China is no longer seeking ‘growth at any cost’, with global implications, as I describe in my latest post for the Financial Times, published on the BeyondBrics blog
A pedestrian covers up against pollution in Beijing © Bloomberg
China’s President Xi Jinping faced two existential threats to Communist party rule when he took office 5 years ago.
He focused on the first threat, from corruption, by appointing an anti-corruption tsar, Wang Qishan, who toured the country gathering evidence for trials as part of a high-profile national campaign.
More recently, Mr Xi has adopted the same tactic on an even broader scale to tackle the second threat, pollution. Joint inspection teams from the Ministry of Environmental Protection, the party’s anti-graft watchdog and its personnel arm have already punished 18,000 polluting companies with fines of $132m, and disciplined 12,000 officials.
The ICIS maps below confirm the broad nature of the inspections. They will have covered all 31 of China’s provinces by year-end, as well as the so-called “2+26” big cities in the heavily polluted Beijing-Tianjin-Hebei area.
The inspections’ importance was also underlined during October’s five-yearly People’s Congress, which added the words “high quality, more effective, more equitable, more sustainable” to the Party’s Constitution to describe the new direction for the economy, replacing Deng’s focus from 1977 on achieving growth at any cost.
It is hard to underestimate the likely short and longer-term impact of Mr Xi’s new policy. The Ministry has warned that the inspections are only “the first gunshot in the battle for the blue sky”, and will be followed by more severe crackdowns.
In essence, Mr Xi’s anti-pollution drive represents the end for China’s role as the manufacturing capital of the world.
The road-map for this paradigm shift was set out in March 2013 in the landmark China 2030 joint report from the World Bank and China’s National Development and Reform Commission. This argued that China needed to transition “from policies that served it so well in the past to ones that address the very different challenges of a very different future”.
The report focused on the need for “improvement of the quality of growth”, based on development of “broader welfare and sustainability goals”.
However, little was achieved on the environmental front in Xi’s first term, as Premier Li Keqiang continued the Populist “growth at any cost” policies of his predecessors. According to the International Energy Agency’s recent report, Energy and Air Pollution, “Average life expectancy in China is reduced by almost 25 months because of poor air quality”.
But as discussed here in June, Mr Xi has now taken charge of economic policy. He is well aware that as incomes have increased, so China is following the west in becoming far more focused on ‘quality of life issues’. Land and water pollution will inevitably take longer to solve. So his immediate target is air pollution, principally the dangerously high levels of particulate matter, PM2.5, caused by China’s rapid industrialisation since joining the World Trade Organization in 2001.
As the state-owned China Daily has reported, the Beijing-Tianjin-Hebei region is the main focus of the new policy. Its high concentration of industrial and vehicle emissions is made worse in the winter by limited air circulation and the burning of coal, as heating requirements ramp up. The region has been told to reduce PM2.5 levels by at least 15% between October 2017 and March 2018. According to Reuters, companies in core sectors including steel, metal smelting, cement and coke have already been told to stagger production and reduce the use of trucks.
The chemicals industry, as always, is providing early insight into the potentially big disruption ahead for historical business and trade patterns:
- Benzene is a classic early indicator of changing economic trends, as we highlighted for FT Data back in 2012. The chart above confirms its importance once again, showing how the reduction in its coal-based production has already led to a doubling of China’s imports in the January to October period versus previous years, with Northeast and Southeast Asian exporters (NEA/SEA) the main beneficiaries
- But there is no “one size fits all” guide to the policy’s impact, as the right-hand panel for polypropylene (PP) confirms. China is now close to achieving self-sufficiency, as its own PP production has risen by a quarter over the same period, reducing imports by 9%. The crucial difference is that PP output is largely focused on modern refining/petrochemical complexes with relatively low levels of pollution
Investors and companies must therefore be prepared for further surprises over the critical winter months as China’s economy responds to the anti-pollution drive. The spring will probably bring more uncertainty, as Mr Xi accelerates China’s transition towards his concept of a more service-led “new normal” economy based on the mobile internet, and away from its historical dependence on heavy industry.This paradigm shift has two potential implications for the global economy.
One is that China will no longer need to maintain its vast stimulus programme, which has served as the engine of global recovery since 2008. Instead, we can expect to see sustainability rising up the global agenda, as Xi ramps up China’s transition away from the “policies that served it so well in the past”.
