There is Risk in Relying on The Chinese Consumer

Aiki14 Market Sense
November 1st, 2009

Several recent articles in the media have Looked at the potential for the Chinese consumer to supplant the American consumer as the premier economic driver in the world today. Authors have made note of the enormous population and the relative poverty, the rise of the urban middle class and the still agrarian lifestyle of the rural population. It seems undeniable that the sheer force of inertia inherent in the large population will make the Chinese consumer one of, if not the, largest economic forces in the not too distant future.
I have heard folks say that this or that American company is poised to take advantage of this shift in demographics. Certainly there is great opportunity to the entity that can do so. I see however formidable challenges to this theory and they are as follows:

Political Risk – The possibility that US relations with China degrade to the point where American companies are banned outright or put at an untenable disadvantage competitively
Social Risk – The possibility that conditions for doing business in China are disrupted by social upheavals
Economic Risk – The possibility that the Chinese economy does not sustain it’s predicted growth or shrinks

Let’s look at each one more closely.

Political Risk
Conditions exist that threaten the relationship between the U.S. and China.
1) The opening salvo’s of a trade war were fired when the Obama administration imposed tariffs on the import of Chinese made tires. China fired back with a threat of anti dumping policies.
In a nutshell, dumping is when merchandise is sold in a foreign market at less than its normal value (determined normally by either the price of the merchandise in its home market or its cost of production). A domestic industry that believes it is being injured by dumped imports may petition its government initiate an antidumping investigation that could result in additional remedial duties being applied to the subject merchandise from the country/countries under investigation. There are currently seven ongoing investigations against merchandise from the United States, primarily involving the petrochemical industry.
While recent moves by the Chinese to remove the ban on U.S. pork products are a positive step, there is still an ongoing condition of friction on trade policies that has the potential to become heated.
2) The complex relationship between the PRC (Peoples Republic of China, Mainland), the ROC (Republic of China, Taiwan), and the U.S. has the possibility of degrading for many reasons. The U.S. has said it will defend the sovereignty of the ROC but the PRC considers it a province. Particularly alarming is the increase of short-range missiles pointed at Taiwan — now said to be close to 1,500. That’s roughly one Chinese missile for every 23 square kilometers of Taiwan’s turf. While the Ma administration (KMT party currently in power in the ROC) has made statements indicating it’s desire for “normalization” of relations with the mainland, recent delays in sending aid offered by the US to hurricane damaged areas have given power to the arguments made by the DPP (Democratic Peoples Party) that the Ma administration was afraid to let US planes in the area for fear of PRC reprisals. This in turn has made the DPP more popular with the populace. The DPP favors a separation from the mainland and if they rise to hold the presidency could be disruptive to US China relations.

