The China factor: the already considerable growth of the Chinese economy may just be starting. (Commodity Focus).

China will become the leading economic force in Asia. China is the only country whose economy is set to grow 7 to 9 percent annually. The nation currently has a total population of 1.3 billion people, or 21 percent of the world population.

China is becoming a manufacturing superpower. Recently, Intel Corp. invested $100 million in Shanghai to assemble Pentium 4 microprocessors. Dell Computers moved its giant PC making operation from Kuala Lumpur, Malaysia, to Xiamen, China, and Cisco Systems closed its manufacturing facilities in Mexico and moved to China.

Why are these multi-nationals all going to China? Because of low wages, higher productivity, an educated work force and a manufacturing infrastructure that provides numerous advantages that no other countries can compete against.

GROWTH FACTORS

China is not just an export platform; its large and expanding domestic market is another major attraction. China is experiencing a consumer revolution. Middle class citizens are buying houses and cars. The demand for cars in China is reshaping the entire global auto industry. GM, VW and Toyota all have multi-billion dollar joint ventures in various parts of China.

To complement this consumer trend, government is embracing radical reforms in the banking system. In the consumer sector, government is restructuring the banking system to support and stimulate consumer spending. Foreign banks will be allowed to open 100 percent foreign owned branches, and they will be allowed to provide financial services to the individual.

Foreign banks will be lending to individuals through car loans, credit cards and mortgages. One of my colleagues in China recently bought a house in Shanghai. During my last visit he said to me, "Jimmy, five years ago when I started working with you, I never dreamed of owning my own home." Today he is the proud owner of a $70,000 apartment. He put $10,000 down and is canting a 20-year mortgage with the Construction Bank of China.

On the commercial side, the nation is embracing reforms between government and business and cracking down on corruption, especially involving state enterprises and banks. China's reform measures in a way resemble the changes that South Korea took as it resurrected itself out of its 1998 economic collapse.

It is getting more and more difficult for Chinese state banks to lend money based on personal relationships. China has accumulated massive bad debt because of this relationship lending. The country eventually must write off bad debts and re-establish clean banks and competitive companies. In this state of globalization, only competitive and profitable companies will survive.

Many traditional industries such as power, electricity and communications long have been dominated by state-owned monopolies. That is slowly changing. Recently the government broke up the country's dominant telecommunications provider, China Telecom, into two separate companies to promote market competition.

Among developing nations, China is the largest recipient of foreign investment, averaging about $40 billion per year during the late 1990s. Membership in the World Trade Organization will result in even higher levels. Analysts predict China will receive $45 billion annually for the next 10 years. Part of the growing foreign investment is driven by global CEOs' obsession with lower production costs to stay competitive.

China is opening up its long protected markets to foreign competition. At the end of 2001 it was formally accepted as a member of the World Trade Organization, or WTO. This was a big step in opening its doors to the outside world.

Immediately, China dropped its import duties in many long protected industries. By 2005 it is scheduled to eliminate almost all import quotas and discrimination against foreign companies. The government has made many promises to the WTO, and so far it has been ahead of schedule in implementing them. Analysts predict WTO membership alone will contribute 0.5 percent to China's annual CDP growth.

THE CHALLENGES

As China's market reforms took hold, unemployment escalated. It is extremely difficult to get an official unemployment number, but many analysts estimate the rate may be around 15 percent.

The pattern of factory shutdowns and layoffs will accelerate now that China is a member of the WTO. No country in the world has ever cut so many jobs in such little time. The threat of social instability exists. Just imagine 15 percent of 1.3 billion people who are jobless or hungry. That can be very dangerous. However, China must accept the pains accompanying reforms. It must endure until the structural changes are complete. This will be the number one challenge for the next generation of leaders.

As China becomes this manufacturing superpower, is the world economy becoming so dependent on China that it soon will become vulnerable to a major supply disruption caused by social unrest or natural disaster? Will China's position in global manufacturing resemble the Middle East position in the world oil markets? Should the U.S. and other countries diversify their manufacturing positions into other countries? Are they putting all their eggs in one basket?

Additionally, will China's economic rise fuel its growing military and regional ambitions? Will it become hostile to other surrounding countries? That will be one of the challenges to U.S. foreign policy.

PUTTING IT DOWN ON PAPER

In 2001, United States' average per capita paper consumption was 364 pounds, Japan's was 274 pounds, Europe's was 137 pounds and China's average was at 31 pounds.

China's overall paper consumption in 2001 increased to 36.8 million tons, making China the second largest consuming country by volume. China's per capita consumption last year was 31 pounds, about half the world average and an indication of the country's future growth potential. By 2015, China's demand for paper and board will reach 75 million to 80 million tons per year, which equates to 61 pounds per capita paper consumption. From 2001 to 2005, 14 million tons of new paper making capacity are projected to be added.

Two promising grades in China that are affecting scrap paper consumption are corrugated and newsprint capacity. In the packaging grades, demand for corrugated containers is expected to rise 8 percent per year. Containerboard demand is expected to reach 7.8 million tons by 2005, and corrugated medium is expected to reach 9.8 million tons by 2005.

In the past two years alone, 1.6 million tons of capacity was added to the market. China will account for 60 percent of the boxboard demand growth in Asia through 2004. Strong growth in manufacturing and a robust economy is driving healthy demand.

