CHINAwatch

To what extent an economic rebound will save the US housing market and what is the global economic outlook for 2012?

Notwithstanding refinancing and other palliatives for home owners announced by President Obama in his State of The Union Address, the recovery of the US housing market depends ultimately on robust demand which in turn depend on strong job and income growth.

The measures "To Recover, Rebalance, and Rebuild" as proposed in the Economic Report of the President Click here (Chapter 1) will take time. Even if the economy recovers, it is by no means certain that corporate production and profits would proportionately translate into more middle-class jobs and better wages.

In the same Chapter of the Report, it is pointed out that "Income growth was stagnant for middle-income earners in the 2001–07 period and, as is common, declined in the recessions at the end and beginning of the decade." This reflects a long-term trend. The chapter admits that "the size of the middle class has shrunk. This disturbing trend has taken place over several decades."

This underscores the phenomenon of globalization of the value chain. More and more low-skilled blue-collar production jobs in high-cost countries have become non-competitive internationally. It is doubtful whether, at least for some time, there will be enough high-skilled jobs (and high-skilled personnel) generated in America to fully offset this trend.

The Report (Chapter 2) reviews the influential works by Charles Kindleberger (1978) and Carmen Reinhart and Kenneth Rogoff (2009), "who argue that recessions associated with financial crises are typically deeper than normal downturns and that the recoveries that follow tend to take longer."

In "The Aftermath of Financial Crises*, a paper prepared for the American Economic Association meetings in San Francisco, January 3, 2009, Reinhart and Rogoff observed -

"Broadly speaking, financial crises are protracted affairs. More often than not, the aftermath of severe financial crises share three characteristics.

First, asset market collapses are deep and prolonged. Real housing price declines average 35 percent stretched out over six years, while equity price collapses average 55 percent over a downturn of about three and a half years.

Second, the aftermath of banking crises is associated with profound declines in output and employment. The unemployment rate rises an average of 7 percentage points over the down phase of the cycle, which lasts on average over four years. Output falls (from peak to trough) an average of over 9 percent, although the duration of the downturn, averaging roughly two years, is considerably shorter than for unemployment.

Third, the real value of government debt tends to explode, rising an average of 86 percent in the major post–World War II episodes.

Interestingly, the main cause of debt explosions is not the widely cited costs of bailing out and recapitalizing the banking system......... In fact, the big drivers of debt increases are the inevitable collapse in tax revenues that governments suffer in the wake of deep and prolonged output contractions, as well as often ambitious countercyclical fiscal policies aimed at mitigating the downturn."

With specific regard to the housing sector, the duration of downturn (from four to seven years) and magnitude of decline (from 12.6% to 50.4%) for advanced countries are featured in Table 10.8 (p. 160) of Reinhart and Rogoff's empirical work "This Time Is Different - Eight Centuries of Financial Folly", Princeton University Press, 2009.

This post-Crisis long-hard slog is echoed in McKinsey Quarterly's January 2010 Report "Deleveraging: Now the hard part". Click here

In an Exhibit "A slow start", in the first two years of a five-year recession, economic downturn begins as the economy continues to increase leverage, followed by further downturn during the first years of deleveraging. In the subsequent four to five years, the economy may ‘bounce back’ while deleveraging continues.

So what is the outlook of the US, Europe and developing economies in 2012?

I can do no better than refer to the overview with a coloured globle chart in "The year of self-induced stagnation" in The Eonomist by Zanny Minton Beddoes on 17 November 2011. Click here

The developing economies will of course be affected by the lack-lustre Western markets, but their growth rates in 2012 should remain respectable as much more trade is being done amongst themselves, especially with a re-balancing China, which is still expected to grow by 8.2%.

For a more in-depth look at the prospects for a soft-landing of China's economy in 2012, you may find it useful to Click here for a short overview


Best regards,

Andrew

EU-China Summit on Valentine Day - Does China love EU enough to save it?

