China's next growth phase could pass us by
CORPORATE Australia desperately needs to reassess how it approaches China. Until recently, Australian companies have viewed China as a commodity muncher with a similar appetite to the Cookie Monster on Sesame Street. And for those companies that don't produce metals or foods, it has effectively been used as a cheap supply of labour.
Suddenly both of these trends are changing and corporate Australia looks under-prepared for the decade ahead.
It is apparent that rumours of China's economic death have been greatly exaggerated. A massive stimulus in 2009 helped its economy to rebound ahead of the Western economies but with the undesired side effects of skyrocketing commodity prices and an oversupply of housing. This led to a tightening of credit by Beijing and seven quarters of progressively slower growth.
That process now looks to have concluded and China is about to embark on its next phase of development marked by growth of between 7 and 8 per cent, with domestic consumption leading the charge.
Critically, fixed asset growth - spending on capital projects - will gradually decline as a percentage of the economy. In the very short term, the capital spend will remain high as Beijing brings forward infrastructure spending to reboot the economy. But this is only a time-buying exercise. The main game for the new leadership group in the Communist Party is to raise domestic consumption through higher wages. This is happening at a rapid clip, but it is balancing act for the authorities. While recently speaking to an Australian businessman who operates a manufacturing plant in southern China, one comment stood out - "there is one place you don't want to end up in China and that is in a hospital. He explained: "There is a good chance of getting an infection and not making it out." To anyone in Australia this sounds preposterous, given penicillin was discovered 85 years ago.
China is not an economic miracle, but a social experiment by the ruling party to appease and retain control over 1.3 billion people. Many industries, such as steel, regularly generate unhealthy returns, but power along because they create jobs. Rudimentary work safety practices in the Western world are habitually overlooked and the standard of healthcare does not rank highly. Since 1979, when the party decided to open its economy, virtually all activities have become subservient to rapid economic growth.
This has spawned a mass of lower middle-class people. But there are still about 400 million mainly rural people who need to be accommodated. Houses, roads, railway lines and bridges have been built to billet them and jobs have to be created in other areas.
What does this mean for Australian companies? First, labour is not going to remain cheap and while the dollar is high, there must be a shift to cheaper pools. In recent years, cost blowouts have been shielded by a strong currency.
Our mining companies also need to prepare for different times. The resources boom is not over, it is just changing. China's demand for a whole range of commodities is likely to remain strong for many years, but rapidly rising prices should not prevail. Steel production will remain around 750 million tonnes into the foreseeable future, but growth rates of 20 per cent look uncertain. To stay in the game producers must ensure their cost base is competitive.
One mining sector that has the ability to change is the iron ore industry. This is different to virtually any other commodity type because of its concentration of suppliers. Australia produces about 50 per cent of the world's exported iron ore and if we add Brazil to the mix the number grows to 75 per cent. The vast majority of this is generated by just four companies.
It seems incongruous, with such supply concentration, that two of these companies - Rio Tinto in 2009 and Fortescue Metals in 2012 - got into trouble and required major financial assistance and restructuring. Is the commodity industry the only one in the world that as soon as prices rise the producers automatically increase supply and butcher the price? The time has come for the iron producers to keep supply short and prices at a level - possibly $US130 a tonne - to ensure longevity and financial health.
It beggars belief that the industry could experience such swings in price as we have seen recently. Towards the end of 2012, iron ore fell from $US130 a tonne to $US86 only to rebound to boom levels of $US160 this month. During this hurdy-gurdy ride Fortescue went within an ace of having its lenders walk away. No doubt the price will settle at somewhere between $US110 and $US140 a tonne. Why not take an OPEC attitude to production and keep China short of demand levels?
With China now officially into its new phase of economic expansion, the handful of producers need to focus more on price than supply expansion.
Finally, Australia's broad range of industrial and financial institutions must have a China plan. The decision by Apple's Tim Cook last week to visit China with cap in hand to see China Mobile is the latest sign that no company with growth plans can avoid dealing with the Middle Kingdom. We have to find products such as education, tourism, finance, transport, media, electronics, telecommunications and gaming to supply China.
Some companies are up to speed, but generally China has been consigned to the too-hard basket. There will be failures along the way, but if we don't go down this path, we will flounder as the US and others flood China with products for the next two decades and Australia will miss the globe's next great growth phase.