Chinese Box

Agriculture, employment and inflation

I hate to pick on Andy Xie again, but he's giving me the perfect opportunity to talk about something that I wasn't sure how to contextualize (and he gets lots of google searches).

In his recent piece "Inflation, not deflation, Mr. Bernanke", Xie pulls up the great Chinese bugaboo of inflation and why he expects the money being printed in the US will just inflate asset markets and prices until they crash again leaving us worse off than before. His recommendation is... literally... to just suck it up and accept that Americans are going to lose their jobs to the Chinese.

The globalization reality is that developed economies like Europe, Japan, and the U.S. will suffer slow growth and high unemployment. Stimulus is the wrong medicine for solving problems. Believing this will lead to excessive stimulus, which causes inflation and bubbles in emerging economies first, and inflation in developed economies later.

I'm actually not going to argue with that, as I'm not horribly confident in the ability of the US to re-employ its populace. I am going to argue though with his arguments that inflation is likely, or even really a possibility, in the current environment.

Let me be clear, he refers to two separate types of inflation in his story, and I think one of them -commodities inflation - is not only likely but pretty much necessary. That's simply a matter of decreasing resources and increasing consumption of the resources, and I'm sure you can argue that increasing the money supply in which to buy those resources will speed up demand for them.

Moving on from the primary sector (commodities) into the secondary sector (manufacturing) though things get much less clear. I will quote Andy:

Labor costs in the emerging economies are rising due to their overheating. Global trade is about one-fifth of the global GDP in value. One often hears that labor costs are only 1/10th of the cost at most factories. But, the components that often account for over half of the cost are made by labor in other factories. The infrastructure and logistics services have significant labor costs too. The total labor content for export goods is probably over one-third in emerging economies. When labor costs rise at 20%-30% per year, it becomes a serious source of inflation.

I have covered this before in a few places (here's one). Labor inflation is simply not going to be an issue for the next ten years. There's a few reasons why: First, labor costs don't translate into final prices very much, the math on which I selfishly steal from Jonathan Anderson in the above link. Second, labor prices in the Chinese interior are still low, as are labor prices in a variety of markets that are just now becoming competitive (Vietnam, Bangladesh, Egypt, maybe one day India).

But here's the big point I want to make: There's a huge labor surplus all over the developing world because of the industrialization of farming. Its a basic rule in the agricultural sector that higher output farms are farmed by less people, and countless developing nations are facing the problem that economic incentives push people to consolidate land holdings and leave the excess workers who have lost the long term security of their land, to find work in the cities. I have talked to government figures in countless places about the economic viability of agriculture, and they all say the same thing: it doesn't employ their large population of young men.

That doesn't mean that they don't want to develop the agribusiness sector, they just need to find other areas to develop to keep young men busy - they set up factories and let them price compete with the Chinese.

This is of course only in countries with functional governments that care about wealth creation (and South Africa is trying to turn back the clock here, "enfranchising blacks" by giving them subsistance farms). But more and more governments are seeing that they can't force their people to live on farms, and they have to provide the basic resources (infrastructure, low tariffs) needed to compete in manufacturing, and ideally services (because it employs more people).

There of course needs to be someone to buy these manufactured goods though... if there isn't, well, you get deflation.

China’s coming boost to the rural sector

This post was originally published on RGE Ecomonitors

If you asked an educated American to identify Norman Bourlag — the Nobel Prize winning agronomist whose hybrid wheat doubled food production in Pakistan, India and Mexico among other places — the chances are you’d get an empty stare. The Atlantic dubbed him in 1997 “the forgotten benefactor of humanity”. On the other hand, the name Yuan Longping — who created a hybrid rice variety 30% more efficient than normal rice, and which now accounts for 20% of world production — is close to venerated in China, recently named China’s greatest businessman by a Sohu poll, often named as the Chinese person most deserving of a Nobel price price, and he was dubbed last April by China Social Sciences press with the somewhat bizarre title “China’s Richest Soul.”

The large disparity of fame between the largely forgotten about Bourlag and the still idolized Yuan is a keen reminder that many people in China still hold memories of starvation. Whereas Bourlag was mostly responsible for averting starvation far away from his country of birth, Yuan’s hybrid rice is primarily grown within China, and is one of the main reasons the country doesn’t have to deal with food shortages.

China is facing some new problems on the agricultural front, and Yuan is not alone in trying to find solutions. China plans to cut its rural population down to approximately 20% of its current levels. Beyond this, China is suffering from both a shortage of land - the land used for agriculture and the land used for cities is the same - and a shortage of water. Creating this difficult transition means more farm equipment, more hybrid seeds, and more agritech in general. There are a pool of company's working around the clock to make this happen.

The international imperative

Besides pushing forward China's industrialization, the changes to China's agricultural sector has become something of an inspiration to a number of African states. As South Africa has returned farmland to blacks, they have been sending experts to China in order to learn how to create high yields on small segments of land. "In agricultural technology China is ahead of the pack," Ron Sandrey, and Agricultural Economist with the Center for Chinese Studies at Stellenboch University told me during one visit, pointing out that it is particularly adept at dealing with small stakeholders. 

