What do China’s constraints mean for business?

Alfredo Behrens
International MBA/FIA, São Paulo
alfredob@fia.com.br
July, 2009

During over a decade we have witnessed the early morning yawning of the Eastern dragon, China grew at astonishing rates for over a decade. Market after market succumbed to lower priced Chinese products.

How long can this last for?
China grew at two-digit rates, but it also increased the depletion of its environment, aggravated income distribution between people and regions and triggered internal migrations to booming coastal cities which have turned into policy headache as China’s export-oriented growth cycle slows down, unemploying over 20 million migrant workers.
The environment issue will take more than the cosmetic “Blue Sky Plan” launched in anticipation of the Beijing Olympics, even though that took abating emissions from the fourth largest iron and steel mill. Besides dealing with the increasing desertification and the sandstorm which dumped 330,000 tons of dust in Beijing in April 2006 - now China must face how to deal with the dust, soot and acid rain resulting from coal-fired energy production targeted at 780,000 Megawatts for 2020. This is almost eight thousand times more than all of Brazil’s installed capacity in 2007. China’s power generation is almost 80% coal-fired. MIT estimated that China will install two 550MWe coal fired plants every week.

Water quality is poor and not enough to go around, certainly not to treble per capita consumption, the growth necessary only to bring Chinese consumption to world average levels. In a country so large there can only be regional disparities. While there are floods in some regions there are shortages in others. But where there is abundance of water it may be too polluted. For instance the Yellow River is so high in ammonia that it might not longer sustain life. But it is not all, up to 40% of China’s GDP is located along the Yantgtze River, however “the ecology of the Yangtze River is facing an extreme crisis, and if it is not addressed there is a fear that the ecosystem will collapse within ten years.” Only five more to go.

In the longer run there are also important demographic trends to pay attention to. China is also fast at being old. Over the next two decades the proportion of inhabitants over 60 years of age will have doubled. Ageing may have happened in any case, because of decreasing fertility rates, but was accelerated by the One Child Policy.

Currently, only 10% of the population takes part in the Chinese pension system; which in 2000 was partially funded by 100 million formaly employed and benefits 32 million retirees. The low coverage means that the majority of old people will have to rely on their savings, as can be complemented by a reduced family system, because of the One Child Policy. How much will these “only children” will agree to pitch up with is to be seen. Singletons share many characteristics of the first born, who, for some time at least, are only children. These tend to be high achievers, assertive and dominant, while laterborns score higher in Agreeableness and are generally more innovative. How these considerations will work out in China is hard to anticipate, but if the theory were correct, one should expect a future mix in the Chinese population which will be still more hierarchical and less questioning of status quo.

What will the waking-up look like?

Indeed, China’s 11 to 13% growth rates underscored a 9% consumption rate. Yet that consumption growth may fall to 5 or 6% if China’s GDP growth rate falls to 8%. Unless, of course, the massive Chinese fiscal policy stimulus manages to prop-up domestic consumption by enough. Even in China there are limits to how much fiscal stimulus the government may resort to without depreciating the currency.

The Yuan had appreciated about 20% since mid 2005 until 2008; an unmanaged depreciation of the Yuan would bring capital flight and a depreciation war with its Asian competitors. If there is a lesson to be drawn from the 1997 currency crisis in Asia is that it is necessary to stabilize the currency rather than let it be determined by the market in a volatile environment.

China has been caught in a difficult situation. At the height of the American-led financial crisis China had revalued its currency, loosing international competitiveness, thus aggravating the domestic impact of the world financial crisis. Besides, China’s growth is ecologically constrained. One avenue to release the latter constraint would be to de-emphasize the coastal-oriented development and regionally rebalance growth towards the Western provinces. This would temporarily dilute pollution pressure on the East and ease the current migration trend to the East of the country. But it would require targeting the fiscal stimulus away from the heart of the domestic crisis - East and South - and into infrastructure to develop communications with the Western provinces. On the other hand, the demographic constraint is harder to release and will lead to emphasizing capital intensive rather than labor extensive industries as its population ages.

Where to invest in China?
This is of course a broad sweep, but if one were to invest in China today I would recommend having a closer look at the mid to Western provinces, providing one’s product is not intensive in water and one can get the products out to a cost effective port, or that, in the longer run, your line of activity would benefit less from cheap labor than from a highly educated and disciplined labor force, in which case, you may rely more on air transportation for business.