Live radio interview on BBC World Service Newshour on 14 February 2012

Download BBC Newshour on EU-China Summit 14.02.12

Outlook on the Chinese economy in 2012

China knows that her past breakneck growth rate is unsustainable, economically, socially, and ecologically. Hence the about-turn to go for a slower and more sustainable growth model in the lastest Five Year Plan (2011-15).

But any drastic drop in growth rates would be convulsive (job losses, social instability etc) especially in a precarious global environment. As China's bank reserve requirements have been increased 11 times since 2009, inflation has somewhat subsided, and house prices are comind down hard, there is room for some easing of credit, especially for hard-hit SMEs.

According to Paul Schulte, Hong Kong–based global head of financial strategy and Asia banks research at CCB International Securities, a subsidiary of China Construction Bank Corp.,"in the past 12 months Chinese regulators have removed 4.4 trillion yuan in liquidity from the financial system—well in excess of the original stimulus spending—through tightening," according to a report by Allen T Cheng in Institutional Investor of 4 January, 2012 - "Beijing Preps for a Soft Landing" Click here

China has therefore been cleaning up its local debt drastically and the general prognosis doesn't support a doomsday scenario. So a measured easing of credit is unlikely to lead to a credit implosion.

As for the economy, while China's export sector is cooling, consumption is showing robust rising trends. KFC is now opening 500 restaurants a year. According to the World Luxury Association's 2010-2011 annual report, China is expected to become the world's largest luxury market this year.

The rising middle class is growing in China's rapidly expanding cities. According to McKinsey Global Institute, by 2025, China will be adding 350 million more urbanites in 221 new cities each with a population of over a million (compared with only 35 such cities in the whole of Europe at present). This rapid urbanization often gives outsiders an impression of "empty shopping malls and roads to nowhere", a refrain of some "China shorters". But there is no mistake the massive urbanization, the largest in human history. This is likely to offset some of the downturn caused by falling exports.

China's latest PMI rebounded to 50.3% in December, suggesting a soft rather than a hard landing. Click here

For now, relatively better equipped with financial resources, China is counting on maintaining at least 7-8% growth this year. This is supported by most forecasts, including those of the World Bank (8.4%), IMF (9%) and the Conference Board (8%). Click here

According to a report "What's in store for China in 2012?" Download McKinsey Quarterly - What’s in store for China in 2012 - February 2012 by Gordon Orr in the McKinsey Quarterly of February 2012, "Despite food price inflation and a stagnant housing market, China should maintain a rapid rate of growth". The balance of his prognosis is based on the following assessments

1. Government policies will spur consumption and investment.
2. Dominant models will emerge for reforming rural land ownership
3. Real estate will stagnate.
4. The fundamentals will cause further inflation in food prices.
5. Chinese investment in green tech will spike upward.
6. Accounting scandals will continue.
7. Private-equity and venture capital funds may go ‘walkabout.’
8. Chinese acquirers will be bolder.
9. The automobile segment will be slow.
10. Hospital reform will accelerate.

Nevertheless, as China is re-balancing the economy away from excessive export dependence, the process is likely to be painful.

In a report on 6 February, the IMF warned that China's economy could drop by half this year in the event of a sharp recession in Europe. According to the IMF, while China could sustain economic growth by repeating the massive stimulus package in the global financial crisis, remaining concerns about its lingering problems of bad loans and credit quality may limit the scope of this palliative. Click here

As Europe is China's largest market (ahead of the US), an European Armagedden would be very bad news for China indeed.

Best regards,

Andrew

How successful are China's Silicon-Valley-type innovation hubs and science parks?

According to McKinsey Quarterly's "A CEO’s guide to innovation in China" dated February 2012, "Chinese authorities view innovation as critical both to the domestic economy’s long-term health and to the global competiveness of Chinese companies. China has already created the seeds of 22 Silicon Valley–like innovation hubs within the life sciences and biotech industries. In semiconductors, the government has been consolidating innovation clusters to create centers of manufacturing excellence." Click here

It begs the question how successful in China are these "innovation hubs" and "science parks". There is a perception that at least some of them may be no more than a disguise for real estate speculation.

