By John Richardson
THE DATA IS always the thing, and the data should have told the petrochemicals industry many years ago that China’s demand bubble could not go on forever.
While China has done superbly well in lifting hundreds of millions of people out of extreme poverty, relative to the West none of the numbers over the last ten years have shown China significantly closing the wealth gap. For example, a recent Pew Research Centre Study showed that just 23m Chinese citizens earned more than $50 a day in 2020.
As the chart below reminds us there were other reasons beyond just the much trumpeted “rise of China’s middle class” for China’s polymers demand surge relative to much slower growth in the rest of the world.
First came economic liberalisation following Den Xiaoping’s 1992 Southern Tour. This created the investment conditions for China to better tap into its then youthful population to make competitively priced manufactured goods for exports to the West.
But as the Peking University Professor Michael Pettis argues, what underpinned China’s export competitiveness was and still is “the very low share of income Chinese workers retain relative to their productivity”. He believes that this is holding back growth in domestic consumption.
Then, whoosh, China joined the World Trade Organisation in late 2001. The tariffs and quotas that had restricted Chinese exports to the West were removed, allowing China to take maximum advantage of what was still a youthful population.
By 2009, China’s population was already travelling down the ageing path as births per woman fell below the population replacement rate of 2.1 in 1999; they have stayed there ever since.
What masked the growing challenges of an ageing population was the giant economic stimulus package that took place in 2009. The mask started to slip in late 2021 due to the Evergrande crisis.
Anne Stephenson-Yang, research director at J Capital, provided some useful historic context in this 26 February Foreign Affairs article, reflecting what fellow Paul Hodges and I have been warning about since 2011.
She wrote: “After the 2008 global financial crisis, fearing a bank contagion and declining exports, leaders put the investment model on steroids. Under instruction from Beijing, banks threw caution to the winds. In five short years, Chinese banks added loans worth the entire value of the US banking system—which had taken 150 years to create, in a country with a much larger economy,”
She said that most of the loans went to real estate, industrial schemes “and much more infrastructure than the country could actually justify”. Real state is said to be more around 29% of China’s GDP, the highest percentage in global economic history.
China’s official lending data shows that the 2002-2008 period saw each $1 of debt creating $0.60 of GDP growth, said the latest PH Report by New Normal Consulting.
“And then China’s ’subprime on steroids’ property stimulus meant 2009-2023 saw each $1 of debt create just $0.37 of GDP growth,” the report continued.
The Economist, in its 10 February 2024 edition, analysed nationwide surveys from 2018 and 2020 that asked participants in China about their income and investments, weighting the responses to reflect China’s demography.
“The survey data suggest that about 50% of China’s wealth is in the hands of the 113m or so people with a net worth of 1m-10m yuan. This cohort—just 8% of the population—has even more influence over financial markets than their wealth would suggest. They own 64% of all publicly traded shares, for instance, and 61% of investment funds,” wrote the magazine.
I worry that China will struggle to raise domestic consumption because of this over-reliance on some 8% of its population for economic growth since 2009, as growth appears to have been so heavily concentrated in asset bubbles.
A 2022 Center for International and Strategic Studies report said that China’s Gini Co-efficient was worse than in Japan, Germany and the US. This could change if there is a major redistribution of wealth, adds Michael Pettis. But he warns that this will be difficult, and if it happens, it will take considerable time.
We also need to assess the constant drag on the economy of the low birth rate. Harmful effects include shortages of manufacturing workers, falling demand for new homes and increasing savings rates to cover rising healthcare and pension costs.
I am therefore with Pettis in his belief that maintaining 4-5% GDP growth is going to be a challenge for China, especially given that boosting exports doesn’t seem to be an option. Rising trade tensions with the West and reshoring in the West suggest that this path is not open to China.
Connecting polyethylene with the macroeconomy
Consider the table below showing China’s percentage shares of global polyethylene (PE) demand versus its percentage shares of the global population.
China was worth 34% of global PE demand in 2023 versus just 18% of the global population. This compared with just 7% and 22% in 1992 at the time of Deng Xiaoping’s Southern Tour.
This is important to consider: Between 2009 and 2023 – as China’s population was ageing, and as its percentage share of the global population fell from 20% to 18% – its percentage share of global PE demand rose by 12 percentage points.
This was during a period when its shares of exports as percentages of GDP declined from 25% in 2009 (and from an all-time peak of 36% in 2005) to 21% in 2022. I again start the chart below in 1992, as it was after this year that economic reforms unlocked export-focused growth.
The chart below is also instructive as it shows how domestic consumption as percentages of GDP did rise after 2009, but not by as much as gross fixed capital investment – a measure of overall investment.
Note that in 2022 both domestic consumption and fixed capital investment fell, reflecting the end of the real-estate bubble.
One analyst I spoke to last week suggested that there was no strong link between China’s PE demand growth and the post-2009 investment bubble. I respectfully disagree.
There is baseload of PE demand in China for daily necessities. But there’s also the “froth” created by the investment bubble – the 12% percentage point rise in China’s share of global PE demand between 2009 and 2023. Remember that this occurred as China’s percentage share of the global population fell from 20% to 18%.
Think of all the PE used to wrap washing machines, refrigerators and carpets etc. to kit out new homes, plus all the kitchenware made from PE, and high-density PE water pipes used in construction.
Then there’s the packaging of luxury goods and the PE demand associated with increased travel and dining-out. Even auto components come wrapped in PE film. The property boom coincided with a dramatic increase in new-car sales, which has since subsided.
A major driver of plastic packaging demand in China in general since January 2018 has also been online sales. January 2018 marked the ban on imports of scrap plastic and scrap cardboard. Cardboard had been used to package online sales. As it was longer available, cardboard was replaced by PE-based and other polymer-based packaging materials.
Online sales have also boomed because the big cities are incredibly well-wired, and in some cases almost cashless. Think of all the food-delivery motor scooters.
But it seems reasonable to assume that increased discretionary spending, the result of surging real estate and stock prices, gave people more money to spend online. We could therefore see a moderation in online sales, along with overall retail sales.
Scenarios for Chinese PE demand and global operating rates in 2024-2030
The old assumptions no longer hold because of events in China and elsewhere. We need to rebuild how we estimate petrochemicals demand growth reflecting, in the case of China, everything we’ve discussed above.
Hence, see the above chart. This assumes three different outcomes for China’s PE demand growth and the impact on global operating rates, assuming the rest of global demand behaves as in the ICIS base case under all these three scenarios.
The difference to the global picture would be huge, reflecting China’s dominant role in driving global demand:
- The perfectly reasonable ICIS base case sees China’s demand growth moderating to 3% in 2024-2030, which would lead to an average global operating rate of 78%. This would compare with annual average demand growth of 10% in 1992-2023, supporting a global operating rate of 85% during the same period.
- For the reasons detailed above, let’s reduce annual demand growth to 1.5% per year. China’s consumption would average 3m tonnes a year lower than our base case with the global operating rate falling to 75%.
- But what if China’s demand growth turns negative for some of the years between 2024 and 2030 with average growth for this period flat or at zero? China’s PE demand would be 5.2m tonnes a year lower than our base case, pushing the global operating rate down to just 74%.
These are of course just very rough alternative scenarios to our carefully thought-through base case. For proper scenario work, you need to invite the ICIS team into your company to conduct confidential workshops.
As I said at the outset, the global petrochemicals business could and should have anticipated today’s events in China. But what is done in. In a later post, I will consider how we apply China’s history to forecasting demand growth in the rest of the developing world.