Social Risk
In any dictatorial or oligarchical political system the potential exists for uprising.
The government is in a tough spot in that they are trying to become a capitalistic entity to a large degree, while maintaining the power of the ruling communist party. In doing so they have violated the rule of law in many cases. The arbitrary detentions of Chinese legal activists and government critics like Gao Zhisheng and Liu Xiaobo, along with allegations of Mr. Gao’s torture during detention. The detention and subsequent persecution of Xu Zhiyong, the head of the Open Constitution Initiative (Gongmeng) is particularly disturbing, and indicative of the governments policies. As law professor at Beijing’s Post and Telecommunications University and as a member of the Haidian People’s Congress, Mr. Xu hardly embodied radical antigovernment sentiment. But apparently a devotion to justice is perceived by the government as just that—a threat to its power. On July 29, Mr. Xu and Zhuang Lu, Gongmeng’s financial manager, were arrested for allegedly evading tax payments on a grant from Yale University, while Gongmeng itself was fined 1.4 million yuan ($206,000). Gongmeng had in fact attempted to pay some of the fine and expected to be represented at a court hearing on the matter, but Mr. Xu was arrested before having that chance.
As any student of Chinese history will note the origins of revolution are with the peasantry. In a country where 1 billion people are in this class, and are increasingly aware of the outside world and their governments policies of oppression uprising is a possibility.
A different aspect of social risk is the ability of the Chinese government to control the information the population has access to. Certainly with the internet and the world wide web, it is increasingly difficult to eliminate anti government sentiment, but the Chinese government is endeavoring to do just that. I won’t address this from the vantage point of social uprising but from the aspect of the government manipulating the population into consuming what most benefits them. This could put US companies at a distinct disadvantage even if the aforementioned conditions do not exist. The Chinese Communist Party’s (CCP) attempts to censor is not limited to their domestic policy, the Chinese government’s effort to prevent dissident authors from taking part in the prestigious Frankfurt Book Fair, an international showcase for freedom of expression, has offered Germany a close-up view of China’s intolerance of dissent. In September, two Chinese writers, journalist Dai Qing and poet Bei Ling, had their invitations to the fair revoked by German event organizers after China’s organizing committee complained. The Chinese delegation threatened a boycott over invitations to the writers for a September symposium promoting the Frankfurt Book Fair, which began on October 14. China was the “guest of honor” at this year’s fair. In the face of this pressure, the event’s organizers withdrew the invitations. The writers’ participation was ultimately enabled when the German PEN club of independent writers invited the two Chinese dissidents. If a US company made statements or actions deemed in opposition to the CCP or it’s policies it could be banned domestically and boycotted internationally.

Economic Risk
The capricious nature of the world economy makes prediction difficult.
While the majority of the punditry is convinced of the rise of the Chinese economy, it is far from a sure thing, world conditions can change rapidly and the Chinese appetite for commodities and energy may find itself unquenched, and the speed of the rise could be much slower than anticipated. Market liberalization in the Chinese Economy has brought its huge economy forward by leaps and bounds – but rural China still remains poor, even as its cities increase in affluence. There are still inequalities in the income of the Chinese people, and this income disparity has increased in the recent times. The per capita income of China is only about 2,000 US dollars, which is fairly poor when judged against global standards. In per capita income terms, China stands at a lowly 107th out of 179 countries. The Purchasing Power Parity figure for China is only slightly better at 7,800 US dollars, ranking China 82nd out of 179 countries.
As the population moves from rural to urban environments the needs for energy and infrastructure commodities may outpace the supply. Competition for these products from both the developed and emerging markets will be increasingly challenging. Even the ability of the government to supply necessities of food and water is not guaranteed. Chinese experts warn that by 2030 when China’s population reaches 1.6 billion, per capita water resources will drop to 1,760 cubic meters — perilously close to 1,700 cu m, the internationally recognized benchmark for water shortages. However this could come much sooner, due to environmental macro forces or domestic policies. China outlined its water resources development strategies in its 11th-five year plan (2006-2010), but the continuing economic growth trends and population increase, as well as growing industrialization and urbanization, are likely to worsen China’s water shortage. In its report “Addressing China’s Water Scarcity”, which was released at the end of august 2009, the World Bank urged China to reform and strengthen its water resource management framework.

Conclusion
While the odds of the prevailing wisdom on China remain in favor, it is worthy of note that events and conditions warrant a hedging of ones position here. I would advise caution before putting ones entire conviction behind the Chinese market, and wariness in regard to the policies of the Chinese oligarchs.

References
Ministry of Commerce of the Peoples Republic of China (MOFCOM)
U.S. Government Export Portal China Page
Central Intelligence Agency “Taiwan” Fact Sheet
“Paranoids feast on China’s peaceful rising” – Japan Times 26 Oct, 2009
The DPP Calls for Round Two – The Far Eastern Economic Review 2 Oct, 2009
China’s Assault on the Rule of Law – The Far Eastern Economic Review 9 Sept, 2009
China’s Export of Censorship – Far Eastern Economic Review 12 Oct, 2009
China Economy – Economywatch
A dragon of many colours – The Economist 22 Oct, 2009
The rich scent of freedom – The Economist 22 Oct, 2009
China Warned of Water Crisis by 2030 – China.org
Water shortage threatens China – The China Daily