Solving the China puzzle

Australia must prepare for a rising Chinese middle class. That means declining infrastructure investment but more consumer opportunities, as Chinese delegates at Hayman made clear.

Australia needs to prepare for the new China.

That means selling goods and services to Chinese consumers, who will become the largest middle class in the world.

That was the message Cheng Siwei, chairman of the China backed International Finance Forum, delivered to Australia via his Kailis Oration at the ADC Hayman Leadership retreat and in his video interview with Business Spectator.

Not only is China is about to have a new leader, Xi Jinping, but it is embarking on a new strategy to lift consumer prosperity. Cheng says that only by increasing productivity can China deliver increased prosperity for its people.

It's a message that applies as much to Australia as it does to China. According to Cheng this new approach will dominate China for the rest of the decade and beyond.

At Hayman, the Chinese delegates were very frank in stating that the stimulation that government engineered in the aftermath of the global financial crisis left them with a housing bubble.

Last year the Chinese moved on a number of fronts to slow the economy and limit the damage caused by the bubble. Unfortunately, the slowdown went a little harder than expected and as a result they are now stimulating the economy to bring growth rates back to around the 8 to 9 per cent mark.

In the past, China has achieved high growth rates mostly by capital works and much of that investment has not been an efficient allocation of money. For example, the steel industry has spent vast sums increasing its capacity to a level that is 20 per cent more than is required. In other words 200,000 tonnes of steel making capacity is simply not being used.

And there are other examples around the country of capital waste as part of the desperate attempt to avoid the consequences of the sharp fall in exports that came with the global financial crisis.

The Chinese now aim to achieve their growth via a much higher proportion of consumer demand. But convincing Chinese consumers to spend will require some form of social safety net so that people are not wiped out by medical expenses and other sudden changes to income. China will need higher revenues from taxation to fund this outlay.

In his video interview, Cheng explained how the Chinese hope to do this in the coming decade. It will not be a short-term fix.

The most important measures that Cheng suggests is that Chinese wages should be linked first to growth in the Chinese economy and second to increases in their productivity. In that way extra rewards can be delivered to employees without boosting inflation and creating another bubble.

The concept that Chinese wages should be linked to the growth in their economy and to productivity is one that many nations, including Australia, would like to emulate.

Australia has used the carbon tax and other measures redistribute wealth to lower income people but that does not lift overall prosperity. Australia has not linked productivity to wage increases, although the Fair Work Act does raise this as a goal.

If the Chinese can achieve such a link it would create a massive middle class and prosperity without inflation. The Chinese middle class would be the largest in the world.

The Chinese delegates at Hayman emphasised that Australia is still going to sell vast amounts of minerals to China but the amount required in a consumer society will be less than when you are achieving most of your growth via investment.

And there will be no need for iron ore to erect new steel plants for a long time. Australia’s challenge will be to try and maintain market share in a minerals market that grows less than it did in previous years but has the benefit of big increases in supply from Russia, US, Africa, Brazil and other places.

The easy minerals pickings in China are over.

The new game is adapting to the new China growth plan.