Chinese Water Management

Economists rarely agree, an inexact science is a lush pasture to graze in. Let’s consider a fact though; the Chinese water management system encourages waste and exacerbates ecological damage. This is not a ground-breaking observation, Elizabeth Economy of the Council on Foreign Relations

(http://journals.cambridge.org/action/displayAbstract;jsessionid=951145E94FD4719323CDF8CE888A476E.tomcat1?fromPage=online&aid=856668)

(among others)has written extensively on the problem of dwindling supplies, unchecked pollution and inefficient use of water resources across all sectors of the economy.

The Chinese government are rightly concerned about the issue and plan to divert huge volumes of water from the relatively abundant South to the parched North over the coming years. Whilst it can be said that the Chinese love a big project, it doesn’t seem clear how this will address a very real problem.

Whilst there are many dimensions to the management of scarce water resources, getting the economics right is key. Water prices have been kept low to support both low-income families and industrial and agricultural sectors. Low revenues have, in turn, resulted in a lack of investment in distribution networks and water treatment to the detriment of water quality and conservation.

Whilst the Taihu Lake and Khabarovsk incidents have caught the headlines and shone a light on water mismanagement in recent years, an exhaustive study by the World Bank

(http://web.worldbank.org/WBSITE/EXTERNAL/COUNTRIES/EASTASIAPACIFICEXT/EXTEAPREGTOPENVIRONMENT)/0,,contentMDK:21028556~pagePK:34004173~piPK:34003707~theSitePK:502886,00.html#reports

has demolished the above social arguments. Subsidized prices do not protect lower income groups, and in many cases the benefits of subsidized tariffs unfairly accrue to financially secure members of society. In Chongqing , households with a monthly income of over 10,000 RMB enjoy a subsidy of 22RMB per month compared to a 3-4 RMB subsidy for households with a monthly income of 500 RMB or less.

Industrial and agricultural users have been found guilty of excessive and inefficient consumption in the past. Users in such industries as paper and textiles are renowned for their water intensive practices and disregard for environmental standards. According to Yuan Zhou of the International Earth Systems Research School , the Chinese agricultural sector uses twice the amount of water used in other countries to produce staple crops. Leaky distribution networks and inefficient irrigation practices are .

The practice of ‘getting prices right’ is a firm favourite in economic policy, it is not, however, a panacea. Investment in water management capacity (distribution networks, treatment facilities, recycling, pollution clean-ups etc) requires funding and a fair amount of political will. Subsidies need to be better targeted to help the most needy. Government action can only go so far, individuals need to be persuaded to ration consumption. The best way to do this is to start to charge a fair price.

The RMB

Whilst the current financial crisis shines a light on some unpleasant truths within the American financial system, Chinese authorities could be forgiven for smugness after listening for years about how best to run a financial system. That there are serious issues in the Chinese financial sector is without doubt (credit rationing to small and medium businesses, the favour of SOE’s for loan funding, interest rate reforms are but a few), however, recent international events will only reinforce the slow and cautionary approach taken by the Chinese on key financial issues.

A case in point is the Chinese approach to currency reform. This issue has generated a huge amount of discussion over previous years, and it is only right that the Sinoconomist chips in. Recent months have seen eminent economists such as Morris Goldstein and Nicholas Lardy (http://www.ft.com/cms/s/0/ffde35ee-5807-11dd-b02f-000077b07658.html ) and Michael Pettis (http://www.chinastakes.com/BlogOneArticle.aspx?id=22&&AID=630 ) restate their views on currency revaluation and argue closely for a one-off step revaluation to address trade surplus and inflation worries. The cases are well made, you would expect nothing less from economists of such calibre. However, too often such reform recommendations such as these espouse what should happen rather than what is likely to happen.

Part of the job of an economist is to accurately predict what is likely to happen in the future rather than what we would like to see. Any consideration of a change in currency policy for a country like China with a notoriously stubborn administration would recognise this. A brief analysis of the current policy regime would reveal a very important feature with immense value to both Chinese government and business – namely, the market signal which slow currency appreciation sends out.

It is without doubt that the export sector has and will continue to contribute a significant part of China ’s GDP growth. It is also true that this sector is dominated by labour intensive manufacturers. A 10-15% revaluation will have untold effects upon employment and most likely social stability, as such, this issue is at the forefront of any state cost-benefit analysis. The implicit social contract between the state and citizens where political rights are traded in exchange for economic growth would well be jeopardized.

What incentive would a 10-15% revaluation send to prospective investors? Academics over the world have speculated about how much the RMB is undervalued, most estimates range from 40-50%. Would this mean that other such moves would be likely? An unstable environment such as this would be counterproductive with clear repercussions for the authorities’ stated priorities of increased employment and economic growth.

A gradual reform and a signal of where the currency is likely to be in the near future is of great value to exporters and investors alike, allowing the opportunity to plan in advance for future terms of trade changes. It is highly unlikely that Chinese authorities will give up this important policy lever, especially as it tries to effect a gradual shift in the export base away from low grade to high grade goods and attempts to drum up investment funds to this end.

That is not to say that the current exchange rate regime is without fault, popular topics such as ‘hot money’ and an ever increasing money supply have been ubiquitous in the financial press in recent years. That administrative rather than market-based policy solutions were used this year is quite telling.

