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China – An Economy in Transition

This year marks the 13th edition of the Chinese Communist Party’s Five Year Plan, a vision for the economy put into motion every half decade. The official name is, however, “Five Year Guideline”, with this term being adopted from the 11th Plan to indicate their intention to shift away from a Soviet style command economy, to a market-based Socialist economy.

The first plenary session commenced in 1953, with the country under the leadership of Mao Zedong. The key outcome of the plan was to industrialize; leadership aimed to develop almost 700 industrial projects, of which the Soviet Union would assist with 156. The key outcome of this plan was largely met – 595 industrial projects were completed and at the end of the 5 year period, gross value of industrial products produced had increased by 128.6%. A key issue with the first Plan was the sluggishness of agricultural output when compared with industrial production. Despite the efficiency achieved from small subsistence farmers banding together and forming cooperatives, grain production was not enough to finance the government’s ambitious industrialization and urbanization plans.

The second Plan aimed to expand heavy industry further, strengthen National Defence and encourage economic growth through industry, agriculture, handicrafts and transportation. The “Great Leap Forward” campaign was also formulated during this period, the principle aim of which was to increase steel production and agricultural output. The result was disastrous; too many workers were diverted away from agriculture and a famine ensued, claiming the lives of an estimated 16 to 30 million Chinese.

From the third to the fifth Plan, the focus was primarily on industrial and agricultural output growth. Perhaps because of this focus on agriculture, the famine resulting from the Great Leap Forward campaign was the last to occur in Chinese history. Attention was also given to improving National Defence and developing a reliable and solid infrastructure enabling the country to grow. These Plans also featured a focus on China becoming a self-reliant economy through the development of steel and base metals production capacity and a wider variety (and improving quality) of consumer goods.

The 6th through 10th Plans achieved even greater strides for the Chinese economy and began to show the signs of a country and economy in transition, as seen below:

  • 6th Plan: Continued focus on Agriculture and Industry production targets, as well as National Defence. Focus extended to stabilizing market prices, using economic resources efficiently, educating the population, developing technology and controlling the rate of population growth.
  • 7th-8th Plans: Focus was still on using economic resources efficiently (including streamlining the tax system and introducing VAT) as well as controlling population growth, moves and ambitions for free-market reform away from traditional command economy systems. By the end of the period marking the 8th Plan (1995), China ranked 11th in the world for total volume of trade.
  • 9th-10th Plans: The government’s focus was still on curbing and capping population growth, education and improved technological research and using resources (especially natural ones) effectively. However, a decidedly people-centric set of objectives were also introduced, such as increasing per capita income and living standards, eliminating poverty and increasing the rate of urbanization.
  • 11th-12th Guidelines: Now presented as a looser set of general targets that the government wished to achieve. This tied in with the objective of moving away from a command economy and toward a free-market one. With this in mind, the focus of these Guidelines was to increase the portion of Chinese GDP that was attributable to the services sector, and moving away from investment-led growth toward consumption-led growth. Following on from previous plans, the government continued to aim at greater rates of urbanization and more efficient use of natural resources.

Now that one has a sense for the direction that the Chinese Communist Party has been pushing the country for the past 60 years, it is appropriate to appraise the plans and objectives which they are aiming for in this next five year period.

While a comprehensive report will not be released to the public until March of 2016, some details have emerged which have grabbed public attention and may inform markets of where best to allocate funds in the coming half-decade.

Of particular importance is the abandoning of the one-child policy, the demographic implications of which were discussed in our previous article. While the negative implications of an aged population are dire (massive pension burden on a comparatively smaller working-age population), there may be light at the end of the tunnel (pun unintended).

The relatively smaller population means that services which would generally be strained can function more effectively and the government has strategically allowed themselves slack in running public services. With smaller families, it may equate to a higher level of education per household – the benefits of which can be transferred to future generations. What this means is that the Chinese generation of tomorrow will be better educated and more skilled.

Furthermore, the focus from previous Plans of increasing services and consumption’s share of GDP persists – with more free-market reforms promised. The desire to have a higher contribution from services (as opposed to industry) dovetails well with the focus in previous years on research and education; the services industry is traditionally skills-intensive.

Finally, the implication of China’s gradual shift has been most telling on the commodities sector and the issue has certainly had its fair share of air-time. While many cannot accurately predict exactly what will happen, our view is relatively simple. The long period of Chinese buy-side pressure, which bid up prices, made supply projects favourable investments. However, with growth slowing globally but most notably in China, the demand was simply not there to support prices and a tumble occurred. With the shift in GDP composition which the Chinese are trying to effect, it seems unlikely that this demand drought will be a temporary blip, and more likely that it is a sign of things to come (at least for China).

While no conclusive proof can be gathered until a) the comprehensive report is released and b) economic performance is realized, we feel that the Chinese consumer is where the noise will be in coming years and feel that the planned transition is finally coming to fruition.