China's newsprint demand is projected to grow 7 percent annually, which is fairly consistent with the country's GDP growth. In 2001 China's domestic newsprint capacity reached 1.5 million tons with 500,000 tons of new capacity. Another 690,000 tons is projected to come online this year.

One of the factors contributing to this massive growth is China's media liberalization. In 1980 there were less than 200 newspaper publications, but today there are more than 2,000 newspapers in China. Relaxation of media control has allowed many newspapers to flourish, particularly in sports and finance.

In the past, China has protected its domestic newsprint industry by imposing high import duties on foreign newsprint. However, after WTO, duties for import newsprint will be lowered, thus bringing in foreign competition. In anticipation of future competition, the Chinese government is promoting domestic production by subsidizing and offering tax incentives to domestic newsprint producers.

THE NEED FOR SCRAP PAPER

In 1999, the U.S. recovered 45 million tons of scrap paper, with 36 million tons consumed domestically in the U.S., 4 million tons exported to Asia, 2.1 million tons going to Canada, and about 1 million tons exported to Mexico. Just 0.1 million tons were exported to Europe.

China Customs provided numbers for China's annual recovered paper imports from all countires for the last four years. In 1999, 2.5 million tons; in 2000, 3.7 million tons; and in 2001, 6.4 million tons were imported. Based on 2002 first quarter statistics, the total is estimated to reach 7.8 million tons.

By 2006 China is projected to import 15 million tons of recovered paper per year. Increases will come primarily from the U.S., Europe and Japan. Many new paper machines coming online in China are scrap-based units, and new projects are projected to add 6.7 million tons of recycling capacity by 2005.

Specifically from the U.S., scrap paper exports to China in 1999 were 1.2 million tons. This increased in 2000 to 2.6 million tons, and then to 4 million tons in 2001. This year the total is projected to reach 5 million tons.

China itself is already the world's third largest consumer of recovered fiber, behind the U.S. and Japan. In the past two years China was the largest wastepaper importer in the world.

Western Europe and Japan have changed from being net importers of recovered paper to becoming a significant exporter.

It is forecast that China will account for 60 percent of the boxboard demand growth (2.2 million tons) in Asia through 2004.

ADDITIONAL ISSUES

Will scrap paper brokers be able to take advantage of all of this exporting opportunity, or will technology link buyers more directly to sellers? Export brokers always will be around because we provide some true value in the following areas: logistics, banking, consolidation, pricing and risk management. The job of brokers is to provide services along the paper mill's supply chain. We take the risk of working with overseas buyers.

Where will all the needed paper come from? Municipalities are promoting single stream recycling programs, with most of California already being single stream. Studies have shown that people tend to recycle more when collection is single stream. It's the convenience of one bin instead of three. The growth in collection activity in the key regions has brought about deterioration in recovered fiber quality. Paper and board manufacturers have to look for new recovered paper processing technology in order to maintain the use of their raw materials. Many producers also are being forced to mix in higher amounts of virgin fiber pulp into their furnish.

In the short-term, how would a labor strike at Pacific Coast ports affect the market? The International Longshoremen and Warehouse Union (ILWU) is one of the nation's strongest labor organizations and Pacific Maritime Association is a powerful group of shipping carriers and cargo distributors. These two groups have a dispute over wages and technology implementation. PMA is looking to implement new technology to improve efficiency in the ports. Trade is expected to double in the next 10 years, and productivity at the ports is a major concern. Labor unions are reluctant to accept it because of potential job losses. The ILWU claims the shippers want to weaken the union, which provides some of the highest wages and benefits in the nation.

Will tariffs cause trade disruption? China, like other countries, was upset with the U.S. when it imposed a 30 percent tariff on certain imported steel products. It has been threatening to retaliate by imposing a 24 percent tariff on scrap paper. According to WTO rules, China must go through the proper procedure and file a complaint with the WTO. It will be a long process before a decision is made. In addition, a tariff tends to fall most heavily on the side of the market that can least escape it.

In other words, if the Chinese buyers have no substitute products to which they are prepared to turn, then the lion's share of the tax will be passed on by them to the suppliers. And if suppliers have no alternative other than going on to supplying a product, most of the burden of a tax will fall on them. Alter WTO, import duties for foreign paper products are being reduced, which means tougher competition for local producers. Imposing a 24 percent duty on their raw materials would leave local producers in an uncompetitive situation.

Exported U.S. Forest Products

(Twenty-foot equivalent unit containers shipped overseas in 2001)

America Chung Nam Inc., Pomona, Calif.             153,900 TEUs
Weyerhaeuser Co., Federal Way, Wash.                97,000 TEUs
International Paper Co., Stamford, Conn.            70,000 TEUs
MeadWestvaco, Stamford, Conn.                       58,000 TEUs
Potential Industries Inc., Wilmington, Calif.       54,000 TEUs
CellMark Pulp & Paper Inc., Corte Madera, Calif.    48,000 TEUs
Georgia-Pacific Group, Atlanta                      44,000 TEUs
Buckeye Technologies Inc., Memphis, Tenn.           35,000 TEUs

STILL SHIPPING

West Coast ports remain open in early August, but labor-management negotiations continue. Read updates as they occur at www.RecyclingToday.com.

The author presented his remarks at the Paper Recycling Conference and Trade Show in New Orleans this June. He is president of Bayside International Industries in Buena Park, Calif. He can be e-mailed at jyang&baysideintl.com.