China's Natural Resource Strategy: Interview with Dr. Minxin Pei
China is one of the world's leading consumers and producers of natural resources. With so much of the world's supply and demand concentrated in one country, it is crucial to analyze both its natural resource strategy and the degree to which it has successfully used its natural resources for development. CID had the opportunity to speak with Dr. Minxin Pei, an expert on governance in China and Chinese political development, to discuss the most important trends in China's energy, agriculture, and mining industries.
Dr. Pei is the Director of the Keck Center for International and Strategic Studies at Claremont McKenna College, a non-resident senior fellow at the Asia Program at the German Marshall Fund of the United States, and a frequent contributor to publications including The New York Times, Foreign Policy, The China Quarterly, and China Today. His latest research focuses on corruption in Chinese politics. Dr. Pei received his PhD and MA in Political Science from Harvard University and a BA in English from The Shanghai International Studies University
CID: Dr. Pei, thank you for taking the time to speak with us. To begin with, What do you think the Chinese government’s push for a less direct role in macroeconomic management will have on the natural resource sector? Pei: The domestic natural resources in China are mostly controlled by the state. In the last 20 odd years, they have begun to liberalize the economy, but the progress is very uneven. The one effect that the government’s “changing” macroeconomic policy has on natural resource management, however, is on demand. So when the Chinese economy is growing slowly, the demand for natural resources is lower, and prices will fall. When the growth is much faster, the demand will be higher, and price will go up. But in terms of the structure of the natural resource market, you have to break it down. You have petroleum, crude oil, and natural gas production which are completely owned by the state, 100%. Then you have the coal industry which is more diverse: the biggest coal mining companies are state owned, but there are small and medium sized private firms. Then you have the mineral sector that produces both non-ferrous and base metals, like iron ore, that has both public and private enterprises.
CID: What is the biggest challenge facing China’s natural resource sector today? Pei: The real issue for China is that domestically it simply does not have enough natural resources. And within China, beside the lack of natural resources, there is also the issue of low productivity. Technologically, they can use better methods and gain foreign technical expertise, but the problem is on the economic side: state owned firms tend to me more inefficient than private ones. But the state doesn’t want to give up any ownership on these strategic sectors.
CID: As you mentioned, a freer market is often associated with more efficient natural resource development. In your opinion, what directive from Xi Jinping will prevail: a call for openness to foreign firms, or a call for stronger, better state-owned firms? Pei: I think foreign firms are not going to China for natural resources because the sector tends to be high cost. They can get much better deals in Southeast Asia and Africa, for example. Xi Jinping’s calls are mixed. You have to separate rhetoric from policy. With rhetoric he issued this call for openness several years ago, but the actual progress on the ground is very mixed—not much has changed at all. Agriculture CID: What do you think are the chances that the CPC will allow for more private collective agriculture in the name of improved efficiency and yields? Pei: The real difficulty is how to achieve scale in Chinese agriculture. The sector is currently fragmented and each household has a very small piece of land, which makes increasing productivity difficult. The challenge, then, is how to merge farms, and that requires quite radical reforms. My impression is that the government is still experimenting and there is a lot of resistance and fear that these new policies will create “landless peasants”
CID: Do you think that China’s current land system is a liability for its future development? Pei: The current system is clearly not efficient. But other than the land management issue, the farmers also have to deal with the environment in terms of environmental degradation. That is a serious issue.
Developing countries should not look to China as a model for sustainable agriculture. The model should be Taiwan. It is fascinating to see how Taiwan moved from low to high value agricultural production.
CID: China's latest 5-year energy plan calls for the growth and liberalization of the upstream fossil fuel industries. Do you think the Chinese government would ever grant mineral rights to private land owners to bring market forces into upstream unconventional energy development? Pei: I think for China it’s not just a property rights issue, but rather an issue of introducing more private actors into the sector. But there are real hard constraints. China’s geology, from what I have read, is very different compared to the United States. Its much more difficult to do shale oil and gas in China. Secondly, shale development is also constrained by water. It tends to be that where there are shale deposits in China, there is often no water.
