China and Energy

China’s government is having a hard time regulating an economy…

The Wall Street Journal had two articles on December 27 about China and sections of its economy. One, entitled “China Urges Auto Makers to Limit Their Expansion”, addresses the tremendous rate at which China is manufacturing cars and, more importantly, the idea that new production capacity coming online might outstrip even the incredible demand. The second article, entitled “Illegal Power Plants, Coal Mines in China Pose Challenge for Beijing” discusses the hunger for energy that the Chinese economy is experiencing and how that demand creates incentives for local governments to rebel against Beijing’s direction.

The two articles imply a few things in common. China’s government is having a hard time regulating an economy that has averaged GDP growth of more than 10% for over two decades. As the population becomes wealthier, demand for goods increases. This is an obvious comment, but it’s only the first order effect. Once that demand is fulfilled, many of those goods require ongoing consumption of energy. New cars require petroleum products, air conditioners required electricity, not to mention that the production process itself requires energy. That might still be obvious, but that could be considered the second order effects.

The real issue is that the third order effects are very significant as well. As a country’s population becomes wealthier, and the income levels are sustained for a period of time, the residents may become more confident that it will continue. Savings levels decrease, increasing consumption, but allowing less money for industrial investment. The expectation from this is further inflationary pressure. If this pressure eventually releases by slowing the economy and the current investment levels cause capacity to indeed outstrip demand, a recession could easily result. (See Housing Starts).

…global energy production cannot possibly keep up

The two articles differ in a couple of their implications as well. Specifically, the article on energy brings a sobering thought to global energy production. As China’s people increase their need for ongoing energy consumption, global energy production can not possibly keep up. China could not consume at the rate Americans do because production levels could not be increased to those levels with any foreseeable technology. Sooner or later, that demand must have an impact on global energy prices. Western countries have no inalienable rights to energy. Eventually, the markets will determine who wants the energy more. Are the Chinese going to be willing to pay more than Westerners for their heat and their cars? But it doesn’t stop there. Who will be willing to pay for the energy of production and industry? This should be yet another inflationary pressure, but this one will not be localized to China.

It is possible that the Chinese government sees all of these things and is trying to reduce the rate of growth of auto manufacturing not because it is outstripping demand, but because of the implications if production capacity growth is not slowed. If China can reduce the growth, the price of cars will increase for Chinese, making sales growth slow. This would have the effect of slowing the growth in energy demands, pollution, and a major problem for the Chinese and many others, traffic.