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Article / 05 May 2016 at 14:30 GMT

China dumping on the global economy

Managing Partner / Spotlight Group
United Kingdom
  • China’s economy is stalling as consumption declines
  • Beijing government is desperate to stop unemployment rising
  • Several initiatives have been deployed to shifts the surplus production
  • Rest of the world will not accept dumping and lop-sided trade programmes

v
This building site in Heilongjiang province capital Haerbin shows that there is so much
work to do but the economy's stalling at just the wrong time. Photo: Martin O'Rourke


By Stephen Pope


The Chinese economy advanced an annual pace of 6.7% in the first quarter of 2016, compared to a 6.8% rate in Q4 2015. Although in line with market expectations it did represent the weakest growth since Q1 2009 at 6.2%.


It should, however, be noted that key factors such as fixed-asset investment, industrial output, retail sales and new domestic loans all increased more than estimated during this year’s first quarter.

China
Source: National Bureau of Statistics of China 

The chart above shows with no ambiguity that the Chinese economy has been slowing steadily since 2007 and although growth in Q1 2009 was lower than has been booked this year, the prospect of a swift and impressive rebound, as seen by Q1 2010 does not appear at all likely to be repeated.

That is not to say that the axis of central government and the People’s Bank of China are not doing all in their power to try and engineer the softest of landings, with hopefully an economic bounce thrown in. The trouble is, as China seeks to boost its own economic performance its strategy has serious implications on the fortunes of its global trading partners.

As China’s economy has slowed, the country faces a problem of excess productive capacity. It is simply producing too much of a range of products and as a result manufacturers in several sectors e.g. aluminium, solar panels, shoes, steel and tyres have entered a frantic search for new sales opportunities.

The unemployment rate in China decreased to 4.04% in Q1 2016 from 4.05% in Q4 2015 and has averaged 4.13% from 2002 until 2016, reaching an all-time high of 4.30% in Q4 2003 and a record low of 3.90% in Q3 2002. (Source: Ministry of Human Resources and Social Security of the People’s Republic of China).

The central government is wary of the unemployment rate pushing much above 4.0% and the issue of youth unemployment is becoming especially acute. This sensitive metric has risen from 9.3% in 2010 to 10.8% at the end of 2015 and will rise to 11.1% this year. (Source: International Labour Organisation).

China's youth population (18 -25 years) will actually have shrunk by 25% over this six-year period to 181 million, but the number of young people without jobs will have dropped by only 1 million over the same period.

Azita Berar-Awad, director of the ILO’s employment department, said slower growth clearly meant fewer jobs for young Chinese who had migrated to the cities. A surfeit of graduates also meant the level of unfulfilled potential was rising as well.

"…They've had an explosion of university graduates in the past so many years, with investments in universities, and not all these qualified young people find jobs that meet their qualifications, even in a growing economy like China,…”

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Chinese graduates are not getting the jobs they crave. Photo: iStock

The Chinese government well remembers an incident in 2009 at a government-owned steel factory in northeastern China. An estimated 30,000 workers took to the streets in protest over workplace layoffs. The protest turned into a riot with Tonghua steel plant workers storming the office of executive Chen Guojun; the anger was such that he was beaten to death.

In 2009, China undertook a massive stimulus programme that prevented a prolonged economic slump and as my first chart indicates, GDP growth advanced from 6.2% in Q1 2009 to 12.2% a year later and mass layoffs were prevented.

Since Q1 2010, the path of GDP growth has weakened and now just six years on from that burst of activity the central government is having to deal with rising labour unrest as the economy is stalling and not firing on all cylinders. Data from the Hong Kong-based China Labour Bulletin suggests mass protests by workers against layoffs are once again on the rise.

The situation is increasingly exigent

In an attempt to keep top line sales revenue constant, if not growing, Chinese manufacturers under the direction of the national government have actively looked to boost exports. In so doing they have offered their products at the lowest possible prices, even lower than in their domestic market. In short they have been dumping goods globally across many markets.

Dumping is the situation whereby one country exports goods to another at a price below the average domestic price of both the exporter and importer in an attempt to destroy competition or to sell of surplus goods or to achieve both.

