Explaining why China's industrial structure is transforming with the factor endowment theory

China's economy has reached a crossroads. As economic conditions continue to evolve, the 30 years of rapid development is gradually reaching its limits in some areas. The shrinking of the demographic dividend, higher labor costs, environmental issues, and the maturing of many industries are all breeding a structural transformation of industry, which has recently become more inevitable. This trend is particularly evident in the chemical industry.

Will the world economy or national factors affect the transformation of China's industrial structure? China's economic growth rate has declined significantly in 2012. Gross domestic product (GDP) grew by 7.8 percent in the first six months of 2012, and did not increase much more in the second half of 2012. Foreign investment remains the main driver, with foreign investment accounting for almost 50% of GDP in 2011. Now that there are signs of overcapacity in certain sectors (e.g. the solar sector), the government is responding with measures to increase private purchasing power and exports have slowed considerably. In a report released in early October 2012, the Asian Development Bank (ADB) predicted that China's sound government finances and the government's stimulus measures will keep the country relatively stable despite the choppy world economy.

The transition from an investment economy to a consumer economy is reflected in various aspects such as higher wages. According to a study conducted by the Boston Consulting Group, China has lost its advantage in labor costs in many areas as wages have increased about 16 percent a year over the past 10 years. In addition, social factors also play a role as incomes rise and domestic demand increases. An aging population and growing affluence have stimulated growth in the healthcare sector, which is growing at an annual rate of around 20%. In addition to nursing homes and hospitals, pharmaceutical and medical device companies have found this sector to be a lucrative market.

The Chinese government's policy goal is to transform the country from a manufacturing center to a hub of high technology and innovation. "The 12th Five-Year Plan identifies seven key areas, including energy conservation and environmental protection, alternative energy, alternative propulsion technologies, new materials, high-end production, new information technology and biotechnology.

Energy trends

Demand for raw materials remains high in China. The International Energy Agency (IEA) estimates that China currently requires about 9.7 million barrels of oil per day and is highly dependent on imports, especially oil and natural gas. Domestic oil production is 204 million t, while imported oil is 5 million t. Therefore, the efficient utilization of resources is highly valued. The chemical industry, which uses coal as its main energy source and resource, has become interested in shale gas after reports about successful shale gas production in the United States. However, China's shale gas is buried deep and the areas with abundant shale gas reserves are remote. China does not yet have mature shale gas production technology. Some multinational companies are now trying to form joint ventures with the Chinese government to produce shale gas.

China is also boosting renewable energy production, with the share of non-fossil energy in primary energy consumption expected to rise to 11.4 percent by 2015. 604 billion euros are being invested in power generation capacity and grids. Non-fossil energy sources include hydropower, wind power, solar power, bioenergy and nuclear power. Although energy consumption per capita is much lower than in the United States and Germany, China is the world's largest energy consumer. In addition to building new nuclear power plants and doubling wind power capacity, the Chinese government is supporting the solar power industry. This policy is not entirely altruistic; given the downturn in the international solar market, the survival of the domestic solar power industry can only depend on stronger domestic demand. The domestic power grid is expanding. Government policy favors support for smart grid solutions, and a number of pioneering projects are being implemented that are the result of domestic research and development.

Bioenergy has attracted a lot of attention in the past as a new source of energy, but its availability has been limited. As the environment changes and urbanization advances, land loss has shifted the focus of agricultural production to the supply of sustainable food. Only liquid livestock manure and agricultural residues are available for biogas production. By 2015, sufficient quantities of bio-based raw materials must be available to support the regular production of 70,000 small and 8,000 large biogas production plants. China's farmers reportedly accumulate as much as 700 million tons of straw in their rice paddies each year, and burn as much as 150 million tons directly in their paddies.

Bio-gasoline will also play a major role in the automotive sector, where the country is trying to develop electric vehicles. "The 12th Five-Year Plan states that bioethanol consumption will double by 2015 compared with the previous five-year plan. Currently, bioethanol consumption is around 170 million tons.

