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May 10, 2013
China’s changing raw materials demand—A new basis of competition
By: Paul Bjacek

China’s economic growth has recently slowed, showing 7.8% real GDP growth in 2012 versus average annual growth of over 9%/yr. in the past five years and 10%/yr. over the past ten years. Similarly, by 1Q13 China’s imports of chemicals, metals and minerals dropped by 5% from the record high of US$186 billion in 4Q11. This is related to the poor performance of the world economy as well as a shift in China’s competitive basis. This shift will define the nature of China’s future economic growth and materials demand.Figure 1

Will domestic consumption drive China’s growth?
China’s private consumption has not replaced exports and investment as the main GDP growth driver (see Figure 1). As a matter of fact, Chinese private consumption as a share of GDP declined by four percentage points between 2000 and 2012, to level of 39% in 2012 (as compared to 71% for the US). Fixed investment is the primary economic growth driver in China and it is largely export driven. Fixed investment and net trade are intrinsically linked, with about 57% of new fixed investment in China being accounted for by production industries, China’s export engine. As a matter of fact, net trade and investment (together) increased in GDP share by 19 percentage points between 2000 and 2012.

Will China’s export performance revive?
Chinese exports have been decelerating significantly, as shown in Figure 2 (based primarily on China trading-partner import data1). But a competitive change was already noticeable with the significant exports decline China experienced during the 2009 recession. In preceding economic downturns, such as in 2001, China’s export position was mostly unaffected. At that time, China was in or near the lowest cost position on the global labor-intensive finished goods manufacturing cost curve, forcing other regions to make the necessary factory shutdowns. This has now changed and represents a significant development for materials suppliers to China.Figure 2

For most of the past decade and a half China has been the center of focus for world growth in basic materials (including chemicals, minerals, metals, etc.) requirements. Large waves of foreign direct investment in new finished goods manufacturing plants characterized this period and it drew large quantities of raw materials imports and investments. By the mid-2000s, China became the established production base for many textile, electronic and other commodity finished products. However, the growing manufacturing activity brought about substantial increases in labor costs and tightness in labor availability. Also, population control measures have reduced the labor pool2. Other competitive factors also came into play which influenced global manufacturers’ location preferences, including the desire to co-locate with markets (developed regions); reduced labor input as a component of manufacturing (due to increased automation and robotics, particularly in developed regions); improved exchange rates; the need for reliable supply chains; and the necessity of intellectual property protection. Over the past few years, as manufacturers began the next wave of plant expansions, other regions captured an increasing share of their investment, causing foreign direct investment in greenfield manufacturing facilities in China to drop from US$108 billion in 2003 to US$66 billion in 2011. See our Global Shifts in Industrial Investment study for more details.

Going forward, the most labor intensive industries (e.g., some types of high volume textiles, electronics and furniture) will be attracted to new low cost areas, such as other Asia countries (like Bangladesh, Indonesia and Vietnam) and Mexico. Textiles tend to lead this trend.

How is China’s manufacturing base responding to the changing competiveness?

As China’s labor costs increased, the country has been favoring a shift toward durable goods and value-added products. In 1Q1999, about half of China’s exports consisted of nondurable goods3. Nondurable goods typically last 3 years or less and mostly include disposable items and inexpensive consumer goods. However, durable goods accounted for about 75% of exports by the 1Q2013 (see Figure 3). Similarly, between 2005 to 2012 investment in durable goods in China grew by 20% per year, versus 15% per year over the same period for nondurable goods4.Figure 3

This means that items like automobiles, appliances, high-end furniture, sports equipment and machinery are more favored for manufacturing in China, although the cost competiveness will not be as extreme as had been the case with nondurable applications in the early 2000s. Durables face different competitive factors, where developed regions may have technology advantage. Also, durables can be more susceptible to economic cycles, as evident in China exports in 2009. Therefore, in the next few years, China is likely to experience slower investment growth in downstream manufacturing (i.e., chemical and metal customer industries).

Actions for basic materials companies

China will remain attractive due to its large base load demand for regional chemicals and natural resources, but basic materials companies should be positioned to serve other, faster growing, regions with manufacturing advantage as well. Much of those will also be in Asia, but other emerging markets as well, such as Mexico and Eastern Europe.

For plastics, China demand growth will slow to less than 8% per year in the medium term. The demand mix in China will also change. For instance, certain types of polyethylene, fibers and polystyrene are used in non-durable goods, while polypropylene is used more in durable applications (such as automobile parts). Other chemicals serving the durable goods markets include engineering plastics, urethanes, coatings, ABS, rubber chemicals, other thermosets and composite materials. Of course, the nondurable packaging segment will continue to grow, as it is also used in nondurable goods.

The metals industry, especially steel and copper, will benefit from growth of durable goods manufacture in China, where transportation equipment and appliances, for instance, will provide good sources of demand.

There are also business model impacts for materials suppliers, where reliability and customer intimacy will be more important. Durable goods typically require a higher level of technical service and have greater quality standards. Supply chain and innovation considerations also weigh in for these industrial customers.

Sources: 

Figure 1: Accenture Research analysis of Oxford Economics
Figures 2 & 3: Accenture Research analysis of Global Trade & Information Services data.


1Adjusted export figures, where I used import data from China’s trading partners, representing 54%-90% of the value of trade (depending on the quarter). The remaining country data are from China export data, to arrive at a total. China’s own export data showed increased exports in 3Q2013.
2 See Boom, Gloom and the New Normal, by Paul Hodges and John Richardson for an informed analysis, at ” http://www.new-normal.com/
3 Basic materials excluded; Durable and nondurable goods exports shares were based on a classification of 85% of China’s exports
4 Based on Oxford Economics data.

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