Home Blogs Asian Chemical Connections China chemicals growth and the 20th Communist Party Congress

China chemicals growth and the 20th Communist Party Congress

Business, China, Company Strategy, Economics, Europe, European economy, European petrochemicals, Fibre Intermediates, India, Japan, Malaysia, Middle East, Olefins, Philippines, Polyolefins, Singapore, South Korea, Styrenics, Taiwan, Thailand, US
By John Richardson on 25-Oct-2022

By John Richardson

AS THE DUST settles on last week’s 20th Communist Party Congress, every chemical company needs to turn its focus to what will happen to Chinese demand over the next 20 or so years.

It doesn’t matter whether you are a polyvinyl chloride (PVC) producer in eastern Europe serving only local markets or, at the other extreme, you are one of the big Middle Eastern export-based polyethylene (PE) players. The future of Chinese consumption matters hugely to everyone.

Before I give you some preliminary thoughts on the 20th Congress, here is some important historical context that explains how China ended up completely dominating global chemicals demand.

1960s baby boom and economic reforms

In the distant world of 1978 (when our database begins) until 1989, China was a vastly different country than the one today. Economic “opening up” had only just begun, which explains why between those years, China only accounted for 9% of growth in global demand for the seven major synthetic resins (see the above chart).

Northeast Asia ex-China accounted for 21% of the growth in demand, not that far behind Europe at 24% and North America (the US, Canada and Mexico) in No1 position at 27%.

Northeast Asia ex-China (Japan, South Korea, Taiwan and, also, North Korea, although what follows doesn’t obviously apply to North Korea) was at that time the export-focused heart of the world.

Because Japan, South Korea and Taiwan were allies of the West during the Cold War, they received large amounts of US funding to develop their economies. A lot of development was focused on “chemicals in and chemicals out”, as in China today: Chemicals that were exported to the region that were re-exported as competitively priced finished goods to the West.

The Japanese, South Korean and Taiwanese chemicals industries were also growing to supply local export-focused factories, which, at that stage, were still competitive because of sufficiently youthful populations.

Everything started to change from 1990 onwards, thanks to Den Xiaoping’s economic reforms. Getting rich quick was encouraged. The main route to riches was replacing Northeast ex-China as the world’s manufacturing engine.

Vast government funding was poured into state-of-the-art infrastructure as coastal dormitory towns next to manufacturing plants sprung up, accommodating the hundreds of millions of young Chinese who moved from the countryside to the urban coast in search of a better standard of living.

Note the demographic bulge in 1964-1966 in the chart below, when Chinese births per mother peaked at 6.4. By then, birth rates in South Korea, one of China’s manufacturing rivals, had already started to decline.

Chinese babies born in the 1960s entered the workforce from the 1980s onwards. Deng’s economic reforms meant China was able to cash-in its demographic dividend of a rising working-age population. But even at that early stage, declining births per mother should have been a concern.

Favourable demographics and economic opening-up explain the remarkable switch in polymer demand-growth trends in 1990-2001 compared with 1978-1989. China’s share of global growth jumped to 35% in 1990-2001 as Northeast Asia ex-China’s share collapsed to just 5%. Europe was at 15% with North America once again in pole position at 18%.

Japan, South Korea and Taiwan adapted to this transformation by switching the focus of their chemicals industries from meeting local demand to serving China’s rapidly growing chemicals import needs. This led to substantial capacity expansions in South Korea and Taiwan from the mid-1990s onwards.

WTO membership and a gargantuan credit bubble

Then came a period of even greater economic upheaval. China gained admission to the World Trade Organization in late 2001, which led to the removal of the quotas and tariffs that had limited Chinese exports to the West.

Even though birth rates per mother had fallen to just 1.6 by 2001, below the population replacement rate, the working-age population was still expanding. China’s working-age population didn’t start to contract until 2015.

This allowed China to take maximum advantage of its low-labour costs and excellent infrastructure. The West was flooded with lots of “cheap stuff” from China, with the demand for Chinese goods in the West buoyed by the pre-Global Financial Crisis credit bubble.

Then came the 2009-2021 period, during which China effectively rescued the global chemicals industry from the Global Financial Crisis through the world’s biggest-ever economic stimulus package. The Chinese credit bubble, centred on real estate, became the main driver of global chemicals demand growth.

If we refer again to the first chart in the post, China’s share of global demand growth in the seven big resins jumped to an astonishing 67% in 2002-2021. Northeast Asia ex-China’s share of demand fell to minus 1% with Europe and North America worth just 4% and 2% of growth respectively. The chemicals world had become dangerously lopsided.

China’s middle-income trap and its high savings rate

Last week’s 20th Party Congress set a clear long-term course of direction – a state-driven economy dominated by the Party.