A second is that, as the chart below shows, China’s producer price index has been a good leading indicator for western inflation since 2008. Its recovery this year under the influence of the shutdowns suggests an “inflation surprise” may also await us in 2018.
Paul Hodges and Daniël de Blocq van Scheltinga publish The pH Report.
The post Anti-pollution drive hits China’s role as global growth engine appeared first on Chemicals & The Economy.
Outside observers often imagine that China’s political structure is uniquely disciplined – unlike, say the US Republican Party, or the UK Labour Party, or indeed, political parties anywhere. But the fact that most arguments take place behind closed doors, and aren’t reported in the state-controlled media, doesn’t mean that the arguments don’t happen.
Yesterday’s announcement that President Xi Jinping is taking the “core leader” designation, only held previously by leaders such as Mao, Deng Xiaoping and Jiang Zemin, is thus a rare moment when the curtain is lifted and the arguments briefly enter the public domain. It highlights the intensity of the debate now underway between Xi and Premier Li over the direction of economic policy.
Li has been very active so far this year in promoting Populist policies, at the expense of Xi’s efforts to promote reform through his Princeling faction. Xi’s move therefore confirms my belief that Xi is determined to “take the pain of reform” before his expected reappointment for another 5 years at the 19th Congress in November 2017. As he emphasised in a major interview last year, before his US visit:
“Reform steps have upset the vested interests of some people, and caused changes to the career and life of some people. It is only natural that there will be difficulties. Otherwise it will not be a reform. That is why I said that we must be bold enough to crack hard nuts and ford dangerous rapids during reform and that only the daring will prevail at key stages of reform”.
This week’s developments highlight the context within which Xi is operating. His only option is to try and tighten his control of the government in response to Li’s renewed push to implement Populist policies. In turn, this confirms that fundamental economic reform depends on the President to make it happen. If Li is able to continue with his policies, and Xi loses control of the government apparatus, reform may well be abandoned.
The announcement also confirms that China’s economy is reaching a difficult stage as the country enters the critical period ahead of the 19th Congress. This is when appointments to the Politburo Standing Committee (PSC) – effectively the supreme governing body – will be finalised for the next 5 years:
As Reuters has reported, Li is currently pushing to appoint 3 Populist allies to the PSC, which would give him a 4 – 3 majority against Xi’s Princeling faction
In response, Xi’s strategy has been to focus on the appointments to the 25-man Politburo, which in turn appoints the PSC. This currently has a 14 – 11 Populist majority. But many will retire next year – giving Xi the opportunity to replace them with loyalists, and hence control the PSC appointments
Another sign of the battles underway is that Xi has not yet made any moves to anoint a successor. This has led to suggestions that he may be aiming to remain in office beyond than the standard two-term ten years. But it may instead be that, as yet, he lacks the Politburo votes to impose his will
None of us know how the next 12 months will play out in China.
My personal belief, having worked with Xi’s father, is that his son has inherited his determination and courage. Therefore I suspect he will win through – but it will probably be a closely fought battle.
Prudent companies and investors would therefore be well advised to prepare for other Scenarios to develop, as it will probably be too late to react after the event.
Everyone is now beginning to notice the change in economic policy in China. And concern is rising about the outlook for all those new petchem investments about to come online, whose rationale has been the need to supply ever-increasing growth in Chinese demand. The chart above highlights the reality behind this wishful thinking:
- Everyone “knew” that China would never go ahead with its PDH and coal-to-chemicals expansions
- But in fact, production data from Chemease shows output is now up 25% in 2015 (red column) versus 2013 (blue)
- As a result, China’s PP imports are up just 1% over the period, and are down 8% versus last year (green)
- Similarly, its exports are on the rise, up 9% versus 2013 and up 42% versus last year
- As a result, imports from NE Asia are down 12% versus 2013 and even Middle East imports are up just 4%
The problem was that commentators chose to ignore the potential impact of China’s New Normal policies. They failed to recognise that China simply couldn’t go on with its failed stimulus programmes, which had created major problems across the country with pollution and corruption.
This threatened the whole basis of Communist Party rule, which has since Deng Xiaoping’s time been focused on increasing living standards to maintain social order. And in addition, there is the sheer waste of resources involved – $6.8tn over the past 4 years, according to the government’s own National Development and Reform Commission. There was just no way that the previous policy could continue.
