China To Stop Importing Chemicals As It Exports New Technologies

By John Richardson

LAST Friday I discussed how, even without the impact of demographics on demand, it is mathematically impossible to fit one two billion into two billion.Robotics

Now bear with me for a few minutes. The themes I discussed on Friday are so critically important to how the global chemicals industry measures growth that they are worth a recap before I move on to argue that Chinese domestic demand will not come to the rescue of the world’s economy:

  • There are two billion people in East Asia who need to escape the “middle income trap” if they are to become the kind of mass consumers of modern-day finished goods that some one-dimensional analysts think is inevitably going to happen. And yet there are only one billion affluent consumers in the world.
  • Why does this matter? Because the only proven escape route out of the middle income trap is via low-income countries exporting finished goods to high-income countries.  So in East Asia alone, as I said, there are two billion people competing for just one billion rich consumers. And this, of course, doesn’t take into account the billions-more people in the Indian sub—continent, parts of the Middle East, Africa and  Latin America that can also only escape the same middle-income trap by exporting to the relatively few, fortunate rich people in the world.
  • But we also know that demographics shape demand, which means that the world’s one billion lucky rich are not quite as lucky as they were a decade ago. This is the result of the retirement of the Babyboomers. I doubt that any of the 50% or so young people who are unemployed in Greece today feel that lucky, even if they don’t have to worry about lack of decent sanitation, safe drinking water, shelter, healthcare and food. These basic needs have yet to be adequately met in much of the developing world. Just look at India as a particularly awful example of government failure to provide enough of the basic needs.
  • So what do demographics tell us? They tell us that people in the US and EU will become ever-more cost conscious because the drain on demand caused by ageing populations will become bigger over the next 20 years and more. The focus will be on buying the minimum of what is required to get by. Automobiles, washing machines and refrigerators will only be replaced when they absolutely have to be replaced. This means no repeat of the demographics and credit-fuelled boom in Western consumer demand that so spectacularly helped China grow its economy from the 1990s until 2008.
  • So countries in East Asia, such as Laos and Cambodia, many countries in Africa, and also India, are at risk of not even getting past “first base” if their governments think that the main route to success is via exports. By this, I mean that they won’t even escape extreme poverty never mind the middle income trap, which is defined as per capita incomes of around $10,000.

But I can still hear the one-dimensional analysts saying that all the above still doesn’t matter because of China. They will point out that because of the size of China’s population, and because domestic demand remains relatively mooted compared with investment, the rebalancing of China’s economy towards far-greater local consumption will deliver another boost to global demand equal that which occurred between the 1990s and 2008.

The next step in this logic is to assume that China will need to import lots of chemicals and polymers to satisfy this voracious increase in domestic consumption, so justifying many of the heavily export-based cracker and derivatives projects in the US and elsewhere.

But here are just five of the many reasons to challenge, and I think entirely dismiss, this argument about the “new China”:

  1. China needs to itself escape from the middle income trap. The only way it can do this in its developed eastern and southern provinces, where labour costs are on the rise, is to move up the manufacturing value chain. Why on earth, therefore, should it import the speciality chemicals and polymers it needs to achieve this objective? If it wants to create a sufficient number of value-added jobs, it must continue to develop its own speciality chemical and polymers technologies and capacities.
  2. If you move inland in China, though, as is the case in so many places in Africa, the challenge still remains escaping poverty rather than the middle income trap. In provinces such as Yunnan, income levels are way behind Guangdong etc. even if in places like Yunnan, the basic needs of sanitation, clean water, healthcare, food and shelter have already been met. So how does China go about escaping poverty in provinces such as Yunnan? Through building basic manufacturing capacity. Thus, I think there is every likelihood that China will move much closer to self-sufficiency in basic chemicals and polymers, via new coal-based olefins and polyolefins capacities in inland China. The sharp rise in local polypropylene production provides evidence to support this argument. Yes, it is of course true that new petrochemicals plants will by themselves not provide much employment. But it is all the employment downstream – in for, instance, logistics, trading, other services industry and in plastics processing – that is the bigger route to job creation and so escaping regional poverty. You want guaranteed local supplies of raw materials and not foreign imports that may or may not arrive, depending on global market conditions. If imports do not arrive, you end up with job losses because local plastic fabricators will be forced to shut down. The other obvious reason to believe that China will move rapidly towards much-greater self-sufficiency in basic chemicals is its feedstock advantage – i.e. lots of local coal.
  3. China’s visionary leaders also get demographics. Demographics are the foundation of their long-term strategy. So here is an example of how all the above might dovetail together as part of this long-term strategy:

a.)    A smartphone production hub in Guangdong makes all the components for a new line of phones that are cheaper, but just as good, as anything that the “mid-market phone producer”  Samsung can produce. This includes all the speciality chemicals that go into the phones, along with the memory chips etc.

b.)    But it is too expensive to actually assemble the smartphones in Guangdong, because of local labour costs, and so the components are moved via China’s vastly improved internal rail links to Yunnan, where final assembly takes place.

c.)     The phones are then moved again via rail, this time along the  international New Silk Road, to Western markets. Ageing populations in the West guarantee that there will be huge demand for Chinese phones. These phones won’t be quite as good, and/or won’t have the same brand-strength as high-end I-Phones, but they will good enough for people on very limited incomes

4. The New Silk Road, which will be funded by the Asia Infrastructure Investment Bank, will also deliver some benefits to neighbouring countries. But as Julian Snelder, a global investment fund  manager, points out in this article:

“Informed Chinese experts tell me that Chinese firms expect to scoop 93-94% of the contract value of all projects funded AIIB, plus the Chinese unilateral initiatives (like Silk Road Fund) combined.

“By Goldman Sachs’ calculation, local expectations for China’s newly re-combined train-making monopoly assume a clean sweep at home and an heroic 55% share of all railway rolling stock bought overseas in the next five years.

“These firms expect a bonanza of construction in which Chinese money, materials, management and manpower can build grand overseas projects. Foreign firms will [instead} have to settle for spillover business, in the form of subcontracts.”

5. And here is another thought, which also occurred to me as a result of reading the same article: If China escapes the middle income trap, it might not only end up exporting smartphones, but also “disruptive” next wave technologies, such as robotics, that would further reduce the potential for new manufacturing jobs in other countries. “Beijing naturally wants an automation industry for itself and targets an advanced domestic equipment base by 2025. When China makes the machines that make the machines that replace humans, workers of the world will unite in worry,” adds Snelder.

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