INSIDE VIEW: From ‘made in China to sold in China’

Made-in-ChinaAs the twelfth five-year plan is outlined in China, Claude Tiramani of Lutetia Capital, expands on what this could spell for the country, its inhabitants and what effect, if any, it could have on the global economic climate­. Command economies, repeatedly declared dead after the fall of the Berlin Wall in 1989, are coming back to life in the post-2008 financial crisis world. Western democracies are facing tough challenges in economic policy. On the one hand, public finance orthodoxy is barely compatible with high unemployment rates, especially around election time. On the other hand, the unconventional monetary policies put in place in developed economies – which have yet to prove their effectiveness – have demystified the inflation-targeting fairy tale of unerring, independent central bankers. Mixing good old Mao-style five-year plans with capitalism’s “animal spirits”, China defines itself as a socialist market economy. Its communist leaders, therefore, have at their disposal a wider range of economic policy tools than their democratic Western counterparts, who appear to be stuck in their “Great Moderation” orthodoxy. Authoritarian economic policies such as price controls and government command over bank lending currently appear to be the only effective means of meeting the Party’s ambitious economic goals. In his annual speech to the National People’s Congress (NPC) in March, Premier Wen Jiabao outlined the country’s twelfth five-year plan – a plan whose priorities may mark a deep shift in China’s core economic model from “made in China” to “sold in China”. Certain observers in the United States and Europe have accused China of causing the global imbalances that floated the subprime bubble. These are a minor factor in the evolution of the Party’s agenda. With one eye on the Middle East uprisings, the communist elite knows it must increase purchasing power if it wants to ensure the regime’s stability. Allowing the majority of Chinese people to access a global consumer society is the connecting thread between three major areas of intervention outlined in the plan: the welfare state, income tax reform and urbanisation. During his speech, Wen highlighted high spending in “areas that directly affect people’s lives”. Over the last five years, education and health care budgets rose 160% and 260% respectively, while the annual increase in pensions averaged 10%. Many policies targeted minimum wage levels, which are set by regional governments according to national guidelines. Even though minimum wage increases were stopped in the aftermath of the 2009 slowdown (after having nearly doubled since 2005), differences between local regulations are narrowing, signaling a smaller income gap across the country. With the government maintaining control over foreign companies’ wage policies, the boost in consumption is meant to happen through fiscal means. The government’s plans for tax reform are expected to come into force at the end of the year. This would raise income strata above levels workers need to pay personal income taxes of RMB 3,000 (€319) compared to current RMB 2,000 per month. This fiscal gift should release RMB 100bn into the economy. Although the tax cut will have little impact on China’s fiscal position (income tax only accounts for 6.6% of total tax revenues), the households targeted by the reform will surpass significant income thresholds – driving fundamental changes in consumption habits. For instance, Italian car maker Fiat estimates the income threshold in terms of automobile purchase at around $3,500 per year. Unlike Mao’s Great Leap Forward, in 1958, which was designed for a nation of peasants, the current five-year plan stresses the importance of urbanisation and targets an increase of urban population from 47.5% to 51.5%. Consumption expenditure per capita for urban households is at least three times that in rural areas. A 1% increase in the urbanisation rate should translate to a RMB100bn increase in consumption spending, accounting for 0.9% of total private consumption expenditures in 2009. While standard economic theory describes a link between urbanisation and increases in consumption contribution to GDP, World Bank historical data and research have shown that China represents an exception to the rule due to the particularly precarious social conditions of migrant workers. The Party seems fully aware of the issues and has announced special measures to qualify rural migrant workers (who until now have needed work permits) as urban residents – giving them better access to public services and social security. Low-income housing is to be made available to about 20% of China’s urban households, with a target of 10 million new units built per year. Wen has made it clear that social housing targets will be enforced by making local party leaders personally accountable. Overall, if the GDP growth target for 2011 is set at 8% – the same as last year, when growth hit 10.3% – the contribution of internal demand and especially private consumption to GDP is expected to rise dramatically over the next few years. Thanks to an increasing focus on internal demand coming from the state, China should reach developed-country levels of consumption as a percentage of GDP (approximately 60%) by 2025. Most critics of command and state-controlled economies point out how bureaucrats are incapable both of maintaining sound public finances without printing money and of preventing major market failures – namely, shortages or bubbles. As far as China’s socialist market economy is concerned, those theories have yet to be proven correct. Of course, China’s unelected elite is deeply corrupt. However, authoritarian economic policies have so far succeeded at averting what most investors fear as the next bubble: real estate. Continued government intervention in the residential property market, targeted particularly at real estate investors, is expected if prices rise faster than 1% per month. Although over-tightening caused a slowdown in new construction in 2007, the market proved resilient and bounced back fairly rapidly. To some extent, the financial soundness of local government and major financial institutions (whose lending policies follow political guidelines rather than economic ones), bad loans have traditionally been underestimated at 5% of GDP by official statistics. Nevertheless, if International Monetary Fund data shows figures three times higher at 15% of GDP, then the Middle Kingdom owns almost 50% of its GDP in foreign exchange reserves: contrary to Western economies, China can easily afford a major bailout in the case of increased loan delinquency. Inflation is also a big concern for investors in China. However, the People’s Republic seems to be much better off than other emerging economies when it comes to facing external shocks affecting commodities prices. The Party has at its disposal effective short-term means of containing food prices, such as formal price controls over a number of items, or the release of strategic state inventories. However, special measures have been dedicated to the structural increase of supply in the medium term: one million soldiers of the People’s Liberation Army have been sent to the countryside to improve irrigation systems across the country. Food prices are expected to decline from September onwards. Moreover, although current inflation fears are mainly not related to monetary policy, the government has stated that “macroeconomic controls should keep overall price levels stable” and indicated this to be their top priority. It should be noted that Chinese policy-makers can target monetary aggregates very precisely through loan quotas and political control over financial institutions. With an M2 target of 16%, in line with the average of the pre-crisis period, the consumer price index should peak in coming months and then average 4% for the year. The global financial crisis has been a wake-up call for the Chinese authorities to speed up the rebalancing of the economy in favour of consumption. The levers associated with the command economy not only facilitate the achievement of this goal in the medium term, but also minimise the risk of negative side effects in the overall economy. Claude Tiramani is head of emerging markets at Lutetia Capital in France ©2011 funds europe

Executive Interviews

INTERVIEW: Put your money where your mouth is

Jun 10, 2016

At Kempen Capital Management, they believe portfolio managers should invest in their own funds. David Stevenson talks to Lars Dijkstra, CIO of the €42 billion manager.

EXECUTIVE INTERVIEW: ‘Volatility is the name of the game’

May 13, 2016

Axa Investment Managers chief executive officer, Andrea Rossi, talks to David Stevenson about bringing all his firm’s subsidiaries under one name and the opportunities that a difficult market...


ROUNDTABLE: Beyond the hype

Oct 13, 2016

The use of smart beta investing continues to grow. Our panel, made up of both providers and users, discusses what the strategy actually means, how it should be used and the kind of pitfalls that may arise when using this innovative investment technique.

MIFID II ROUNDTABLE: Following the direction of travel

Sep 07, 2016

Fund management firms Aberdeen and HSBC Global meet with specialist providers to speak about how the industry is evolving towards MiFID II.