Equally important, however, in the quest for social stability, is China’s need for jobs. This was made clear at the critical 3rd Plenum in November 2013, which adopted what has now become known as the New Normal economic programme. Jobs are rapidly disappearing in traditional, high-polluting industries such as steel, as an excellent analysis by the Wall Street Journal confirms. But something has to take their place.
Petrochemicals and polymers are an obvious choice, as they support jobs down the value chain in compounding, as well as in end-user industries such as autos, food packaging. Unlike steel, these jobs are not heavily polluting – and they are also relatively high margin. This is important, as it will allow domestic incomes to increase – and so help to support social stability. The growth of coal-to-chemicals production also provides a replacement outlet for coal no longer needed for steel production – thus helping to preserve jobs in the mining industry.
Polypropylene thus highlights the level of change taking place in China. Its pace is now increasing, as President Xi must take most of the pain over the next 18 months, before all eyes turn to the next National Congress in November 2017, when he is due for reappointment. It would make no sense at all for him to turn up for this with a job half-done.
When the Congress meets, he instead needs to be able to look forward, and point to the opportunities ahead from the Belt & Road initiative and the Asian Infrastructure Investment Bank. The next 18 months will be a tough wake-up call for those companies and investors who still want to believe that stimulus is just around the corner.
Everyone remembers the old joke, “Why did the elephant wear dark glasses?”, and the answer, “So that she wouldn’t be recognised”. A new version popped into the blog’s mind this week, when finishing its new Research Note on the impact of China’s new policies on the global economy:
“Why did nobody notice that China was the ‘elephant in the room’, in terms of being the main cause of today’s downturn in global demand and financial markets?” Answer: “Because we were all wearing rose-tinted glasses”.
Over the past 5 years, China’s boom has stabilised the global economy. But it was based on the largest debt bubble in history. Lending went from $1tn in 2008 to $10tn last year,
Our rose-tinted glasses make us want to believe that the boom will return, and that the new leadership will soon begin another major lending programme. This was the pattern since 2008, as in Japan’s ‘lost decades’.
But what if we are all wrong?
The blog came to know of President Xi Jinping’s father back in 1987, when helping to lead ICI’s major expansion in the Asia-Pacific region. Xi Zhongxun had then been in charge of Guangdong for almost ten years. He had torn up the Maoist rulebook, and pushed forward with major economic reform, telling his nervous team:
“We have to do this, even if we have to lose our lives.”
Xi Jinping is his son, and grew up whilst his father was being purged under Mao. The blog thus suspects we are missing the key fact: “Like father, Like son”. History suggests instead that Xi Jinping will stay the course. Thus the new Research Note expects his new policies to have 7 major impacts on the global economy:
- Domino effect. US-centric observers have understandably but wrongly assumed that concern over the Federal Reserve’s taper is solely responsible for destabilising emerging economies in a wide arc from Argentina through India and Indonesia to Turkey. Historians, however, will almost certainly recognise these economic tremors as also being an early warning of the policy shift now underway in China
- Double-digit growth. The leadership have already made clear they intend to bulldoze polluting factories, and devote major resource to cleaning up the one-sixth of China’s farmland currently contaminated with toxic waste. Therefore the days of double-digit economic growth are unlikely to ever return
- Deflation. Premier Li confirmed in October that maintaining employment was his key priority. China’s producer price index has been negative for 22 months, and it is likely exports will be a key focus for policy during the transition. This will effectively export deflation – as volume rather than profit will be the priority
- Export Demand. China’s main export focus will no longer be the cheap textiles and plastic products of the past. Instead it will create jobs via an aggressive drive to sell affordable cars, smartphones and relatively high-value chemicals into emerging and Western markets, based on the major new capacity installed in recent years
- Dollar strength. China’s economic crisis will come as a shock to most of the financial community, as did the US subprime crisis. We can therefore expect China’s currency to begin to fall in value, and the US$ to rise, all other things being equal. This, of course, will also help to boost China’s exports
- Domestic Demand. Similarly, the focus of China’s domestic demand will change. Sales of high-end western luxury goods will continue to decline as the corruption campaigns continue. Instead, the focus will be on affordable necessities such as $50 refrigerators for the 90% of the population who earn less than $20/day
- Debt. China’s record $1.3tn holding of US debt was built up as a form of vendor finance, to support US purchases of China’s products. But this strategy is no longer relevant, so we may well see China slowly reduce its holdings for use at home – potentially putting upward pressure on Western interest rates
The new leadership have spent 2 years preparing for this moment. They know that we are at the end of China’s latest ‘Boom and Bust Cycle’ of the post-Mao period. Like Deng Xiaoping in 1977, and Jiang Zemin in 1993, Xi knows he has to push forward with the plan that has been developed. Once we take off our rose-tinted glasses, we realise the obvious truth – the risks of continuing with the old policies are simply too great.
