3.2 China's commodity imports will continue to rise

Continuing growth in incomes in China, along with an accompanying rise in demand for protein and a movement towards more westernised diets, will result in growing agricultural imports. This was the experience of Korea over its period of expansion beginning with a level of per capita GDP similar to China's currently (Figure 5.1).

Demand for agricultural commodity imports will also be boosted by a low amount of water resources relative to China's population. The availability of freshwater resources in China is only around one-third of the global average on a per capita basis and is well below the average of low income countries (Figure 5.2). The water that China does have is unevenly distributed with Northern China having 47% of the country's population but only 20% of the water available. This shortage of water will be intensified as growing incomes bring an increase in domestic use of water, with households currently using only 7% of water. Increasing water use is encouraged by the low price of only about a third of the international average.[40] In addition, farmers are not encouraged to used water efficiently as they are often charged by the area they irrigate rather than the amount of water used, which further intensifies the shortage.

Figure 5 – Indicators of agricultural imports

Figure 5.1:  Agricultural imports and GDP per capita - China and Korea

Sources: WTO, World Bank

Figure 5 – Indicators of agricultural imports (continued)

Figure 5.2:  China's freshwater resources

Source: World Bank

There is also a shortage of arable land, with China having only 0.08 hectares per person compared to the world average of 0.20 hectares per person (World Bank, 2013).[41] This is very low compared to high income countries (0.32) and still low compared to low and middle income countries (0.18). The amount of arable land available has been shrinking over time as urbanisation and industrialisation have resulted in land being procured for other uses. Around 37% of Chinese land is degraded and unable to be used for farming. Desertification (the erosion of fertile land) is one of the biggest challenges facing China. In China, 20.2 million acres of arable land have been lost owing to wind and water erosion, urbanisation, industrialisation and natural disasters (United Nations, 2010).

Of the available arable land, nearly 20% is thought to be affected by pollution to some extent, which will make the land less useful or require expenditure to bring it up to standard. This shortage of arable land will restrict the domestic supply response to growing agricultural demand and will make it harder to produce the agricultural products required to feed China's large population. Furthermore, land is owned centrally and allocated to households by village leaders who change frequently. This means that farmers and leaders do not have much incentive to farm land in a sustainable way. In addition, land is often allocated to a household in multiple blocks, rather than as a single patch of land, which increases production costs and makes production less efficient.

Furthermore, with continued urbanisation the availability of rural labour to produce agricultural products is diminishing. The UN projects that a further 100 million people will move from rural China to cities by 2022, which will limit the number of people available to work on farms. This shortage of labour, along with the shortages of land and water will likely result in a domestic production shortfall, with the deficit required to be met by agricultural imports. The OECD-FAO expects China's agricultural production to grow at 1.7% per annum between 2013 and 2022, which is not sufficient to keep up with consumption growth of 1.9% (OECD, 2013).

There are concerns about the quality of locally produced food, especially milk, which was highlighted by the melamine scandal in 2008. In the Chinese domestic production chain, products from different producers are often aggregated together and marketed as a single product. Counterfeiting and mislabelling are common. As a result of these factors, any investment in quality control adds little value to producers as they do not gain much reputational advantage and poor quality products from other producers could be attributed to them. The production chain in China is segmented, making it difficult to establish where the quality standards were infringed and enforcement of standards can be lacking. Chinese producers will have to work hard to gain back the trust of local consumers and until this occurs, the concern about the ability of local Chinese companies to set up safe supply chains will remain.

The concerns around food quality apply especially to baby milk formula. According to the UN, China has 82 million children under five years old and only 28% are breastfed, meaning there is a huge potential market. Over the past six years the Chinese baby formula market has tripled to US$12.5 billion and Euromonitor expects it to double to US$25 billion over the next four years (Financial Times, 2013). As a result of the melamine scandal, much of this growth will be sourced through imports, including New Zealand products which can be imported tariff-free.

These quality concerns should increase the demand for agricultural products from countries known for their quality, including New Zealand. China currently sources around 90% of its milk from local production, leaving scope for further expansion in dairy exports from New Zealand and for New Zealand processors to set up farms and manufacturing plants in China to meet China's growing dairy needs. Fonterra is planning to set up a cluster of four to six farms in Hebei with up to 30,000 cows to have direct access to the Chinese dairy market. Chinese groups have also invested in dairy farms in New Zealand, including the Shanghai Pengxin investment group buying 16 farms for NZ$200 million. Investment links between the two countries will help to develop trade. In addition, the Renminbi has appreciated and is expected to continue appreciating, especially in real terms, making domestic production less competitive and imported agricultural products more attractive.

As Chinese incomes rise, consumers are likely to demand higher value food products. This gives New Zealand an opportunity to focus on exporting food products with higher value added, rather than the commodities that have dominated trade. If exporters can add more value to the products before they are exported, the benefit to New Zealand from Chinese demand will be even greater. New Zealand could leverage off its image of producing high quality, safe food products to promote these products in China.

While it is expected that consumption will gradually take over from investment as a driver of growth in China, it still requires significant amounts of investment to support its growing urban population. For example it is estimated that 350 million people will be added to the urban population over the next 20 yearsand the high speed rail network will increase from its current 10,000kms to 50,000kms by 2020 (World Bank, 2012b). These types of developments will continue to support demand for hard commodities, even if at a slower growth rate than in the past decade.