China Monthly: a pivotal meeting

13 December 2013 15:04 Source:ICIS Chemical Business

November’s Third Plenum of China’s top leaders will have wide and long-last implications for chemicals demand growth

OK we lied. In our last China column, we promised to deliver you a rosy outlook for the country in 2014 and beyond, but I am afraid we feel compelled to go back on our deal.

The reason is the pivotal Third Plenum meeting of China’s top leaders, which took place in November.

The plenum has huge implications for economic growth and therefore chemicals and polymer demand and so needs to be addressed here.

We might well return to the subject in the New Year as the outcomes of the meeting become clearer.

In 1978, Deng Xiaoping, who was then the leader of China, decided to liberalise the economy following an earlier Third Plenum meeting. This led to enormous manufacturing and infrastructure-led growth (the two things are linked as infrastructure spending has given China a huge global competitive edge in low-value manufacturing).


Xi Jinping (centre), Li Keqiang (centre-right) and other officials at the Third Plenum in November

Copyright: Rex Features

A Stunning Communique
As we have discussed before in this column, this growth model has long past its sell-by-date. This is the result of rising labour costs due to an ageing population and horrendous levels of pollution because of poor environmental standards that have further supported the competitiveness of manufacturing. Over-investment has also taken place to the point where some analysts think China’s debt problems are greater than those of the US just before the sub-prime crisis.

Xi Jinping, who officially became China’s president in March of this year, and Li Keqiang, who took on the role of prime minister at the same time, had signalled back in February 2012 that they were intent on major economic reforms. This was through their backing of a World Bank report – China 2030: Building a Modern, Harmonious, and Creative Society – that pulled no punches. It recommended a complete overhaul of China’s economic growth model.

Expectations in the build-up to this year’s Third Plenum were therefore huge.

Xi and Li didn’t disappoint. A communiqué released a few days after the 9-12 November was over was nothing short of stunning.

The communique, for instance, promised to:

  • Reform land ownership rules so that rural residents would eventually have full title to their land. This would enable them to mortgage or sell their land, thus providing a huge boost to consumer spending. This would make it a lot easier to rebalance the economy away from investment towards much-greater domestic consumption.
  • Change the Hukou residency system. Under the current system, rural residents, when they move to the cities, are not entitled to free healthcare, education and other social services. This affects some 270m people. Again, the theory is that if and when they are given access to these services, they will spend a lot more money.
  • Relax the one-child system that has left China at risk of becoming old before its rich and so being unable to afford soaring healthcare and pension costs as its population rapidly ages. From now on, if one partner in any couple living in an urban area is from a one-child family, the couple will be allowed to have two children. Previously, both members of a couple had to be from one-child families.

Getting Out Of the Family Habit

But what looks marvellous on paper may well falter in practice.

China has to first of all create a new nationwide taxation system to prevent local government officials from fighting against reforms of land ownership, said many observers.

Right now, local authorities are heavily dependent on getting hold of land at knock-down prices and selling it on to developers at a profit because of low tax-revenue transfers from central government. Land sales enable provincial and city and town governments to meet education, health and other social liabilities.

“Reforms to the Hukou system confront the same barrier, as local authorities right now simply could not afford to provide free services to all the rural migrants,” said an Indian chemicals trader who frequently visits China.

“This is why the planned changes to Hukou will be limited to China’s second-tier cities [its smaller cities, not including Beijing and Shanghai etc].”

As far as relaxing the one-child policy goes, many commentators worry that this involves bolting the stable door after the horse has already bolted.

Assuming that women in urban China are willing to have more children as a result of the policy change, it will obviously take 20 or more years for demographics to improve. Only then would a cohort of youngsters have become old enough to work and so boost domestic demand, the labour force, and, crucially, also, government tax revenues. Increased tax revenues would help pay for all the retirees.

Meanwhile, as Paul Hodges, chairman of the UK chemicals consultancy International e-Chem points, the immediate outlook seems very bleak.

“China has become the manufacturing capital of the world over the last 15 years. But the future looks very different, as 450m people (41% of the adult population) will be in the New Old 55+ generation by 2030,” he wrote in a 3 December post on his ICIS blog, Chemicals & The Economy.

He warns that rising pension and healthcare costs – and also weaker demand because of the lack of young people – will make it very difficult to rebalance the economy away from investment towards consumption.

“Just imagine the challenge this poses for the new government,” he added, in the same post.

“Yet as the OECD [the Organisation of Economic Cooperation and Development] reminds us, China’s average earnings are just $7,500 (versus $42,500 across the OECD). So, 30 years employment gives a pension of just $2,250, plus an annuity.

“So how will all these New Old – 250m people today, 450m by 2030 – afford to buy lots of consumer goods and services?”

But, as we said, this problem might eventually solve itself thanks to the relaxation of the one-child policy. We could then see China’s birth rate rising from the current 1.1 children per woman, which is well below the population replacement rate of 2.1.

“I wouldn’t want to have children unless I left the country because of the high cost of living. More importantly, though, I worry about pollution and food safety standards. The big cities in China are no long healthy places to raise a family,” said a Beijing woman in early 30s, who works for a global bank.

And many commentators worry that middle class urbanite women, facing not only high living costs but also increasingly busy lifestyles, have got out of the habit of having children.

Plus, they point to how wealth in the developed world has acted as form of contraceptive. Increasing economic opportunities make people think harder and longer about starting families, they believe.

There are many potential outcomes from China’s bold reform process, meaning an equal number of different scenarios for chemicals demand growth.

“The problem in our company is that only scenario is hard-baked into all our forecasts – successful reforms,” said a corporate planner with a chemicals company.

“When you stick your head above the parapet and raise too many ‘what ifs’ you tend to get accuse of pessimism and so most of us keep quiet and go along with the management view. I call this the ‘tyranny of the consensus.’ “

Does this apply to your company?

By John Richardson