

A big difference between the transition in China, and the US presidential election on 6 November, is the role of politics in setting economic direction.

Separation of powers in the US gives whoever wins the White House limited ability to reshape policy.

But in China, the overarching role of the Communist Party in both government and business means that the new members of China’s politburo will assume a far greater ability to shape the future.

Thus, ever since the fall of the controversial party chief of Chongqing, Bo Xilai, in March of this year, which added to uncertainties ahead of the leadership handover, politics has dominated the investment mood of the domestic chemicals industry.

Plastic converters have, for instance, been unwilling to invest in new capacity.

And there are widespread reports of wealthy businessmen, including plastic processors, moving money offshore because of political concerns.

If the 18th Party Congress, which is due to last about a week, is viewed as a success, some polyolefins traders are betting on a price rebound.

But such a recovery would likely be driven only by sentiment.

A real improvement in demand isn’t expected to happen until the second quarter of 2013 at the earliest. By then, it is hoped that the new leadership will be firmly in place.

But the challenges the new leaders face could well take a lot longer than a few months to resolve.

They include reducing the role of state-owned enterprises (SOEs) in the economy, which has greatly increased since 2004.

"Under Hu and Wen, [the country’s current president and prime minister, respectively] the revenues of the SOEs have increased 15% to 25% each year, while household incomes have risen at a paltry 2-4% per year," wrote Dr John Lee, in the 3-4 November issue of The Australian newspaper.

"There are still an estimated 500m Chinese living on $2 a day or less," added Lee, who is a University of Sydney professor.

Eighty percent of poverty reduction since 1979 took place in the first decade of reforms, when the private business and household sectors, rather than the state, were given the biggest share of opportunities, he said.

More than three-quarters of bank loans are estimated to flow to the country’s 150,000 SOEs, often at interest rates 70% below what the private sector pays.

Tax breaks and free land are also said to benefit the SOEs. Not having to pay for land represented a yuan (CNY) 4,000bn ($641bn) economic benefit in 2001-09, according to the Unirule, the Chinese think tank.

The SOES have become inefficient as a result of easy bank lending, claim several economists. Lee, for example, believes that one-third to one-half of fixed asset investments are offering zero or negative returns.

And because the SOEs have enjoyed such an easy economic ride, they often lack the innovation necessary for China to escape the “middle-income trap”, warn economists, who argue that the best place for innovation to thrive is in the private sector.

But “vested interests” are believed to stand in the way of reform, as many SOE officials are politically well-connected.

If the influence of the state-owned companies persists, income inequality could remain a major handicap to growth in domestic consumption. China's consumer spending is just 35% of GDP, the lowest of any of the big economies, and has fallen from 45% a decade ago. In the US, consumer spending makes up about 70% of the economy.

Over-reliance on the wrong kind of investment - in low-value industrial capacity and unneeded infrastructure - might also persist, adding to China’s bad-debt problems and environmental degradation.

Another major challenge is the after-effects of China’s one-child policy, which led to 250m fewer births than would have otherwise been the case in 1998-2000, according to official data.

The policy has already driven up labour costs and is said to have slowed-down the rate of urbanisation.

"Based on demographics, the labour force will continue to decline and should fall by 5.4% over the coming 10 years and by a further 11.2% in the 10 years to 2032. The implication is that non-inflation driven growth will slow dramatically," wrote Simon Hunt of UK-based macro-economics and copper consultancy, Simon Hunt Associates, in a September report.

"Whilst urbanisation growth will remain a significant contribution to growth it will be far less than in the last decade.

"Then the number of households that entered the urban sector rose by 50.6 million, but in the coming ten years it will drop to just 18.5 million."

China could also become an old country before it has achieved sufficiently equal income distribution, leaving many people unable to afford escalating healthcare and pension costs - see chart below right compiled by International eChem.

Insight chartThe one-child policy has also led to a dangerous imbalance between females and males, due to selective abortions. There will be 30m more men than women in 2020, according to China’s National Population and Fertility Commission.

This imbalance, along with the rise in income inequality, has raised concerns over social stability.

China’s new leaders have, therefore, more than one reason to press-ahead with creating a fairer society.

They also need to build a social safety net big-enough to provide for the country’s growing number of retirees and their families.   

There are numerous other challenges, not least avoiding the temptation of quick-fix fiscal stimulus if 2013 GDP growth starts to weaken. An emergency injection of more government money into the economy is likely to lead to a further surge in unproductive fixed-asset investments.

But a dilemma is that despite the decline in the overall workforce, a minimum of 7% GDP growth per year is thought to be required in order to create enough work for the 7-8m of graduates entering the workforce each year.

At some stage in 2013 we should, hopefully, have a clearer idea about China’s policy direction.

Clarity won’t necessarily bring relief, however, as this could well mean that chemicals demand-growth estimates will have to be re-assessed and company strategies adapted.

($1 = CNY6.24)

Read John Richardson and Malini Hariharan's Asian Chemical Connections blog


By: John Richardson
+65 6780 4359



AddThis Social Bookmark Button

For the latest chemical news, data and analysis that directly impacts your business sign up for a free trial to ICIS news - the breaking online news service for the global chemical industry.

Get the facts and analysis behind the headlines from our market leading weekly magazine: sign up to a free trial to ICIS Chemical Business.

Printer Friendly

ICIS news FREE TRIAL
Get access to breaking chemical news as it happens.
ICIS Global Petrochemical Index (IPEX)
ICIS Global Petrochemical Index (IPEX). Download the free tabular data and a chart of the historical index