Future reforms such as stronger credit quotas, a fairer allocation of bank capital away from fat SOE’s in favour of smaller businesses are worthy of promotion. The use of a wider basket of currencies to which to peg the RMB to would also make sense. However, to expect a 10-15% jump in the RMB is unlikely and is inimical to the stated objectives of the Chinese government. Such a move would be out of character and would not go down well with a citizenry unwilling to accept outside influence on the state’s economic policy. That the People’s Bank of China as reported in Reuters (http://www.reuters.com/article/usDollarRpt/idUSPEK29014920080928) recently announced that currency appreciation would proceed at a slower pace this proves the point, and the reasons outlined here give a clearer view of what is likely to happen in China over the next 12 months.

Ready to Pounce?

Over the preceding 18 months, the activities and aspirations of both sovereign wealth funds and Chinese banks have attracted a great deal of scrutiny. With the current economic climate and crisis in financial markets, it would be interesting to gauge whether attitudes have changed. With funding channels locked-up in financial centres across the globe and with governments under increasing pressure to support ailing institutions, it would seem that capital inflows would be most welcome.

In the midst of the maelstrom, recent comments made to the South China Morning Post at the World Economic Forum by Bank of China vice-president Zhu Min seem instructive, ”from a business point of view, we are looking at all possible deals everywhere,” he said. However, cash -strapped banking executives should take note, he qualified his remarks by saying that,”In our overseas acquisition endeavours, we are more interested in unique and profitable business models and financial products rather than….. seemingly undervalued financial assets.”

Recent events put an interesting twist on a very divisive issue and will test the resolve of governments who may have previously stood in the way of asset acquisition on the part of foreign entities. To fence-sitting observers however, it will give an indication of the depth of the current crisis.

Talking ‘bout a Green Revolution

Figures for economic growth in excess of 10 % per year have been common in China over recent years. That this is impressive is without doubt, a more interesting question though is what China’s future growth prospects are given current modes of production.

In a huge country like China it is difficult to get a holistic view of the whole economy; the complexity of the task is prohibitive. However, a close look at one sector and the use of one fundamental resource within it presents us with a partial view of its future sustainability and productive capacity. A recent paper entitled ‘Impacts of Cultivated Land Conversion on Environmental Sustainability and Grain Self Sufficiency in China’ by Shuhao Tan of Renmin University, explores patterns of land use within the agricultural sector.

China is a land poor country, the sheer weight of the population on existing land assets is huge and is expected to increase as measures of arable land area per head diminish due to population growth, land appropriation, increased urbanization and the onset of desertification. Professor Tan found that over the past fifteen years, actual levels of cultivable land in China have decreased from 132m hectares to 122 hectares a drop of 7.8%. This decline has not been offset by growth in agricultural productivity and thus inhibits the state goal of grain production levels appropriate for self-sufficiency

These observations are not particularly new, but the detailed form of this development is. Aside from aggregate figures, the actual change in the nature of grain production is an important development. Prof. Tan shows that over the past ten years, grain production has largely shifted to the North of China where rainfalls are erratic, yields are lower and water resources scarce. Professor Tan argues that this development puts pressure upon the environment in these areas and will mean that grain production levels will become unstable and insufficient in the near future.

The clear implication of this paper is that as China develops and as consumer tastes change to require more grain intensive foodstuffs, China’s productive capacity will not be able to meet burgeoning demand – with further knock-on effects for food prices on both domestic and global markets in excess of those witnessed over the past two years. The onus here is to make agriculture more productive via; protection of existing land assets, field improvement technologies, irrigation initiatives, crop management education and the development of land rental markets.

China: Economies within an Economy

The Chinese set great store by the significance of numbers. Today, the importance of the number eight was obvious to even the most numerically-challenged at the launch of the spectacular ceremony to open the Beijing Olympics. Festivities kicked off at the auspicious time of eight minutes past eight on the eighth day of the eighth month of the eighth year of the new century.

For Sinoconomists and number-obsessed analysts the number eight has had an alternate resonance. Inflation as measured by the CPI index has hovered around the eight per cent level for much of the past year. Quite rightly, this has been a cause for concern and debate. Concerned government officials have (wrongly in my view) enacted price controls to cushion the populous from inflationary effects, academics and China-heads have debated underlying causes and explanations.

Away from the focus on one number, important dimensions are being ignored though. Average figures for consumer price inflation are widely reported and mulled over, yet the very real and significant variations in inflationary conditions within China are overlooked. Inflation levels in poorer provinces such as Xinjiang and Gansu have been running at and have consistently hovered around the 12-13% mark over the past year.

These provinces have the lowest levels of income and yet suffer the highest rates of inflationary pressure on basic consumption goods. In this context these alternate numbers also mean a lot. Now more than ever we are confronted with an image of ‘One-China’. This image is not realistic; there exist many states within one-centrally controlled entity. Each area has respective peculiarities important to consider before making an economic analysis.

To understand the significance of inflation in China we must cast our gaze away from narrow measurements and understand the very real variations which exist across space. By doing this we will forge a more prescient understanding of this continually perplexing country and understand both the severity of social problems and the difficulties associated with implementing an economic policy in such a wide and varied country.

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