The impact dumping of Chinese steel into the European Union market is shown in the diagram below.

Dumping
 Source: Spotlight Education

Here, we can see that the dumping of Chinese steel, having been produced at significantly lower variable costs (like wages, capital, electricity/water, etc.) establishes a completely independent supply, indicated by the supply graph “S China”. 

Due to the dumping of cheap Chinese steel, domestic producers that once sold the quantity QE at the price PE now have to compete at an unsustainable price level of P China. At this price level, domestic producers can only produce at Q1, hence domestic producers suffer enormously in profits, while Chinese steel manufacturers gain a huge share in the EU steel market. 

Across the EU steel plants, even the most modern cannot compete with Chinese rivals, which offered products at 20% below prevailing rates in the EU:

• In the chart above, P China = 0.8 PE

Of course UK steel plants have been heavily featured in the news in the past few months, but the problem is felt on an EU wide basis. For example, the Celsa Group headquartered in Barcelona, Spain has estimated that Chinese companies at one point accounted for about half of the region’s sales in a certain type of reinforcing bar, up from essentially nothing in 2012.

Speaking to the International New York Times, Luis Sanz, Managing Director for Celsa’s UK operations aid:

“…It’s nice to have free trade, but it has to be fair, …”

The steel industry is just one of several that are pivotal to the direction that will be taken by a global discussion in the global economy. It has the potential to turn ugly if changes in the global trade rules see reactionary tariffs being imposed across many trade areas.  

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The steel sector is perhaps the most notable victim of Chinese dumping strategies. Photo: iStock


Chinese trade policy is a tool of a wider agenda

Staying with steel, Chinese producers have for several months now flooded the global market with cut-price exports as they have sought to exploit the devaluation of the yuan last August. As a result, there policy has unleashed angry protests from competitors across Australia, Europe and the US.


This policy of dumping foreign markets with cheap goods compounds the deflationary pressure across the developed world and the steel mills in the Chinese industrial hub of Hebei have aggressively cut prices in an attempt to bleed out almost all their overseas competition.
Steel pricing
Source: TSI 

The chart shows that in the past 28 months to the end of 2015, Chinese steel prices began to decline before there was a reactive move lower in the EU and US. Still, the price reductions in the two targeted markets have not been able to keep pace with the percentage decline enacted by Chinese steel manufacturers.

It is highly likely that the EU and US will eventually react with penal tariffs and so local prices may start to increase, however that will lead to a potential reactive action from China in addition to the measures already undertaken. The net effect, however, is that overall consumer welfare will decline.

It would appear that in addressing China’s problem of overcapacity the Third Party Plenum held in November 2013 has gained a jump on the west.

The central government has recognised that the Chinese economy has three major issues to confront.

1. How can it manage the domestic decline in Total Factor Productivity (TFP) growth?
2. The marginal product of capital is dropping.
3. Domestic consumption is extremely low, just 30% of GDP.

China’s response to this changing growth dynamic is partly external and partly internal.
It is not the place of this paper to suggest how China should run its internal affairs. However, I have as an economic analyst a duty to evaluate Chinese policy as it affects the global economy.

On planning its external strategy it is no surprise that this period of excess capacity at home is the moment at which China launched expensive new initiatives.

These include the Asian Infrastructure Investment Bank (AIIB), the BRICS Bank, and the “One Belt, One Road” initiative in order to strengthen infrastructure both on the westward land route from China through Central Asia and on the southerly maritime routes from China through Southeast Asia and on to South Asia, Africa, and Europe.

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China's Silk Road plan may not necessarily be a
panacea to its excess capacity issues. Photo: iStock

These initiatives have generally received a welcome response from China’s Asian neighbours as they are intended to boost Asian integration. However, it may be that these programmes will not solve China’s excess capacity problems and will actually enhance resentment from trading partners the further from Beijing one travels.

China’s initiatives in Asia are a setback for the US as long-standing strategic ties with the Australia, South Korea and the UK were ignored as all three became partners if the AIIB.

