The last few months have seen the phrase “supply-side reform” become the latest direction set by China’s top government officials. It is now being parroted at every level of government, in some cases to set their priorities, and in others to rationalize whatever it was they already had underway.
There are half a dozen major themes included in supply-side reform that range from nurturing new industries to reducing financial risks in the economy. In this note though, I want to focus mainly on the theme of capacity reduction, where my key point is that it will be slow and incremental, with the pace set less by the financial performance of a specific industry, and more on the job situation in areas where capacity is being reduced.
And remember, capacity reduction has been part of various industry plans since 2009, while new capacity in steel and other sectors continued to be added through 2014.
In 2015 when the situation got really tough, both the coal and steel industries reduced employment roughly 10% without the benefit of this new plan – the market did have an impact.
Capacity reduction
In early 2016, the government published its latest plans for capacity reduction in both steel and coal, which is a good sign of further intent. However, the numbers cited in these plans are probably the high end of what might be achieved, as their impact gets diluted as it trickles down to cities and mayors for whom the potential job losses are very local and personal.
And don’t forget that while the majority of capacity may well be state-owned, there is substantial privately-owned output ranging from wildcat coal mines to privately-funded steel mills.
Steel: The plan aims to eliminate 150 million tons or 13% of current capacity over 3-5 years. This for an industry operating at best at 70% utilization today and losing US$1 billion a month.
In short, it’s a plan to take out 2-4% of capacity a year, with a priority given to removing capacity through consolidation, to minimize job losses. There is an estimate of potential job losses from the capacity reduction, 400,000 over the next 5 years, a very small number in an economy that claimed to add 13 million new urban jobs in 2015, and about the same number as lost their jobs in the industry in 2015 alone.
It is much better for the government if workers can be kept on in some form and paid, even if only subsistence wages, rather than have them totally unemployed and dependent on local government handouts. The chance of large-scale demonstrations would be much lower.
Coal: The logic of the capacity reduction plan in coal is similar to steel. With annual production of 4 billion tons per annum, the aim is to shut down 500 million tons over the next 3-5 years, so again 3-4% per annum.
In coal, it’s likely that the capacity reductions will be focused on the smaller, private mines. As the coal industry lost almost 10% (or nearly 500,000) of its jobs last year, the plan seems almost to be a weakening of the downsizing trajectory, not an acceleration.
It is very likely that a share of the capital that the government pushed into the economy in January 2016 will have ended up on the balance sheets of state-owned enterprises struggling in the coal and steel sectors, pushing back restructuring into the medium term.
Other supply-side themes
Other elements of “supply side reform” incorporate a number of themes that have been part of the government agenda for a while. These include:
Accelerating the development of new industries. This continues the initiatives from “Indigenous Innovation” and “Made in China” to provide capital to investors in the semiconductor, biotech, e-vehicles, Internet+ and similar industries. The myriad attempts by Chinese companies to acquire international companies in the semiconductor space is one outcome of this.
Reducing the housing market oversupply. The market is doing this quite effectively in most Tier 1 and Tier 2 cities. Reducing the required deposit for first mortgages to 20% is a relevant action on this theme, as is making it easier for migrants to acquire homes in cities where they still lack a residence permit. However, no actions will persuade citizens to buy apartments built in poor locations with little attention to quality. These will eventually be taken down.
Cutting costs for business. While businesses will never be satisfied on this theme, they have reason to claim little has been done. With the greater focus on ensuring taxes are paid in full and FX is only given out when the paperwork is fully in place, they can claim in early 2016 that conducting business is in fact becoming harder.
Reducing financial sector risk. While regulators are doubtless hoping that we are entering a period of lower volatility in the financial sector, the hunt for returns by middle class investors will continue unabated. It is likely that the failure of Ezubao, a leader in the P2P lending sector, will be the first of many more. Investors still expect to be bailed out for investment decisions that don’t work out and as we saw in the stock market in 2015, the government still gives the impression that it is there to provide that support. This will continue to be an expensive commitment.
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So in the end, more “slow, slow, quick, slow, slow” for supply-side reform, mainly slow with occasional jumps forward. But, as always, look at what the underlying numbers say about how an industry restructuring is progressing, don’t just assume that what is in the plan is what will happen.
Read more about business in China on my blog, Gordon's View, and please follow me on Twitter @gordonorr.