Trends in the chemical industry

The chemical industry is China's third largest industry after textile and machinery manufacturing. The chemical industry is able to contribute 10% of GDP and China is the second largest consumer of basic chemicals after the United States. The growth rate slowed down in 2012 due to the development of the world economy, however, the growth is still very impressive. According to figures released by Germany's Federal Agency for Trade and Investment, production in China's chemical industry grew by 32.3 percent year-on-year, exports by 31.1 percent and imports by 21.1 percent.

China's chemical industry structure is vastly different from that of Western industrialized countries. More than 3,300 companies in China are active in the chemical industry, according to a KPMG report. According to a related industry analysis in September 2011, the 10 largest companies in China's chemical industry totaled 21 percent of the market. In contrast, the five largest companies in Japan have a 39% market share, while the five largest companies in Germany have a 67% market share. Due to the highly fragmented nature of China's chemical companies, many of which are not profitable, there is a lack of integrated management at all stages of value-added and material flows.

Chinese chemical companies should therefore merge and reorganize. The steel, cement and coal industries have proven that such mergers and reorganizations can be carried out quickly. In addition, since September 2011, projects involving the production or storage of hazardous substances can only be approved within industrial parks. This will facilitate the further concentration of chemical plants within industrial parks.

Foreign experts point out that there is an unequal distribution of resources between state-owned and private companies and foreign companies in China. According to AT Kearney, the unequal distribution is mainly in raw materials and low-cost loans. Domestic companies have a shorter approval process than foreign companies. In addition, the Chinese government encourages state-owned enterprises to invest abroad and conduct mergers and acquisitions.

So far, the chemical industry is mainly concentrated in coastal and eastern China. To address the imbalance in domestic economic development, the Chinese government has encouraged investment in the west, and the incentives have triggered a "gold rush". Although growth in the coastal areas has largely stagnated, there are still enough cheap labor resources to be found in places like Chongqing and Chengdu. The Chinese government has also introduced tax incentives to encourage companies to set up factories in the central and western regions.

China is expanding its downstream petrochemical production capacity, for example by investing heavily in clean coal technology. Multinational companies are showing strong interest, such as Dow Chemical, which is investing in a $10 billion project with Shenhua in Yulin, and Celanese, which plans to build one or more coal-to-ethanol plants using a new process.

Changes are not limited to the raw material mix, but also in the product mix. Figures released by China's National Bureau of Statistics show that the specialty chemicals sector is growing at roughly more than three times the average rate for the industry as a whole. However, this has come under heightened scrutiny, as the development goals for the specialty chemicals industry have been specified in the Further Development Plan. Demand for new materials for consumer goods is driving the industry, and the Chinese government hopes that modernization of the industry will improve environmental protection and lead to sustainable development.

Sustainable development and environmental considerations have become extremely important in China. "The 12th Five-Year Plan proposes a 16% reduction in energy consumption by 2015, a 45% reduction in carbon dioxide emissions by 2020, reductions in SOx and NOx emissions, efforts to eradicate water pollution, and a reforestation program are all major items on the policy agenda. The Chinese government has already invested around USD 500 million to accomplish these goals. As a result, the outlook for the environmental technology market is bright, with an average annual growth rate expected to be 15-20 percent.

Water Conservation Projects

Solving water resource issues is also a current priority for China. A combination of desalination plants and a major south-to-north water transfer project will provide water to the drought-stricken northeast. But it's not just the availability of water that's causing concern; water quality needs to be addressed as well. China's Ministry of Land and Resources rates 57% of the country's water supply as poor or very poor, and improving water quality will require major investments. China Water Network points out that the Chinese government will invest approximately $420 billion in water quality improvement projects within the current five-year plan. This creates opportunities for German suppliers, whose exports of pumps, valves, fittings and analytical equipment to China grew significantly in 2011. Exports of filtration and water purification equipment, on the other hand, declined, but demand for equipment accessories grew.

Summary

China's industry is in a state of transition, and as the situation evolves, foreign companies will have to adapt to it. However, new developments will create more opportunities for investors and suppliers.