Blue skies for communist China?

Shanghai

China is attempting to develop a more rounded and richer economy, with more coming from services and higher value added activities – a difficult balancing act.

China’s achievement under President Xi, as under his immediate predecessors, has been impressive. According to the World Bank China now has the world’s largest economy as measured in Purchasing Power Parity dollars, and the second largest in dollars at market prices. The old strategy of rapid growth through industry and exports has taken China into a dominant positon in many sectors, including the now topical steel and aluminium markets. China produces half the world’s steel and is the main producer of aluminium. The new strategy is showing that China, like the US, can exploit the new digital technology through the huge growth of companies like Alibaba and Ten Cent.

President Xi came to power wanting to move China on from producing cheap industrial materials and products for export into a more rounded and richer economy with more coming from services and higher value added activities. This was given greater urgency by a political imperative. Chinese air quality had fallen to very low standards in many of the cities, as coal home boilers combined with huge industrial plants and more diesel vehicles to cloud the air with dangerous particulate matter. From 2014 onwards the Chinese authorities have been making air quality improvement an overriding priority. We in the west got an early glimpse of the emerging importance of this issue when the Chinese government closed factories ahead of the Olympics to clear the air for the athletes. This has now become a nationwide crusade to improve city life.

This winter, new curbs were introduced to cut the particles. Construction was stopped on many urban sites. Steel and aluminium, bricks and pottery plants were closed for the winter or permanently. Gas replaced coal in some power stations, and people were put under pressure to stop using coal boilers in their homes. There is evidence that the last four years of a tougher environment policy has registered a material improvement in air quality in major cities.

China is suggesting that it is trying to eliminate substantial surplus and dirty capacity in steel and aluminium, the two areas so far targeted for special tariffs by the US. Doubtless there will be more closures. There is also quite a programme of new plants going in at the same time. China does not wish to cease being the world’s main producer of these industrial sinews, and has a strategic view that she needs control of resources like steel and aluminium for weapons production amongst other things. The country is moving over to coastal location larger more modern plants, whilst closing smaller older dirtier plants in cities.

All this is a difficult balancing act within China, and outside with the US. The Chinese government needs to shut old capacity at a pace people find acceptable. Air quality gives them their best reason to do so whilst keeping many more people onside for the job losses and disruption this causes. It will not want to farm all this lower value added activity outside the country, as it will take a strategic view of its industrial needs. It will need to allow the markets to tighten and prices to rise for these products to contain the US trade retaliation.

It is possible the regime can tread this difficult path in the months ahead as it has successfully done in the months past. It is going to get more difficult, as it looks as if the US pressure is about to go up. It is a negative for Chinese shares, which on the Hong Kong exchange have just had a great year. The US President is on the trade war path over technology businesses, where China has had big domestic success with its versions of digital service. Maybe China can offer up closed steel and aluminium plants as proof of good citizenship, closures they need for air pollution reasons as well. It also looks as if there will be a battle over intellectual property, which could prove more bruising for Chinese shares. There’s a way to go before the skies are blue enough.

 


The above article was previously published by Charles Stanley on 15th March 2018