Xi’s reforms mean major change is underway in China. His policy shifts are already impacting the global economy, directly and indirectly. We cannot know if he will succeed in moving the economy towards a more sustainable future. But the blog hopes this Research Note will help readers to better understand the scale of what is being proposed, and to prepare themselves accordingly.
Please take a moment to download the Research Note, and circulate it to your colleagues and friends for discussion.
Major change is already underway in China, with potentially enormous implications for all of us.
- Corruption is being stamped out via a policy of ‘shock and awe’
- Similarly, wasteful lending is under attack in both the official and the so-called ‘shadow banking’ sectors
- Thirdly, pollution is being tackled by literally ‘sending in the bulldozers‘ to destroy polluting factories under the eyes of TV cameras, and introducing quotas on car sales in the major cities
It is impossible to underestimate the scale of the changes now underway. Just as under Deng and Jiang, they are being led from the top by a new leadership group headed by Xi himself. Its key focus is on the “economy and ecology“, highlighting the economic and political crisis that developed during the “lost decade“.
Equally, as the blog has detailed this week, these challenges clearly mirror those faced by Jiang and Zhu in 1993, and by Deng and Zhao in the post-Mao period after 1977:
Today’s challenge is not to restore order after the chaos of the Gang of Four, or after Tiananmen Square. Instead it is to head off an existential crisis over pollution, coupled with demographic decline. The Party’s main think-tank, China’s Academy of Social Sciences, has thus headlined the “shrinking demographic dividend, overcapacity, choking pollution, risks from the property sector and local government debt“ as key threats to be tackled immediately.
Bankruptcy was the key economic challenge facing Deng in 1977. Whilst as the World Bank noted, the major risk in 1993 was that ”China could have lost economic control and landed in a Latin American-style inflationary spiral”.
This time, as a major World Bank report with China’s National Reform and Development Commission has warned:
“China’s growth is in danger of decelerating rapidly and without much warning. That is what has occurred with other highflying developing countries, such as Brazil and Mexico, once they reached a certain income level, a phenomenon that economists call the ‘middle-income trap’.”
This comprehensive Report was issued to coincide with the 5-yearly Party conference in March 2012 and highlighted 5 key risks:
“The end of export market growth; wasteful infrastructure investment; the need to boost personal consumption via higher wages (which has the downside of reducing profit margins and job creation); managing the transition to a new economic model; and the threat of hitting ‘the middle income trap’ described by Nobel Prize winner Sir Arthur Lewis”
Xi and Li follow the Deng/Jiang model
In response, it is clear that the new leadership is closely following the successful strategies developed by Deng and Jiang in response to similar crises:
- The return of ‘the man who knows what to do’. Deng was brought back in 1977, having been purged 3 times, because he was the only person who could manage the situation. Similarly he returned a second time with his Southern Tour in Q4 1992 to build Jiang’s powerbase. This time it has been Jiang who returned. He ensured the removal of the corrupt Bo Xilai, and forced through the leadership changes in November 2012 that meant 6 of the 7 current Politburo members are his men
- The immediate assumption of control over the military. The Bo Xilai affair highlighted the risk of military unrest – there were well-reported rumours of tanks moving in Beijing in March 2012. Xi has followed Deng and Jiang in immediately taking control of the Central Military Commission by becoming its chairman
- The use of the World Bank to develop a policy framework. Again, Xi has followed Deng and Jiang in this, with no delay. In fact, the World Bank began work even before Xi formally took power – highlighting his early awareness of the depth of the crisis that China faces
- Focusing on the economic challenge immediately. Deng had premier Zhao Ziyang, and Jiang had premier Zhu Rongji, both entirely focused on the economic issues. Today, Li Keqiang is taking the same role. Equally important is that Xi has followed Deng and Jiang in taking personal leadership of the issue via chairmanship of the new “Leading Group for Overall Reform”. Without his active involvement, reform will inevitably be blocked by those who would lose out as a result
- Willingness to take tough measures. China’s new leadership have 10 years of power ahead of them. Thus they are already sending in the bulldozers to destroy polluting factories over the heads of local government officials. Whilst Xi’s appointee at the central bank, Zhou Xiaochuan, is taking power back from the regulators who have failed to control the shadow banking sector. All this has clear parallels with Deng and Jiang’s ‘no nonsense approach’, and their appreciation that a sense of urgency is critical for success
What does this mean for the outside world?
