One thing that China does well, perhaps better than any other country, is to articulate a vision. It might not know every step of the journey but it knows where it wants to be. Ultimately, China wants to be a global economic and geopolitical force; to put behind it the humiliations of the 19th century and the chaos of the 20th.
To achieve this, China has mobilised labour and capital to build infrastructure and an industrial base to create wealth and an urbanised population. In 30 years, the republic has reached second place in the economic rankings with GDP of $11trn (€10trn). Holding the world’s largest foreign exchange reserves, the largest domestic car market selling over 25m vehicles a year and trading more than $3.8trn of goods annually, China really matters. Any investment based on assumptions of world growth and stability has to assume that China works.
The country is at a crossroads. On the one hand, it has created a manufacturing base and knowledge networks that make it competitive in more ways than just a reliance on low-cost workers. When we look around our homes, the range of goods produced in China (office equipment, computers, smartphones, music systems, TVs, expensive work-out clothing, furniture) is more than from anywhere else. These goods support higher wages, household incomes and therefore higher Chinese spending. And this makes China the biggest single market for Volkswagen (4m cars), General Motors (3.9m) and Hyundai (1.1m).
But this success has a toxic legacy, financially and literally. The economic model that delivered growth placed a reliance on building things. This involved creating production capacity for aluminium, cement, plastics and steel. To feed these industries required the production of raw materials, petrochemical products and, of course, power.
To sustain growth of over 9% annually, as was achieved for nearly 20 years, there was a need for electricity. At the end of the 1990s and up to the global financial crisis, China was growing its installed generating capacity by the equivalent of that of the entire UK, about 80 gigawatts (GW) every year. The bulk of that came from coal-burning power stations because they are cheap to build, easy to run and provide a steady supply. China no longer needs to expand its building programme, so the 1bn tonnes of steel capacity exceeds its needs by perhaps as much as 400m tonnes. Excess capacity and debt form the financial legacy. Environmental damage to air and water quality is the other legacy.
For years, China has sought to address environmental problems indirectly. The focus has been on energy efficiency and husbanding resources. It has also tried to tackle polluting industries by requiring scrubbers to be installed in coal-burning facilities and by levying pollution fines. There has been some effect. For example, 10 years ago an inefficient cement producer required 90-120 kilowatt hours (kWh) of electricity to make a tonne of cement. Today the most efficient only need 65kWh.
But the smog in China’s cities is still appalling and in Zhejiang province in 2014, a section of river caught fire. Weekly environmental protests are reflecting the extent of the problem as well as underlying social changes – people are better off and focusing on quality of life.
The Chinese leadership is promising to cut pollution. At the opening of China’s annual National People’s Congress, Premier Li Keqiang promised “we will make our skies blue again” by tackling pollution caused by coal-burning for heat and power. The economic growth target has been set at “around 6.5% or higher, if possible”. This is lower than last year’s target and suggests a more determined approach to economic reform and the closure of excess industrial capacity at the expense of growth.
The solution to the economic problem is linked to an emotive popular issue. The government needs the heavy industrial sector to cut debt and capacity but it has encountered resistance from local government and vested interests. Environmental reasons have been used before by central government as a tool to push through change. Now it appears to be leading with it.
However, there is more to this than redressing the imbalances of the past; there is a desire to shape China’s future. The country’s path toward prosperity depends on its ability to develop and dominate key industries of the future. One is alternative energy, especially solar power, and here we can see China’s seriousness. The total installed electricity generating capacity in China grew by 125GW in 2016 to stand at 1,646GW. Solar capacity increased from 43GW to 77GW (the total UK capacity is 84GW). Wind generating capacity in China is now 149GW and hydro power, 332GW. Combined electricity generation from renewables has almost matched that of Germany.
China’s goals are to add another 110GW in the next three years at a cost of $364bn and to increase power production from renewables to 20% of total generation by 2030 from its current level of 11%.
Electric vehicles are another area of focus. Urban air quality provides the impetus but electric cars represent the future of the auto industry as well as having implications for the oil industry. Tesla in the US has garnered most of the press about electric vehicles but its products are both too expensive for the mass market and there are not enough of them (83,922 produced and 76,230 delivered in 2016).
China, like Tesla, is focused on pure electric vehicles but it is looking to produce domestically and in higher volumes. In 2016, Chinese customers bought 351,000 electric cars, up from 190,000 in 2015, compared with 221,000 in Europe and 157,000 in the US where the market for hybrids is considerably larger.
Investors appear to be playing catch-up with the opportunities in China. Either they are choosing to focus on, or they are being swayed by, the continuous stream of stories warning against environmental crisis while giving little thought to the global and investment implications were such a crisis to materialise.
To get ahead of China, investors need to identify the successful Chinese businesses that have achieved higher profitability on their own strengths rather than a dependence on favourable policy conditions, connections or bank borrowings. China is modernising and specialising; the focus on the environment is a sign that eyes are firmly on the future.
Edmund Harriss is the manager of the Guinness Asian Equity Income fund and the Guinness Best of China fund