INSIGHT: Third Plenum will mark change of course for China

13 November 2013 16:23  [Source: ICIS news]

By John Richardson

JAKARTA (ICIS)--Perhaps the most crucial social, political and economic event in China since 1978 finished on Tuesday.

The ultimate outcome of The Third Plenary Session of the 18th Central Committee of the Communist Party of China, widely referred to as the Third Plenum, will shape the strength and nature of chemicals and polymers demand in China for the next decade or so.

The meeting ended with the release of a formal communique that some financial analysts have interpreted as positive news for economic reform.

Others, however, are disappointed, while a third group of commentators is sitting on the fence.

This might not seem like much help for chemical company corporate planners. But the meeting is hardly unique in that it reflects the ambiguity and complexity that now characterise China’s economic direction.

Gone is the old guarantee of strong GDP growth driven by favourable demographics and investment in infrastructure and industrial capacity.

But this latest Third Plenum might be similar in nature to the Third Plenum of the 11th Central Committee, which took place in 1978.

Deng Xiaoping, China’s president at that time, only set out of the broad outline of economic reforms. Implementation often took place at local, as well as national, levels over a period of several years – and involved lots of trial and error.  

The end-result, though, was the opening-up of China’s economy, industrialisation on a globally unprecedented scale and mass migration of workers from the countryside to China’s towns and cities. All of the above led to many years of double digit chemicals demand growth.

“The Third Plenum has met our expectations. In particular, it upgraded the role of the market in resource allocation to ‘decisive’ from  ‘basic’ previously, and reiterated the ‘push for domestic reforms though further opening-up’,” said Jiang Chang, a Hong Kong-based economist with Barclays, in an investment note quoted by a 13 November post on the Finanical Times Alphaville blog. 

“Based on the communique, we judge that there will be meaningful progress in deregulation, fiscal reform (our gauge of the new leaders’ ability to push for reforms), legal and judiciary reform, service sector liberalisation and a push to the Shanghai pilot free trade zone,” she added.

However, Chang said that “while the lack of mention of family planning policy or Hukou reform may have disappointed some, it has been our long-held view that meaningful, or revolutionary, progress in these two areas is simply unlikely given various social, economic, and fiscal constraints.”

China’s one-child policy was introduced by Beijing in 1979 in order to alleviate pressure on the economy, society and the environment from excessive population growth.

But now China is in danger of becoming old before it is rich enough to afford the cost of caring for an ageing population.

It has also lost the 'demographic dividend' of abundant labour supply.

Wage costs are escalating by as much of 20% per year in China because the one-child policy has led to a more limited supply of workers.

Between 15% and 25% of China’s 1980-2010 GDP growth was due to favourable age structure, according to the Brookings-Tsinghua Centre for Public Policy.

The Hukou system is a registration document that migrant workers carry with them from the countryside to China’s towns and cities.

Even though China became a country with an urban majority in 2011, around 240m people who have permanently moved from the countryside to the cities still have a rural Hukou – a small red passbook that indicates that they are still, in effect, rural residents.

As a result, they do not have access to the same education and healthcare benefits as those who are registered as urban residents, often cannot buy homes and are even unable to obtain driving licences.

As a result, they save a lot of money in order to pay for all of these essentials themselves, thus depressing China’s domestic consumption. This makes it harder for China to rebalance its economy away from investment and towards private spending.

But the cost of getting rid of the Hukou system is viewed by some observers as prohibitive, as local governments don’t have sufficient revenues to pay for all the additional social services.

Yesterday’s Third Plenum also closed without any clarity over another reform said to be vital for economic rebalancing – a change in land rights.

At present, rural residents do not own full title to the land they farm. As a result, they cannot trade their land and so use the money this would generate to, for example, set up businesses and buy property.

But lack of land rights is a cornerstone of China’s investment-led growth model.

A reason why local authorities have been able to fuel China’s rapid economic growth over the past decade or so is that they have been able to obtain land at low prices from farmers. 

They have then made good profits from selling the land to industrial and real-estate developers, but still at prices way below what many observers say would have been fair market costs.

Cheap land, along with low labour and energy costs, gave manufacturers a huge edge in export markets – enabling them to create many more jobs when job creation in basic manufacturing was more of a priority (ie when China had surplus labour).

Plus, the sale of land by local authorities remains a vital form of revenue-raising.

“SOE [state-owned enterprise] reform seems to have not been considered a priority by the Plenum,” added Wang Tao, the Hong Kong-based head of China Economics Research, in the same FT Alphaville blog post.

“The communique used the same wording as 10 years earlier, making it clear that public ownership and the state-owned sector is the pillar and ‘foundation’ of the ‘socialist market economy’. This is disappointing.”

But she did say that the government statement also talked about how private companies were “also the base” of the economy. This suggested that discrimination against private companies could be reduced in the future, she added.

The SOEs play too big a role in China’s economy at the expense of private business, warn numerous commentators.

“Their return on capital employed was always very bad. It has become even worse since the big fiscal stimulus package that was launched after the 2008 global financial crisis,” said an Asia banking source.

“Even more government money was thrown at the SOEs post-2008, via the state-owned banks. This was spent on yet more projects in already oversupplied industries.”

The SOEs are viewed as inefficient and lacking the innovation potential that China needs to escape the ‘middle income trap’. 

But, perhaps, all that is needed is time for Beijing to get it right.

“Looking back at China’s reform history, it was the decisive action that followed the Third Plenums that made those meetings the turning points of the Chinese economy,” said Wei Yao, China Economist with Societe Generale, who is also based in Hong Kong [for example, the Third Plenum in 1978].

“We think that the Plenum that just concluded has the potential to mark a new beginning of positive changes. Now having said what needs to be said, the new leaders should do what needs to be done. The real test has just started.”

But how much time do China’s leaders actually have, given that social, political, economic and environmental pressures to press ahead with reform seem to be building almost by the day?

Bookmark John Richardson and Malini Hariharan’s Asian Chemical Connections blog
Read Paul Hodges’ Chemicals and the Economy blog

By: John Richardson
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