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Monthly Comment
September 2012
Life’s Essentials: China and New Zealand
Last week, and somewhat against the world’s expectations, it was announced that the
Chinese Purchasing Managers’ Index had fallen below 48, its lowest level for nine
months and a level that might be considered as being consistent with a technical
recession in China. Moreover, our own weighted estimate of the true underlying
industrial production growth has dropped to a 1% year-on-year rate, which implies that
production year-to-date has been essentially flat in China’s vast industrial sector.
Initially, financial markets responded to this latest run of weak Chinese data by rallying
on the belief that the local authorities would now “have to ease” on the back of this
weak economic performance. With China, though, potentially having suffered a $60
Andrew Hunt
billion balance of payments deficit in the second quarter as a result of sharply
International Economist
accelerating levels of domestic capital flight, there may now be a binding external
sector constraint to domestic policy initiatives; China may not be able to ease without sacrificing its currency at
a most inopportune moment in the global
China: Estimated Weighted IP Growth
political calendar. Hence, the “big easing
50
in China” may still be some way off,
40
despite the weak output data.
Moreover, even if the external accounts
were not seen as a constraint by
domestic policymakers, the still rapid rate
10
of wage inflation within the economy
should be a constraint. According to
0
China’s own data, wage inflation is still
‐10
north of 20%, although this is not
currently being reflected in either the CPI
‐20
or even export prices. We suspect that
this dichotomy between the behaviour of
China
wage inflation rates and output prices is
largely because companies are being obliged by the weak demand situation to absorb the wage pressures,
with an unwelcome impact on profit rates.
20
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Jul‐08
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Apr‐12
% YoY 30
To many, it may be surprising to find that China still apparently has a wage inflation problem, given the acute
economic weakness that we are observing. In fact, we suspect that the demand for labour resources is
indeed quite weak at present but despite this, wages are rising simply because they cannot fall below
subsistence levels. It is the rise in the latter that is continuing to drive up wages at present, even against a
background of very weak industrial output trends.
According to our analysis, the cause of a sharp rise in (particularly urban) subsistence costs in China over
recent years has been a mixture of the effects of the past increases in property prices and – most importantly
of all – the continuing food supply issues that have dogged the economy for some time now. China’s own
population data reveals that, over the last 10 years, China’s urban population has expanded at an average
rate of 3.7%, implying that the urban population has increased by almost 40% in a remarkably short space of
time. We estimate from the available data, though, that the growth in “marketable” food output over the same
period has been notably slower, perhaps only expanding at an average rate of 2.7%. This proprietary
estimate of agricultural production is based on a weighted average of the food output data, rather than on the
authorities’ official aggregate data, which is reported rather unhelpfully in nominal terms.
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The reasons for the relatively slow
rate of agricultural output growth
(which is certainly well behind the
15% average growth rate of IP over
the last ten years) are likely to centre
on the ongoing stagnation in the
amount of farm area that is being
sown, the various water supply
issues, the removal of labour from
this traditionally relatively lowproductivity
sector
and
the
inefficiencies implied in the farm
ownership system. Certainly, China’s
agricultural sector remains ripe for
reform but, in the near term, more
temporary measures have to be
found in order to address the Chinese food crisis.
In the short term, we would suggest that virtually all that can be done to correct China’s food output shortfall is
either for the country to slow the urbanisation process and/or to begin to import more food and both these
seem to be occurring at present. Indeed, we find that, according to press reports and anecdotal evidence, the
pace of urbanisation does seem to have slowed of late and, more reliably, China’s own trade data reveals that,
in nominal USD denominated terms, Chinese food imports officially rose by 31% in the year to July and that
they have grown at close to a 40% average annual rate over the last 3-4 years – a seemingly consistent
development within our overall story.
This food supply constraint and what it implies for the growth rate of the urban population will have significant
implications for the wider economy. Specifically, we estimate based on the reasonable assumption of there
being little or no trend improvement in food output growth over the next five years that China will in theory
need to limit its urban population growth to around 1% per year over the next five to ten years in order to cool
its food shortage problems. This slower rate of urban workforce growth would then seem likely to lead to a
lower average rate of industrial production growth (perhaps 10% rather than the 15% rate that was achieved
over the previous decade). Moreover, the slower urban population growth should also lead to a slower trend
in tertiary sector output growth and therefore to a notably lower sustainable headline trend rate of GDP growth
– perhaps a 6-7% average rate rather than the 10% that was achieved over the last 10 years.
Admittedly, on an average basis, 6-7% trend GDP growth over the next 10 years would not seem too bad and
indeed still quite optimistic for many of the world’s “China plays”. We doubt, though, that even this lower rate
of average growth could be countenanced initially since, in order that the food output numbers can “catch up”
with the urban population (and so remove the food shortages and inflationary pressures that they have caused
within a timeframe that would be acceptable to the general population and political system), there could be
little or no growth in the urban population or their output.
We would therefore suggest that in the next year or so, China can only hope to reduce its subsistence cost
inflation problem if urban population and indeed total output growth slows below the 3-4% speed limit implied
by the food production data. This seems to be precisely what is happening, judging by the latest output series
and the trends revealed by the country’s very weak import data.
More positively, it is apparent from the industrial production series that China is now investing more in its
agricultural sector to solve the country’s speed limit problem in the longer term. For example, although the
overall production data is clearly very weak, fertiliser production is very strong, as are other agricultural inputs.
Hence, there is some chance that food output growth may manage to accelerate a little and thereby raise the
economy’s speed limit a little but, nevertheless, in the near term we suspect that China’s overall rate of GDP
growth will be limited to 3-4% or even lower so that the price of subsistence problem can be addressed and
inflation brought down. Therefore, in the long term, while China may still be able to produce an average rate
of GDP growth of around 7%, in the near term, growth may be limited to half that rate – although as to whether
this will ever be admitted remains to be seen.
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Over the last 12 months, Chinese food imports have risen by around 30% in nominal terms but its imports of
coal and other fuels are only up by 5%. Meanwhile, China’s imports of iron and steel are either not growing or
are in fact declining, with the result that its total imports of primary goods are barely growing despite the sharp
rise in food imports. Unfortunately for food-importing China, though, the drought in the US has already
resulted in a collapse in US food export growth and we understand that the country may only be weeks away
from being obliged to begin slaughtering dairy cattle for want of food supplies. This juxtaposition of the effects
of the US drought and China’s rising demand for food imports could clearly lead to some further disruption in
the global supply of dairy goods and we wonder whether, as a result, New Zealand may be able to gain a
terms of trade and perhaps even an export volume windfall as surging Chinese food import demand collides
with weak US food export trends. Thailand, Indonesia and the Philippines, which have seen weak agricultural
export trends of late, may also be beneficiaries of such an event, as could some African nations. Australia’s
agriculture sector should also be a beneficiary but, unfortunately, its mineral industries may face tougher times
given the import patterns noted above and this could prove more important to the aggregate economy. We
therefore wonder if the NZD may be about to gain from a China theme of its own.
Andrew Hunt
International Economist, London
Tyndall Investment Management New Zealand Limited is one of New Zealand’s largest investment managers and is a wholly
owned subsidiary of Nikko Asset Management Co., Ltd., a leading Asian investment management company.
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