The years after 1977 and 1993 were stormy periods in China’s history. The period to 2020 is unlikely to be different, and there are no guarantees that the new leadership’s policies will succeed. But it is already possible to identify some of the likely major impacts on the global economy:
- Domino effect. US-centric observers have wrongly assumed that the Federal Reserve’s taper has somehow begun to destabilise Asian economies such as India and Indonesia. They will now have to rush to catch up, as it becomes clear that this is really early warning of China’s massive policy shift
- Double-digit growth. The imperative of political survival means the leadership have to continue to bulldoze polluting factories, and also clean up the one-sixth of China’s farmland currently contaminated with toxic waste. Therefore the days of double-digit economic growth will never return
- Deflation. Premier Li made clear last year that maintaining employment was his key priority. We can therefore expect China to focus on maximising export sales during the transition, effectively exporting deflation – as volume rather than profit will be the priority.
- Export Demand. China’s main export focus will no longer be the cheap textiles and plastic products of the past. Instead it will create jobs via an aggressive drive to sell affordable cars, relatively high-value chemicals and other products into Asian and developing country markets, based on its vast new capacity.
- Dollar strength. China’s economic crisis will come as a shock to most of the financial community, as did the US subprime crisis. We can therefore expect China’s currency to fall in value, and the US$ to rise, all other things being equal. This, of course, will also help to boost China’s exports
- Domestic Demand. Similarly the focus of China’s domestic demand will change. Sales of western luxury goods will continue to decline as the corruption campaigns continue. Instead, the focus will be affordable necessities such as $50 refrigerators for the 90% of the population who earn less than $20/
- Debt. China’s record $1.3tn holding of US debt was built up as a form of vendor finance, to support US purchases of China’s products. But this strategy is no longer relevant, so we may well see China slowly reduce its holdings as it will have more use for the cash at home – putting pressure on Western interest rates
Readers will no doubt have their own insights into the impact of these changes on their own businesses and personal lives. But one thing is very clear. China not only has to go down this path, as we described in chapter 6 of ‘Boom, Gloom and the New Normal’ in November 2011. But its leaders now clearly recognise that they have to change policy with great urgency.
The blog always feared that the recent boom would turn out to be another of the ‘boom and bust’ cycles that have characterised the post-Mao period. No sane person would ever want to go back to the days of the Great Leap forward and the Cultural Revolution. It therefore hopes that Xi and Li will not only manage to overcome the current crisis, but also succeed in establishing a more sustainable future for the country.
President Jiang Zemin inherited a difficult economic and political situation when taking power in 1993, as did Deng in 1977 and current president Xi last year. Jiang had to set in motion China’s second economic cycle of the post-Mao era, or risk seeing the country fall back into poverty and the political turmoil of another Cultural Revolution.
Similarly today, as the Financial Times warns:
“Former President Hu Jintao and Premier Wen Jiabao ruled China from 2002 until late 2012 …and have been accused by powerful Party figures of overseeing a “lost decade” of missed opportunities to put the country on a more sustainable path. Time is running out for the old Chinese model, based as it is on credit-fuelled property and infrastructure investment, and highly polluting low-cost manufacturing.”
If Xi does not move today, he will lose all the momentum that he has painstakingly built up over the past year. Essentially, it is ‘now or never’ for Xi and Li to act. The playbook they have followed till now is modelled on that developed earlier by Deng and Jiang, suggesting they understand what they have to do.
1993 – 2012, Jiang Zemin’s era, and its aftermath
Jiang took over as president from Yang Shangkun in 1993, having been General Secretary of the Chinese Communist Party since 1989. Like Deng, he was not impressed by ideas of democracy or political liberalisation.
