OneBeltOneRoad

By John Richardson

IS the whole world really turning again free trade? No, if you consider the potential improvement in trade flows between the 65 mainly developing countries which make up China’s One Belt, One Road (OBOR) initiative.

What we could instead see is the creation of the world’s biggest free-trade bloc, accounting for 40% of global GDP with a combined 4.4bn people.

What is more accurate is that the West is turning against free trade, as the Brexit vote so clearly demonstrated.

We also have the febrile atmosphere of this year’s US presidential election. Even though a majority of US citizens still favour free trade, Republican pollster Neil Newhouse told the New York Times:

I can guarantee you that the intensity and energy on the issue is all on the anti-trade side. It’s a motivating issue, and one that hits home to Americans who are still struggling to make it back from the recession. Those who support free trade are more ‘lukewarm. For them it’s not a voting issue.

The mood towards the proposed US-led Transpacific Partnership (TPP) trade deal amongst those most-likely to vote in the election is also important. As Democratic pollster Geoff Garin also told the NYT:

Most people don’t really live in the world of geopolitics, and don’t think very much about China’s influence in the Pacific relative to our influence in the Pacific. But they do think about jobs and wages and whether corporations can be trusted to use these trade agreements for the greater benefit of the American people.

Both of the US presidential candidates have come out against the TPP.

 

The importance of jobs and wages

Jobs and wages. Absolutely. The above quote from Geoff Garin is on the money because of the perception amongst many voters in the West that jobs are either scarce – or when they can be found pay too little.

A lot was made earlier this month of US Census Department data showing a 5.2% increase in US median middle class incomes between 2014 and 2015. This was the biggest increase since 2007. But:

  • Incomes have yet to regain their 1999 peak, and if it were not for weak inflation, 2015 middle class incomes would have only been 3% higher.
  • Income inequality, as measured by the Gini coefficient, was unchanged from 2014 to 2015.

I believe that the anxiety over jobs and wages – in not only the US but also in Europe, of course – reflects this reality: Tens of millions of people have lost economic ground because of the failure of Western policymakers to address today’s demographic challenges.

Until or unless the challenge of ageing populations is dealt with, public discontent can only increase as voters turn increasingly to populist politics.

An immediate threat arising from this discontent is that free trade between the West and the rest of the world will break down after this year’s US presidential election – and following presidential and parliamentary elections in Europe next year.

In contrast, jobs and wages go to the very heart of just about everything that Chinese policymakers do because they understand the importance of demographics  in shaping opportunities for people – both domestically and in its OBOR partner countries.

To again detail the theoretical example I gave earlier this month, China can no longer compete in low-wage industries such as textiles and garments because of its ageing population, which is part of the OBOR

Iran, however, can because of its youthful population.Youth unemployment is also a big challenge in Iran which would be addressed by growing its textiles and garments industries. China would also win because its textiles and garments manufacturers would be able to establish new businesses in Iran – thus compensating for lost investment at home.

Iran might in turn supply China with the oil that it needs – and perhaps the paraxylene to help China run its purified terephthalic plants a lot harder. Polyester fibre could then be re-exported back to Iran, to feed its rapidly-growing Iranian textiles and garments sector.

The big gain for China here is that these types trade flows would place a floor under the fall in GDP growth that will result from further economic reforms.

This brings us back to demographics – i.e. China’s middle-income trap: Limiting the fall in GDP would give China the time it needs to create millions of new jobs in higher-value manufacturing and services.

The OBOR is thus a win/win for every country that it is taking part – because it is centred on jobs and wages.

 

What This Means for Petrochemicals

The charts at the beginning of this blog post focus only on two products – linear-low density polyethylene (LLDPE) and purified terephthalic acid (PTA).

They were chosen because they represent two extremes.

PE in general remains in big demand in the West because of its use in food and non-food packaging.

The US and Europe also have big existing PE capacities, with of the US about to bring on-stream a major wave of expansions because of its low cost of ethane.

And yet the OBOR region will still account for 58% of global LLDPE consumption and 57% of capacity in 2020. This will rise to 63% and 60% respectively by 2026.

The PTA story is  less of a surprise a of course the OBOR region is a big producer  of textiles and garments because of its low labour costs.

A while ago it became a major exporter of the polyester fibres needed to make its textiles and garments. And of course the feedstock for polyester fibre is PTA.

More recently, China has gone a step further up this manufacturing chain, by aggressively raising its PTA capacities.

Most of the OBOR members, as I said earlier, are developing countries and so have comparatively low labour costs. This has led them to supply most of the world’s textiles and garments, as to be competitive in these sectors you need cheap labour.

Not surprisingly, for the reasons I’ve already detailed above, the OBOR share of global PTA consumption and capacity will range between 78% and 80% in 2020 and 2026.

These numbers should give every strategic planner in every petrochemicals company pause for thought. They should also make investors in petrochemicals companies think again.

The obvious scenario is that a break down in free trade in the West will make it much-harder for petrochemicals companies who are located there to export to OBOR countries. The OBOR not only accounts for large percentages of global petrochemicals demand, but is also made up of many of the world’s strongest growth markets.

The other risk is on capacity. Closer economic cooperation may result in the region building more plants in products such as LLDPE, where it makes economic sense.

You might be right to assume that the West will not retreat from free trade, for the time being at least, by accurately predicting the results of the forthcoming elections in the US and Europe.

But I believe you would be very wrong to underestimate the importance of the OBOR. This is a multi-generational economic, social and political plan that has China’s deep commitment. As for China’s OBOR partners, the benefits are, as I said, huge.

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