It is true these facilities are not necessarily a silver bullet for China’s innovation drive. Some may indeed be a camouflage for real estate development. A recent study on China’s science parks by Stuart Macdonald of the Management School, University of Sheffield, et al exposes the fallacy of over-emphasizing the importance of these innovation hubs. Click here

However, as with so many things in a vast country in rapid transition, there is often a mix of myth and reality, hype and truth, seldom black and white.

First, while there is no dispute at all with the main thrust of the study’s cautionary tale, it doesn’t disprove entirely the value of at least some of these hubs or science parks. Some of them are designed as incubators. As soon as competitive success is attained, some firms may choose to relocate to gain economy of scale. The study’s choice as criteria for judging the efficacy of science parks is thus debatable. Instead of the number of firms, number of employees, annual production, net profits and net exports, it would be more instructive if the study had managed to trace to what extent science parks have succeeded in growing China’s innovative enterprises in the national if not global market place, as in the case of the Silicon Valley.

Second, some of China’s science parks have proved more successful than others. According to the China Daily, “Zhongguancun-based companies garnered business revenues of 380 million yuan ($69 million) in the first quarter of this year (2011) , up 12 percent on a year-on- year basis. The State Council recently approved a development plan called the Zhongguancun National Innovation Demonstration Zone (2011-2020) that allows companies in the area to try out new measures and pilot projects.” Click here

Third, China’s innovation drive especially in green technologies is beginning to catch international attention, at least that of the United States.

A US-China Clean Energy Cooperation Agreement signed on 17 November, 2009 provides for the following -

• A US-China Clean Energy Research Center with World Resources Institute, supported by $150 m combined public-private funding from US and China.

 •Joint research and development in advanced coal research, carbon dioxide capture and storage, building energy efficiency, and clean vehicle technology.

 •A US-China Electric Vehicle Initiative, a US-China Energy Efficiency Action Plan, a US-China Renewable Energy Partnership, a ‘21st Century Coal’ project on Carbon Capture and Storage and a US-China Energy Cooperation Program for renewable energy, smart grid, clean transportation, green building, clean coal, combined heat and power, and energy efficiency.

A World Resource Institute Working Paper dated December 2009, “An Emerging Revolution: Clean Technology Research, Development and Innovation in China” “summarizes China’s policies to prioritize, fund and deploy clean technology R&D and innovation over the short and medium term. These comprehensive policies reflect China’s ambition of emerging as a global power in science and technology through clean technology R&D and innovation.” Click here

A Report to the President of MIT dated 1 April 2010, “The MIT-Greater China Strategy”, noted that “China spends over $136 billion on research and development alone, making it the second highest investor in R&D in the world. During the last decade, China’s R&D intensity has doubled. The number of scientific researchers in China has increased by 77% in just ten years. The scale of its research force, about 926,000 researchers, makes it a significant talent hub.” Click here

Fourth, a McKinsey Quarterly report by Guangyu Li and Jonathan Woetzel, “What China’s five-year plan means for business” dated July 2011 details “ a handful of industries as emerging battlegrounds where countries will be competing for technological leadership during the next wave of development. These industries, including new energy sources and biotechnology, are distinguished by their high profit growth potential and moderate state oversight. In these areas, the government has dedicated itself to incubating national and global champions by helping them gain leading technologies and expanding their commercial capabilities.” Click here

Many of China's teeming researchers work in labs and incubators in universities, science parks and other research hubs. Although some of the off-campus facilities may be less successful, there are those which may well promise to be the cradle of a new generation of indigenous innovative enterprises capable of scaling some of the national if not global commanding heights.

In a fast-changing and globally connected world, governments and businesses disregard China’s massive innovation drive at their peril.