The China-Africa Development Fund has also been investing heavily in this area. In my interview with them, Mark Fung describe a cotton project they were working on in Malawi: "If they start producing more cotton, our farmers in Xinjiang could transition to producing processing equipment, or something along those lines." African development depends on a large net increase in the agricultural sector, and many people in both Africa and China see this as a place where the continent and the country can work together.

Finally there is also "agricultural substitution" driving this sector. As oil prices have gone up, agriculture has been increasingly used as a substitute, both in ethanol, and as a replacement for synthetics in fabrics. Agriculture is a far more renewable resource than most commodities, and has the biggest potential for long term gain.

Why this is a China story

There are two reasons why this is a China story more than it is a Monsanto, or Dupont, story. The first is the issue of cost. Monsanto has been credited (though they claim wrongly) with bringing up the price of inputs through aggressive patenting. In a developing market situation, and particularly in a country with poor IP protection that simply isn't going to fly. Monsanto has a tiered system which produces its products first for the US market, and secondly for the African market. China is specifically targeting a developing market. Their technology may not be nearly as good, but their speed and cost are much better.

Second is a question of market. The primary market for new agricultural goods in the coming years will be China, meaning that outside market participants need to deal with the Chinese tendency towards protectionism. I can think of few markets where governments are less active than agriculture, and I expect China to be no different. Then there is the differences in Chinese tastes - rice and soybeans have a different set of demands than wheat and tomatoes, and producers specifically focused on those areas will have a leg up. 

Last, Americans are not yet used to seeing Africa as a market, whereas China has for some time. Monsanto does not sell to the poor in Africa until they are ready to do it for no profit. China is looking for a profit in Africa, and in agriculture they are likely to find it. Which is enough to motivate 1000 budding Yuan Longpings.

Why Chinese agriculture is a good investment

Below is a quote from my interview with Jing Ulrich of JP Morgan (cover story in April), which I'm cutting because its somewhat tangental from the overall interview, but speaks to my specific interest. She notes quite interestingly that China's agricultural space competes with its residential space, which is very much not the case in the US.

The agriculture industry in China is of critical importance. We still have 700 million farmers, producing food sufficient to feed 1.3 billion people. 60% of the population is still in agriculture. In developed markets like the US, 2% of the population is in agriculture. So productivity needs to be substantially improved. And this is the government’s goal as well, you improve productivity in agriculture, you urbanize the farmers, put them into urban jobs, factories, industries, incomes will just go up substantially. But, I think overall, given China’s constraints – the landmass of the US and China is similar in size, but China is not as richly endowed as the US. China has huge mountains, and deserts, whereas the US is from sea to shining sea. While the US has a bread basket in the center, in the Midwest, that produces all the agriculture and produce that can feed not just the Midwest but [large parts of the world], in China, two-thirds is mountains, so you have industry and agriculture pretty much on the Eastern sea shore, and most of the people live in the eastern provinces, so you have huge competition for land. Agriculture, industry, whatever. That’s China’s big challenge, just because of the huge size of the population.

Interesting Sort-Of Fact of the Day

"One of my Russian pals says you can buy a mink fur coat here for half the price back home, cos the Chinese are farming minks, hence cheaper and surely bad for Russian fur coat industry!"

That's from Mark Godfrey, one of our regular freelancers, and one of those clever people who learned both Russian and Chinese. No real surprise here as factory farming of animals, particularly for fur, is something of a Chinese specialty. I just always find Russians in fur coats creepily fascinating.

What's the difference between FDI and Colonialism?

So I've been lazily visiting museums for the past few days, not much to blog about there, but if anyone is wondering what I'm actually working on that leads me to Europe, you can read here(PDF) a fairly good run down of the particular issue I'm most concerned with.

The short of it is, land acquisitions in Africa are often seen as straight forward colonialism, as can be seen in the Daewoo Madagascar deal (or here). But its relatively unclear what they did differently than numerous Chinese agricultural FDI projects, which by necessity involve some ownership of land. 

Africa vastly needs FDI, and agricultural FDI could both help the nations specialize and help them secure their own food resources, but agricultural investment is the most sensitive type of investment there is.

Africa and food security don't go together

Had a very productive meeting today with a Chinese person involved in African investment, and one of the more interesting on the record things that came out of it was the reaction he had towards Saudi Arabia's recent statement that it was investing in food production in Sudan for food security reasons.

China is investing heavily in agriculture in Africa, but according to this source and a few other articles that I've read, the general consensus in China is that Africa and Food security don't go together, and any attempts to secure land in Africa for your own country is "stupid."

You can see the reason with just common sense, besides the empirical observation that when South Korea bought out 1/2 of Madagascar's arable land it led to the overthrow of the Madagascar government, there is a 0% chance that in the case of a food shortage in Sudan (where I believe there is usually a food shortage), the country is going to peacefully allow its food to be exported with no profits to the country. According to my source Saudi Arabia thinks this is going to help them 20-30 years down the line, when Sudan's government will most likely not be as fantastically corrupt (how can it be worse).

The fact that my Chinese sources see the ridiculousness of food security investments is what makes me optimistic about the answer to the question I posed in the comments of yesterdays post. The best way to ensure food security is to establish food security for everyone, because only when yields are high will people trade. This seems to me to be the goal of most Chinese agriculture investments I've looked at...

but some people say that's the goal of the Saudi investment as well, so who really knows.