So unless you solve these two problems, the sector wont develop. The geology increases costs and the lack of water would simply not allow any project to advance. When we talk about gas, China’s only viable option seems to be to import cheap gas from Russia.
CID: Do you think there’s merit to the argument that more private competition in the sector would lead to private firms solving these issues? I think there’s promise to that argument. CID: Continuing on the topic of upcoming reforms, several of the government’s goals call for increased international cooperation with the private sector. What should investors make of these plans and their chances of implementation? Pei: These cooperation contracts tend to be signed between the Chinese state and other states. Therefore, investors should be looking to deal with firms that can provide critical technology, not necessarily by getting in the upstream sector which will be controlled by the state, or the downstream sector which will likely be controlled by a Chinese firm.
Businesses that provide pipelines, technical services, pumps, pressure valves— those companies might benefit from China’s push to develop energy distribution infrastructure. If you want to use gas for heating, for example, you need to lay a lot of gas pipelines. That may be an opportunity for companies that build that equipment. Foreign firms will face competition from Chinese suppliers, however.
CID: Do you think China’s efforts to reduce coal consumption and increase renewable energy capacity are more in response to domestic or international pressure? Pei: I think it’s mostly domestic because of air pollution, but China’s signing of the Paris Climate Agreement should not be overlooked.
CID: China is rich in minerals and has attracted foreign investment to develop its mineral resources. Considering this fact, what role does China’s investments in other parts of the world, such as Africa, play in their development strategy? Pei: It’s a supply question. They don’t trust the spot market and want to depend more on long-term supply agreements. With market forces you pay more and there is a lot of volatility. They also believe that equity investment insures security. That is their thinking. So if they develop a mine in Africa, for example, they want some kind equity investment or a long-term agreement to secure that supply of resources.
CID: Do you think China’s foreign investments in natural resources is a good strategy for its development, or do you think it should be focusing more on its domestic resources? Pei: Well I think the simple math for China is that it doesn’t have enough stuff at home, so it has to go out. The key question then becomes, how do you secure access? Do you do it through the market, or do you do it through non-market means? China opted for the latter. There are clearly huge financial and political consequences to this strategy. So far, China has been ready to absorb these costs because this strategy also has non-monetary benefits: how does one value security? So far their model of long term contracts and equity investments to improve security has not been proven wrong, considering that there hasn’t been a resource supply shock. We will have to wait for a supply shock to see if China can successfully go to their partners and demand supply.
CID: One of your research focuses is corruption in China. What is the role of corruption in the Chinese natural resource sectors? Pei: It is one of the most corrupt sectors because natural resources have huge rents. In my book, China's Crony Capitalism, I talk about a lot of coal and metal mines and energy projects that have been mired with corruption problems. I think this is because they have all the right ingredients for corruption: they are state owned and thus the state can allocate natural resources, so if you have connections you can secure a lucrative project for almost nothing. The state can choose the winners and losers.
CID: Overall, what grade would you give the CPC in terms of its ability to use China’s resources for development? Pei: I would give them a B: they could do better, but they could certainly do much worse. So average.
CID: Where should China invest the revenue it gains from resource production? Pei: What is interesting about this question is that almost all of their resource revenues goes into production or consumption. Therefore, they do not look at natural resources from a financial perspective, but rather a purely supply and demand perspective. They are not stocking up natural gas and oil with the intention to flip the supply for profits later, for example. It is not a traditional model of a government collecting revenue on production, developing a surplus of revenue, and investing that surplus elsewhere.
CID: What would you say are the most important trends in Chinese political economy that will affect its management of its natural resources? Pei: I think the biggest trend will be if they switch from a consumption driven model to a more investment driven one, there will be a fall in demand for certain natural resources. There will be more demand for gas, less demand for oil, especially if the EV sector takes off. But I wouldn’t put my money in iron ore, for example, or steel. The demand for rare earth metals, however, should go up based on technological demands. It is all dependent on the structural changes in the Chinese economy. CID: That is all the time we have. Thank you for your insights! Pei: Thank you for having me!