Rich nations aren’t used to the dark side of globalisation. For them, the phenomenon tends to reduce costs, boosting corporate profits, securities markets and living standards. Recently, wealthy economies have gotten a taste of globalisation’s other side.
High-paying jobs are migrating to cheaper locales, while demand from developing nations is driving up commodity prices. Nowadays, the Group of Seven nations have little control over global trends. Things may be about to get worse, and Chinese pollution could be a catalyst.
As ’06 unfolds, global inflation could make an unexpectedly fast comeback. Surging prices for commodities from crude oil to copper to cocoa are one reason. Property booms from New York to Sydney are another. Yet pollution in China may put more upward pressure on prices than many investors anticipate.
“China has kept the global cost of production artificially low by not paying for pollution and labour benefits,” said Andy Xie, Hong Kong-based chief economist at Morgan Stanley. “The political pressure within China is as such that the government is normalising production costs, which could boost global inflation.”
It’s often thought that cheap labour is what draws executives to China. Yet, Xie argued, the mainland’s “lax environmental rules and their enforcement are not well understood and may have become more important than labour costs in attracting production relocation in the past three years.”
Pollution’s Costs: Since the early ’00s, multinational companies have contributed to China’s pollution to the detriment of its long-term outlook. Xie points out that China’s pollution is 12 times the world average per unit of gross domestic product.
Two-fifths of China’s seven major river basins are badly polluted, as are 90% of the rivers running through cities. Roughly 300m rural Chinese don’t have access to purified water.
Chinese pollution is becoming a problem for neighbouring economies, too. Increasingly, mainland factories are adding to local pollution in Hong Kong. Foul air cost Hong Kong $300m in medical bills and lost productivity last year — a 3.8% increase from 1995, according to the University of Hong Kong. The city may soon be counting the cost of lost talent and investment.
“The thing is, it’s just not possible for developing countries like China and India to pollute the way the West did when its economies rose,” said William Barron, an environmental economist and a visiting scholar at Hong Kong University of Science and Technology. “As politically incorrect as that sounds, I’m not sure our planet could handle it.”
Normalisation: In Beijing, Communist Party bigwigs are talking more and more about the environment. They’re realising pollution is a growing risk to the party’s credibility. It could just be the thing that pushes rural Chinese — the vast majority of the nation’s 1.3bn people — to turn on the government.
China is waking up to the need to normalise pollution costs. On May 15, the South China Morning Post reported that about 2,000 Hong Kong-owned factories operating in Southern China’s Pearl River Delta face closure or relocation because of pollution or environmental hazards they pose.
The paper also said that about 300 manufacturers of dangerous goods were notified earlier this year that their operating licenses would be renewed on a monthly basis until they agree to move to designated areas. Part of China’s push to promote sustainable development and cleaner production, the move — and others likely to follow — will be a major step toward accounting for production costs.
‘Regurgitated’: If China’s factories followed the environmental standards of Organisation for Economic Co-operation and Development countries, producing goods will be far more expensive. At the same time, China’s efforts to spread the benefits of 10% growth could result in higher wages nationally, increasing mainland export costs substantially.
“Normalisation of China’s production is a major source of cyclical inflation,” Xie said. “Part of the unsustainable disinflation globally between ’02 and ’05 has to be regurgitated.”
That poses risks for China. Will companies search for new economies in which to produce cheaply in developing Asia, former Soviet states or Africa? If foreign direct investment begins bypassing China, the world’s fastest-growing major economy loses a key pillar of support.
Another question is whether executives relying on China to pump up corporate profits are ready for the shift. Wal-Mart Stores, for example, may have some explaining to do to shareholders growing rich off low-cost China. Investors may be in for a shock, too. Central banks will have to adjust to Asia’s No 2 economy adding to global inflation, as opposed to restraining it.
Inflation Scare? The waning of the global labour arbitrage from rich economies to China could hit the Dow Jones Industrial Average, the Nikkei 225 Stock Average and other major equity markets. Ditto for world bond markets used to tame inflation.
It’s always been odd how the global liquidity boom of the past five years didn’t put strong upward pressure on wages. One explanation — the outsourcing of jobs to low-wage countries like China increased worker insecurity everywhere. Another — surging property prices and easy central bank policies around the world made it easier to maintain lifestyles with debt.
Rising Chinese wages could change everything. “While the central case is for inflation to tick up slowly,” Xie said, “the possibility exists for inflation to flare up sharply.”