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| Special Reports | Center News | China Events Vol. 4, No. 1, Winter 2005 | |||||
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ECONOMIC TRANSITION AND PRODUCT DEMAND PATTERN IN CHINA --Evidence from China’s Paper and Paperboard Industry by Haizheng Li ,Jifeng Luo & Patrick McCarthy (Continues from previous page) Interestingly, we find that the demand response to both domestic price and international price changes is statistically insignificant before 1993, indicating that Chinese consumers of paper and paperboard products, mostly industrial consumers, were not responsive to price changes. In the early stage of China's economic reforms, most firms were state owned, and thus had much weaker incentives to meet market criteria for continued operation. Moreover, in the early stages of economic reform, a dual pricing system existed for the same good, a market determined price and a price set by the planning system. State-owned enterprises (SOEs) usually enjoyed the privilege of paying for goods and services at planned prices, which were much lower than the corresponding market price. For these reasons, it is not surprising to find that, in the early stage of economic reform, the demand for paper and paperboard products was relatively insensitive to price changes. This situation has changed after 1993 and the demand becomes more sensitive to price changes. According to our study, after 1993, the own-price elasticity of demand is -0.69 and statistically significant (i.e., when domestic price increases by one percent, the demand for domestically made paper and paperboard products drops by 0.69 percent). The economic reforms forced SOEs to adopt more market oriented approaches and increasingly employ market-related criteria to evaluate the success of the enterprise. Eliminating the dual pricing system and growth of non-state owned sectors has contributed to the increasing price responsiveness. As China becomes more integrated into the world economy, the demand for domestic paper and paperboard products becomes subject to the vicissitudes of the international markets. Although insensitive to the international market in the early stages of economic reform, the demand of domestic paper and paperboard products does respond to international markets after 1993. The related price elasticity is 0.59 and statistically significant, suggesting that imports are a substitute for domestically made products. The response of import demand to changes in the international price is -0.60. This relatively inelastic response to price suggests that relatively few substitutes are available for imported paper and paperboard products as a whole. This observation is also confirmed by the insignificant cross-price elasticity. More specifically, the import demand does not seem to be affected by the domestic price, although the demand for domestic products is responsive to international price. Therefore, these results are consistent with the notion that imports are a substitute for domestically produced paper and paperboard products but that domestically produced products are not a substitute for imports. This result can almost certainly be attributed to quality differences. As the economic reforms deepened after 1993, the import demand response to international prices becomes even less price elastic (the difference of 0.10 percentage point is significant at the 10% level). One explanation is that as China’s ability to produce higher quality products has increased (for example, due to foreign direct investment; replacing small inefficient mills with state-of-the-art mills), its imports are increasingly targeted on some specific grades of products. Thus, demand becomes even less sensitive to price. If this is the case, we may expect that the income elasticity of imports for high quality imports will increase as the economic transition continues. Overall, as economic transformation progresses, the Chinese economy is becoming an increasingly market-oriented system. This is particularly evident from the increasing demand response to both domestic and international prices. However, there is a need for more research in order to discern the effects of other structural changes and of joining the WTO. DISTRESSED ASSET MARKETS IN CHINA: AN INTERVIEW WITH PHIL GROVES (Continues from previous page) PP: Where do you see the greatest opportunities in distressed assets and non-performing loans in the next two years? PG: The greatest opportunities will be the privatization of the thousands of SOE’s and the NPL’s currently still held by the banks (as opposed to the AMC’s). PP: What is the expected pace of the SOE privatization process? PGl: China is working hard at privatizing SOE’s now. In my opinion the next 2-3 years will be the “golden age” for investors. Since no new SOE’s are being created (unlike NPL’s) they are a scarce resource. PP: I understand that right now the banks are not allowed to sell their NPL’s. Is that correct, and if so, when do you expect this to change? PGl: You are correct that there has never been a direct bank sale of NPL’s due to regulatory and approval issues. Many distressed investors have been waiting for the first bank NPL for some time. I expect it to happen in 2005, but the timing is uncertain. PP: What are the greatest risks and challenges in working in this sector? PG: The greatest challenge is establishing an on the ground team that can successfully acquire and profit from distressed assets and debt. It is a long and arduous process that requires infinite patience. The greatest risk, in my opinion, is the uncertainty of the laws that impact distressed investing in China. The laws and regulations in this area are not clear and not well established. Thus, there is uncertainty that makes long term planning difficult. PP: Mr. Groves, thank you very much for talking with us.
Phil Groves' contact information:
President, DAC Management, LLC 200 South Wacker Drive, 31st Floor Chicago, IL 60606
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