BREE’s 2013 China Review

By Leith van Onselen

The Bureau of Resources and Energy Economics (BREE) has released its 2013 China Review, which provides a detailed examination of challenges and opportunities facing the Chinese economy, and the attendant risks and opportunities facing Australian exporters as the Chinese economy shifts away from investment-led growth towards consumption-based growth.

At over 140 pages in length, the BREE report is incredibly long and I have not had the opportunity to read it in detail. Nevertheless, below are some extracts that I found interesting.

Regarding the growing structural imbalances within the Chinese economy, and the over-reliance on fixed asset investment to fuel growth:

In particular, there are evident imbalances in the current structure of China’s economy—consumption is low and has declined as a proportion of GDP (Figure 2). China’s service sector is relatively small and undeveloped, and its economy is heavily export dependent. During times of sluggish world economic growth, high export dependence may contribute to a less resilient economy.

China’s very high savings rate—at around 50 per cent of GDP—has allowed its extremely high investment to be largely domestically funded. Over an extended period, investment has been strongly oriented toward infrastructure and the heavy industries which provide essential inputs to infrastructure spending. Large investment in the manufacturing sector has allowed it to use abundant low-cost labour. As a result, production of manufactured goods has underwritten China’s burgeoning exports. China’s strong GDP performance has been supported by this domestic investment and foreign demand. Thus, with slowing investment and external demand, China will require stronger domestic consumption to sustain growth.

While China’s high savings rate supported high economic growth in the past, it is now a key hurdle in the transition to a consumption-led economy. A high savings rate is, typically, seen to be unfavourable to balanced economic growth because it reduces the demand for goods and services. Several factors contribute to China’s relatively high savings rate. One is the policy structure that promotes a high level of precautionary saving by much of the population (Figure 3). The dominance of SOEs in some industry sectors and the policy environment in which those enterprises operate supports both high levels of profit and rates of corporate saving by some of those enterprises. Further, a combination of interest rate controls and limits on overseas investment by Chinese residents oblige individual savers to subsidise industry and government at the expense of potential consumption.

China’s social services system and social safety net have many gaps relative to developed economies…

Regarding China’s worsening demographics:

Perhaps the greatest set of challenges that China faces over the next two decades is related to an inevitable shift in the age and regional structure of its workforce… Over the past 20 years, China’s growth has been bolstered by a particularly favourable population structure. A combination of factors, including the flow-on effects of China’s one child policy, gave rise to a population with a proportionally large working age component and low dependency (Figure 5). Between 1980 and 2011, the proportion of China’s population aged between 16 and 65 rose from 59 to 73 per cent (World Bank 2013b). While China’s total population grew by 37 per cent over that period, its working age population grew by 67 per cent and supported faster economic growth. Wei and Hao (2012) estimate that since the 1990s, China’s demographics contributed to one-sixth of its economic growth, facilitated by increased market competition.

The surge in the working age population in China is almost over. During the next two decades, population growth will stall and possibly reverse. Under the high population growth scenarios considered by the UN (2011), China’s population will still be growing in 2030, but only just. Under the low population growth scenario, China’s population will start to shrink by 2020. Regardless of the outcome for its total population, the age structure of the population will change dramatically over the next two decades… The change will be in a direction that may be much less conducive to economic growth without changes in labour markets and other policies. This is because the working age proportion of the population will begin to decline and, eventually, the absolute number of people of working age will begin to fall within the next two decades.

Regarding environmental degredation:

One of the consequences of China’s pursuit of economic growth has been a widespread deterioration in the condition of natural resources, including land, water and air quality. In effect, over much of the reform period, natural resources such as clean air and the waste assimilation capacity of waterways have been priced at, or close to, zero and, consequently, overused. That overuse has downstream effects including higher costs for industries using polluted water and health costs from urban air pollution…

Many of the benefits of better environmental conditions, such as clean air and water, either do not enter national account measures or do so only indirectly and with long lags. Some of the costs of mitigation, however, are immediately evident1. Thus, while policies to address China’s environmental issues may improve the quality of life they may not contribute to measured growth in GDP.