The US Asia economic initiative in the Trans-Pacific Partnership is finding major economies in Asia e.g. Australia, Singapore, South Korea, and Vietnam want to ride both horses by being involved with China’s AIIB and One Belt, One Road programme and the American effort to reduce trade barriers.

The obvious problem is that the Chinese and US initiatives are competing forces and will lead to regional blocs and a disintegration of free trade. China would argue that it has established the AIIB as it has grown weary of waiting for the US to approve additional funds to the International Monetary Fund and the World Bank.

This angle of thinking has some merit, but I am concerned that as the dominant force within the AIIB, China may dictate terms and conditions to its neighbours when it comes to financial and material support in a manner parallel to the way the USSR used to boss around the old Iron Curtain client states.

As for the One Belt, One Road programme the outcome that China is eying is one where countries in Central Asia that lie along the ancient route of the Silk Road and the ancient maritime routes will gain from more transport infrastructure, some of which China could finance bilaterally.
one belt, one road
 Source: MERICS China Mapping 

However, several economies of Central Asia are not that large, and the potential for investment is more likely to be targeted at larger economies such as India, Indonesia, and Vietnam. There is therefore a risk that smaller nations will be marginalised by such grandiose schemes.

However, when it comes to the targeted nations these economies are relatively well run with strong levels of governance and they will not simply accept an army of Chinese workers on One Belt One Road infrastructure development at the expense of their own people especially if these nations are meant to share some of the debt burden from constructing such a great economic highway.

So the One Belt, One Road programme will have to be openly implemented bilaterally between China and different partners. China may find it cannot use the programme to easily shift some of its surplus and as such will not be able to boost its GDP by enhancing its GNP as effectively as it hopes.

China will have to moderate its trading strategy or else it will find the rest of the world will slowly but steadily stop using its cheap, dumped products and the retaliatory reaction will not bode well at all for global economic gains.

-- Edited by Martin O'Rourke

Stephen Pope is managing partner of Spotlight Ideas
3y
johnnyw johnnyw
the cheap goods from china benefit the consumers. amazing that this could be seen as unwelcome (putting up tariffs etc). Countries that are importing the cheap steal can free up capital to invest in other areas of the economy, putting it to more efficient use, and cause the pattern of employment and deployment of capital to be shift from one industry to another where the consumer really demands it.
3y
Stephen Pope Stephen Pope
Dear Johnny,

I am all favour of low prices. However, there is a workd of difference between genuine low prices because of efficient production techniques and low total costs and dumping.

China has blatantly dumped goods overseas at prices that are artificially low...below the prices charged in their home market as well in the target markets.

It has also imposed high tariffs on overseas products that could threaten domestic producer sales.

I want inefficient producers squeezed out, but I do become concerned over extraordinary uneven playing fields. That is expecting global ex China employment to rise so that Chinese unemployment can stay at 4%.

Steve
3y
Marcus Antonius Marcus Antonius
I'd like to add that developed countries consider approaches such as using existing resources more effectively -- actually, these are the most successful and hyped "innovations" of the last years (making low income folks with a car work as illegal taxi drivers, illegally renting one's apartment to tourists, etc) which are clear LIME approaches (less income, more entertainment) and show that there are substantial growth issues.

Developed countries are only spending more in areas which they suddenly figure are required to maintain what they already have achieved (surveillance, security) while they're willingly allowing themselves to be attacked and fail to identify ways to handle this situation effectively.

The "more efficient use of capital" claim can only be applied to scenarios where there's actually something to invest in, and some sustainable growth perspective.
3y
johnnyw johnnyw
Thanks for the comment/different perspective, I value it. Looking at the supply and demand schedule, the quantity demanded in EU at the lower price will be much greater. You would expect this to have positive impacts for other industries (car manufacturers, or building construction?). You would expect there to be upward price pressure for EU suppliers (potentially driving them out of business), but this cheap product would benefit other industries. Maybe its China's comparative advantage to produce the steal and therefore EU should go with the flow, focussing on manufacturing? As China will find it unsustainable in the long run to continue to produce a loss at the expense of the Chinese tax payer?

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