Political risk in China

The predominantly young populations in North Africa and the Middle East are finding their voices, and the political order that has held sway for the past 40-60 years is now under threat from all sides. The story there is profound because it is one of human progress thwarted. The autocratic rule and sterile polices of the regimes in the MENA region have nothing of economic value to offer to their expanding and youthful populations.  Wealth, generated by production of resources, has not translated into broader economic well-being but instead has been concentrated in the hands of a few.

This stands in stark contrast to the situation in China, which also has an autocratic system of government but has decided its best course is the creation of what it calls the ‘harmonious society’. Human progress there is measurable in terms of lower infant mortality, longer life expectancy, the rise of hundreds of millions out of poverty and the expectation of, rather than a hope for, a better life.

 

 

Life Expectancy at Birth (Years)
	China	US
1950-1955	40.8	68.9
1955-1960	44.6	69.7
1960-1965	49.5	70
1965-1970	59.6	70.4
1970-1975	63.2	71.5
1975-1980	65.3	73.3
1980-1985	66.4	74.3
1985-1990	67.4	75
1990-1995	68.8	75.7
1995-2000	70.4	77.6
2000-2005	72	78.3
2005-2010	73	79.2

 

 

The unrest spreading across the MENA region has caused some to question whether China’s government ought to be worried about its stability, given the well-known social pressures that exist and the authoritarian character of the government. We do not believe that China’s situation is comparable to those nations in upheaval.  The populations of the Middle East and North Africa are predominantly overwhelmingly young, and their economic prospects are limited. Hopes for a rising standard of living are poor under their present regimes and policies. 

In contrast, for the past thirty years Chinese economic policy has been wholly directed toward investment and a mass-industrial model designed to increase wealth and improve the standard of living for as many people as possible in the shortest possible time.  The reasons for this are not wholly altruistic, of course; the Chinese ruling party have long been aware that to continue in power means improving the lot of the people - hundreds of millions of whom were living in poverty back as recently as 1978.

The effectiveness of these efforts is beyond question.  Life expectancy has risen from 41 years in 1950 to 73 years today.  The population, which was one of the most static in the world in 1980, is now one of the most mobile.  Wages in both urban and rural areas have risen significantly and a growing consumer market is evident.  In 2010, for the first time, more cars were sold in China (13.5 million of them) than were sold in the United States.

This is not to say that China’s population is universally satisfied.  Pressures exist and the government is highly sensitive to them. The prices of electricity, gasoline, diesel, staple foods and even the rate of interest paid on bank deposits are all tightly regulated in acknowledgement of the fact that there are huge divergences across China and within cities between different income groups. For example, the recent increases in minimum wages mandated by the government have served two purposes: addressing complaints from workers about exploitation and raising disposable income to the benefit of the broader economy.

While there are many good causes for grievances against the government which are generally met with minimal tolerance, there is a general sense, absent in many countries in the Middle East and North Africa, that life in China is better than it was and is likely to get better still.

The greater risk: a prolonged oil shock and inflation.

China looks most vulnerable to an oil shock as it has a high dependency on oil imports, especially from the Middle East, and the economy is still more manufacturing oriented rather than services based.  Oil consumption in China is about 4% of GDP Each $10 increase is estimated to increase that proportion by 0.4% of GDP.

Inflation in the region has been a growing concern for some time as a result of food prices.  Food accounts for 20%-25% of the inflation basket (the basket of goods by which consumer price inflation is measured) in developed Asia, but in China it is significantly higher at 33%. Therefore, higher energy prices are compounding China’s inflationary problems and the concern is that this may result in more aggressive monetary tightening than is currently forecast by the market. 

Conclusion:

The long term growth story in China and Asia remains unchanged, in our opinion. Economic reform and liberalization accompanied by investment and rising wages are creating consumer markets in the world’s most populous region. Higher oil prices inevitably hurt a region that is based so heavily on manufacturing and has a high dependency on imported oil, but we believe that this will not result in sustained damage to the economic model.  The region’s finances are strong both at the national and at the corporate levels. After good stock performance in both 2009 and 2010 we believe this could provide a good entry opportunity.

 

(c) Guinness Atkinson Asset Management

 www.gafunds.com