BREE remains sanguine about the implications of China’s slower growth and economic rebalancing on demand for Australia’s export industries:

The structural change driven by the resources boom is most evident in investment and exports. China’s resource-intensive growth contributed to historically high commodity prices, which supported the expansion of Australia’s resource output. Given the capital-intensive nature of resource production, the growth in productive capacity has resulted in a largescale increase in resource-related investment. New mining-related capital investment as a proportion of total new capital investment has reached new highs, accounting for 52 per cent in 2011–12 compared with 21 per cent a decade ago (ABS 2012a, Figure 12). Over the same period, China’s investment in the Australian economy, particularly in the resources sector, increased dramatically although it still remains a relatively small overall investor in Australia (ABS 2012b).

There has also been a clear transition in the composition and direction of Australia’s trade, with the resources and energy sectors increasing the share of export earnings to 60 per cent in 2011–12 from 49 per cent a decade earlier (ABS 2012c, Figure 13). China is now Australia’s largest merchandise trading partner and resources trade has been reoriented to China. China accounted for 29 per cent of Australia’s total exports in 2011–12. The main exports were iron ore, coal, gold and crude oil…

The resource intensity of China’s future growth, particularly given plans to move to a consumption-led economic growth model, is uncertain. However, there are a number of factors that will support strong demand for commodities over the short to medium term. While the pace of growth may begin to decline, the scale of China’s growing demand still represents large volumes in absolute terms.

China’s urbanisation and rising household income have increased investment in new, higher quality housing. Residential construction has been a key contributor to strong demand growth over the past decade, particularly for steel, and is expected to remain important over the medium term. Construction activity is expected to wane over the longer term as the rate of urbanisation slows and the building stock improves, requiring fewer rebuilds. Infrastructure development, such as rail and electricity networks, will also contribute to commodity demand over the short to medium term. Further, the central and western regions are still largely undeveloped in terms of infrastructure and are targeted for expansion by the government…

Between 2014 and 2018, China’s steel consumption is projected to grow at an average rate of 3 per cent a year to total 822 million tonnes in 2018. China is expected to remain the main driver of consumption growth in base metals over the short to medium term…

China is the world’s largest consumer of coal and it is the dominant source of energy, accounting for around 66 per cent of primary energy use in 2010. According to the IEA’s most recent medium term forecast (IEA 2012b), its coal consumption is projected to grow by 25 per cent over the period to 2017. This will be largely driven by the power sector, where consumption is expected to expand by one-third. Non-power demand (steel, coke, chemicals, cement and household use) is expected to ease over the same period as more modern energy sources are increasingly utilised and cement production slows (Cronshaw 2013). Given the efforts to reduce reliance on fossil fuels, China’s total coal demand can be expected to moderate over the longer term…

Australia’s role in meeting China’s resource demand will depend on (1) the volume and composition of China’s demand, (2) China’s ability to meet its own demand and (3) the ability of other countries to meet this demand.

China has vast reserves of minerals, but they can sometimes be insufficient to meet domestic requirements or, like the case of coal, be located far from regions where they are required. China aims to be as self-sufficient as possible in the production of resources, and some industries have been investing in overseas assets, including Australia, to ensure supply security.

Australian producers are not, typically, marginal producers, so will continue to supply commodities to the Chinese market despite an expected decline in commodity prices (Findlay 2011, BREE 2013). However, there will be increasing competition from abroad to provide resources to China. For example, the United States has the potential to rapidly expand liquefied natural gas (LNG) export capabilities based on its vast resources of shale gas. Australia’s ability to compete will continue to rely on the provision of a stable investment environment, control of capital and operating costs and improvements in productivity…

There are varying views on whether China’s economic growth can be sustained, and the resource intensity of that growth. However, as economic growth and urbanisation slows, it is likely that the growth in demand for the current set of products Australia has a competitive advantage in supplying, such as iron ore and coal, will decline and the absolute demand for commodities may even peak and possibly decline by the 2030s.

The BREE report also includes detailed chapters examining Chinese iron ore, steel and energy demand, which are a topic for another day.

Full report below.

BREE China Review (June 2013)