Can firm central control enable the type of innovation that allowed South Korea to escape its middle-income trap?  This is a question I first posed in 2012, in Boom, Gloom and the New Normal, a book a jointly authored with Paul Hodges. We are just as far from an answer as we were a decade ago.

“The great advantage of the Chinese system is that huge amounts of government funding are being spent on innovation with few strings attached,” said the head of strategy for a global polymers producer.

“Typically, this is how it works. There are, say, six start-up companies in a hi-tech sector. The government says to the employees of the start-ups, ‘only one of you is likely to succeed. If you work for the winner, you’ll make a fortune. But even if you work for one of the losers, we will write-off all your debts and give you a job with the winner at the end of the process,’” he said.

This gave Chinese entrepreneurs greater confidence to take risks than under the Western system, claimed the head of strategy.

But in the critical area of semiconductors, where China still lags-behind the West, does strong top-down state control work? Not according to the experts quoted in this 29 August New York Times article.

Self-reliance or what’s called “dual circulation” – a key policy headline emphasised during the 20th Congress – may also be antithetical to creating a world-beating semiconductor industry, said the same NYT article.

“The chip industry is highly complex and interconnected. It depends on an integrated global supply chain and draws upon expertise from different regions: design in the United States; manufacturing in Taiwan and South Korea; assembly, packaging and testing in China; and equipment from the Netherlands,” wrote the newspaper.

The comparative advantages of each region in the semiconductor supply chain had been built up over decades of capital expenditure and research and development, the NYT added.

China must win in the high-value semiconductor spare. High-value chips are essential in all the cutting-edge manufacturing sectors where China needs to excel if it is going to escape its middle-income trap.

The Financial Times, in the second of a two-part series on the future of China’s economy (the first part looked at the property crash), said: “The IMF estimates that if Chinese households consumed comparably to Brazilian households, their consumption levels would be more than double,’ “.

If this consumption can be unlocked, imagine the sunny uplands for Chinese chemicals demand.

But the FT said that savings rates were high in China because of poor pensions and healthcare provision. As I again argued in 2012, China has to escape its middle-income trap in order to generate the tax revenues necessary to pay for a better social safety net.

Since the property crash, savings rates have increased. “In the first half of 2022, households’ new savings deposits jumped more than a third year on year, to a record Rmb10.3tn ($1.4tn) and exceeding the Rmb9.9tn for all of 2021,” wrote the FT.

China watchers are questioning whether a system of firm state control can unleash all this pent-up consumer demand.

“To really unleash the ‘animal spirits’ of a consumer-led society, you must look at the characteristics of what that means in other nations: it is an aspirational mindset, upward mobility, freedom of communication, shared values that continually change and move into new areas,” said Stephen Roach, a former Morgan Stanley chief economist, in the same FT article.

And we must not forget the scale of China’s demographic challenges. No country of the size and importance of China has faced an ageing-population crisis on this scale before.

A 2019 American Enterprise Institute study found that:

  • Between 2015 and 2040, China’s population aged 50 and over will increase by roughly 250m as the population under 50 falls by the same amount. During the same years the 15-29 age group – which across all modern societies has the highest education and is the most IT and tech savvy – will shrink by 75m.
  • Equally as bad will be the fall in the 30-49 age group during this same time frame. It is forecast to fall by a quarter or by more than 100m. This is the generation that tends to be the most innovative and entrepreneurial.
  • The only cohort expected to grow is the 50-64 age group and those over 64. In 2015-2020, the 65+ population will jump by almost 150% – from 135m to close to 340m.

The need for constantly revised scenarios

Our base case is just 2% annual average China polymers demand growth in 2022-2060 versus 13% in 1978-2021 – and a much smoother trajectory of growth than we’ve seen in the past.

The chart below shows actual annual percentage growth for the seven resins between 1978 and 2021 and our forecasts for 2022-2050.

Maybe this sharp decline will be enough to accommodate a scenario where China fails to escape its middle-income. Or maybe not. A worse outcome could happen. But China may once again prove the sceptics wrong. 2022-2050 polymers growth may be stronger than we forecast.

Assuming that our base case is correct, this is what the polymers world would look like in 2022-2050 in millions of tonnes of consumption.

Because China’s annual demand growth is forecast to fall to just 2% in 2022-2050, its share of the growth in global demand during this period would decline to 31% from 67% in 2002-2021.

But China’s share of global demand – the brown-shaded area – would continue to overshadow every other region. This would be because of the high base of China demand in 2021.

I hope I’ve convinced you that deep and constantly revised scenario planning on China is essential, whether, as I said, you are a small and locally focused eastern European PVC producer or a global Middle East PE giant. The scale of the upsides and downsides for markets everywhere is huge because we are so dependent on China.