His first move, after appointing Deng’s protégé Zhu Rongji as central bank governor, was to follow Deng’s 1980 policy initiative and call in the World Bank for advice. The reason was simple, as Zhu said when welcoming the World Bank team, “Foreign monks know more than local monks“.
This Dalian conference of June 1993 set out the economic programme to be adopted, with the aim of bringing China back from the abyss, and formalising Deng’s earlier dictum of the ‘socialist market economy’. The aim was simple – to keep the Communist Party in power by providing the population with increasing living standards.
Jiang inherited a number of major economic problems, as the opening up of the economy had provided wonderful opportunities for corruption to flourish. The privileges of the Special Economic Zones such as Shenzhen were being increasingly abused by corrupt leaders able to buy products and services at advantageous prices for their own personal profit. Economic disaster, in turn, was leading Party hardliners to demand a return to the ‘old ways’.
Zhu’s first objective was to resolve the enormous debts that had been built up by the powerful State Owned Enterprises as a side effect of the economic liberalisation. At the same time, he implemented extremely tight policies to bring China’s chaotic financial markets back under control. Asset prices had been allowed to rise out of control whilst corruption had flourished.
His policies led to a decade where China achieved double-digit economic growth, whilst tackling major problems of bad loans in the banking system and rising unemployment. Jiang/Zhu maintained Deng’s control over the army and his focus on raising living standards and personal consumption, and aimed to tackle the power of the SOEs via large-scale privatisations.
Equally, Deng’s policy of opening to the outside world was maintained. This encouraged the emergence of a strong export sector, which helped to support the economy through the Asian financial crisis and led finally to China’s entry into the World Trade Organisation in 2001.
The ‘Lost Decade’ under Hu and Wen from 2003-2013
However, just as with Deng’s period, these early successes were not maintained once Jiang and Zhu left power in 2003. New president Hu and premier Wen instead focused on the easy option of developing China’s role, post-WTO entry, of being the ‘manufacturing capital of the world’. The SOEs were able to regain powerful positions in major industry sectors, whilst corruption again flourished.
Then in 2008, just as in 1989, crisis intervened. Once again it was both economic and political in nature. The global financial Crisis sharply exposed China’s economic dependence on export orders, as personal consumption had actually declined since 2000 as a proportion of the economy. And so when orders disappeared in Q4 2008, 26 million people lost their jobs. Hu and Wen thus felt driven to replace this lost growth with a massive lending stimulus, as shown in the above chart.
It is fair to say that no country in history has ever undertaken such a policy on such a scale:
- Official lending doubled from $719bn (Rmb 4.9tn) in 2008 to $1.5tn in 2013 (blue column). In addition, as the blog will discuss tomorrow, the banks were allowed to develop an unregulated shadow banking system that has been lending as much, or maybe more, than the official system
- This temporarily rescued economic growth. Electricity consumption (red line) jumped an unprecedented 50% between 2009 and 2013. But the price was a massive increase in pollution, as factories and coal mines were allowed to cut costs by emitting toxic fumes
- The lending also stimulated another boom in asset prices. Jiang/Zhu had opened up the urban property market in 1998. From 2008, easy lending policies led to major speculation, with prices rising almost exponentially as buyers panicked over being left behind
- Auto sales also took off, adding more risk to the financial system, as well as more pollution in the cities. They have grown so fast, and in such an unconstrained way, that traffic jams are now an endemic part of almost any journey. Whilst pedestrians and cyclists now routinely wear masks in the major cities during days of heavy pollution
Now, as in 1977 and 1993, it looks as though the new leadership will have to pick up the pieces. As the blog described in November 2012, it is clear that the return of Jiang to a more active role was the prime cause of the changes that are now underway. The attack on corruption is a carbon copy of his earlier policy, as was the decision to bring in the World Bank for policy advice. Clearly, too, the trial of such a prominent and well-connected figure such as Bo Xilai could never have taken place without Jiang’s support.
Tomorrow’s post will therefore draw out these parallels, with the aim of highlighting the key developments that we should expect the new leadership to implement with speed. It will be a very bumpy ride, but Xi and Li know that the alternative of ‘kicking the can down the road’ would risk leading to disaster.