The Neo Neo-Colonialists

Neo-colonialism is the term given to the involvement and dominance of modern capitalist businesses in nations which used to be colonies. Typically these were large corporations from the developed world taking advantage of resources and labour in the developing world. This, however, isn’t the trend which we are seeing today. What we are seeing is China’s largest firms becoming the first neo neo-colonialists – a developing nation’s firms dominating the economic affairs of other developing economies.

I’ve written before on how rising inflation in China caused by the increasing prices of factors of production (namely labour) represent the nation’s approach to the steep end of their long-run aggregate supply curve (see below) where any increase in output will result in a significant rise in the price level (see article: ‘China’s inevitable inflation’). Indeed, the reason for China’s foreign scramble for resources is obvious enough. China’s third-largest steel maker Wuhan Iron & Steel Group is in talks with ArcelorMittal, the world’s largest steelmaker, to develop overseas mining projects which would make Wuhan Steel less dependant on expensive imports of iron-ore. This is the latest in a string of moves taken by Wuhan Steel to achieve iron-ore self-sufficiency in ‘three to five years’ (Deng Qilin, chairman of Wuhan Steel). Wuhan Steel has acquired stakes in iron-ore mining firms from Brazil to Venezuela.

Wuhan Steel isn’t the only large Chinese firm with a voracious appetite for foreign firms. PricewaterhouseCoopers (PwC) said in a recent report that Chinese outbound merger and acquisition deals for the first six months of 2010 are at record highs, up by more than 50% over the same period last year. The report also said that the main targets of mainland firms were industries involved with natural resources – a trend that supports the view that the mainlanders are aggressively trying to shift their LRAS curve outwards to curb inflation.

The rate of growth of Chinese interests abroad is only quickening. In 2000, China-Africa trade surpassed $10 billion, this year it is likely to cross the $110 billion mark. The Chinese government is a vocal supporter of this neo neo-colonialism – on August 16^th 2010, the Ministry of Commerce launched the China-Africa Research Centre which will (among other things) ‘help Chinese firms planning ventures in Africa with consultancy services’ (Fu Ziying, vice-minister of commerce).

The rest of the world should be at least a little concerned at this growing trend. With China snapping up foreign resources at breakneck speed, other countries’ firms may be cut off and face decreasing competitiveness due to the higher costs of imports of raw materials. This could have serious unemployment repercussions outside of China and could stunt the growth of other developing nations by giving China an absolute advantage in manufacturing. The only upside is that we’ll continue to be able to buy cheap goods from China. In light of these implications, perhaps the West shouldn’t be so aggressive in urging China to raise the value of the yuan – an action which would certainly expedite China’s rise as the first neo neo-colonialist.

Cross Strait Travel

Due to the recent Free Trade Agreement (FTA) between the two countries, the mainland is allowing a fixed quota of flights across the Taiwan Straits. The government has also ordered mainland carriers to slash fares by 10-15% - potentially sparking a price war.

The legalisation of direct flight paths could lower flight times by half - lowering costs and fuelling the price war. Second-tier cities like Xiamen will recieve more traffic due to a lack of landing slots at major cities.

The outlook: The FTA could harm Hong Kong carriers like Cathay Pacific and Dragonair as it will bring lower demand for Hong Kong - Taiwan flights - formerly one of the most lucrative short-haul flighs in the world. Hong Kong will no longer be a stepping stone. In fact, the introduction of direct flights has already reduced traffic in Hong Kong International Airport by 7%.

Solving China's Property Bubble

China’s property market is getting too hot. Inflation is rampant at 11.7% and finally the Chinese government is taking steps to cool it down. The government said they would increase mandatory down-payments on second and third homes as well as on first homes larger than 90 square meters. They also plan to increase the supply in the property market through the construction of affordable small and medium sized houses. Though some of these actions are laudable, I feel that they are not the most effective set of reforms to deal with this problem.

The Chinese government has announced an increase in down payment on first homes of more than 90 square meters from 20% to 30% and an increase from 40% to 50% on second homes. The increase in mandatory down-payments, especially for the purchase of second or third homes, was intended to deter speculators. However, this reform isn’t going to be very effective as a quarter of Chinese home-buyers pay cash for their houses and the average mortgage only covers about half of the value of the property because home-buyers want to avoid paying interest. Hence, while this reform will not deter that many deep-pocketed speculators because they are paying similar down-payments anyway, it will adversely affect those people who aren’t wealthy, can’t afford large down-payments and are buying a house for their own use.

This said, the other reform adopted by the Chinese government to cool the property market -increasing the supply of houses will, in theory, reduce the equilibrium price of houses. Also, the fact that the houses are small and medium sized means that the increase in supply is aimed directly at those who are worst hit by the inflation. However, the large flaw with this plan is that building houses and apartment blocks takes a great deal of time and, by the time construction is completed, the housing bubble may already have burst.

So if increasing down-payments is actually missing the point and increasing supply will take too long to have an effect, what should the government do? Well, they have got to look at the root of the problem which is why people are putting money in the property market in the first place. In my opinion, the main reason for this is the fact that Chinese deposit rates are capped at a paltry 2.25% - not even enough to compensate for inflation which ran at 2.7% this February. If deposit rates are so low, why would anyone put money in a bank? What China needs to do to cool off the property market is raise its deposit rates so people make deposits rather than spend money inflating the property bubble.

Raising the deposit rates will have the added advantage of mitigating the effects of the imminent rise in inflation. I hear you say that China’s inflation rate is at a ‘perfect’ level of 2.7% according to the Consumer Price Index. Indeed, this rate of inflation is near-perfect but is likely to rise later in the year. We can see this from the Producer Price Index which rose at a rate of 5.2% in March as a result of an increase in commodity prices – foreshadowing inflation.

However, though raising deposit rates seems to be the ideal solution, it cannot be put into practice as the central bank cannot raise the deposit rate because of the peg on the USD. Clearly, in order to cool down the property market, the Chinese government must allow some flexibility in the price of the yuan – in turn allowing for upward adjustments in the deposit rate. The increased deposit rates will increase speculative inflows - hence the yuan will appreciate. This will rebalance the skewed trade balance with the US by reducing the competitiveness of Chinese exports. It will also bring about a structural change in the Chinese economy, making it less dependent on exports and more driven by domestic demand.

Deep Vaze

16/4/2010