Global industrial production and what it means for mining, Part 1

The focus of most analysis of the world economy continues to be the “developed” countries, and understandably so. These countries, commonly represented by the Organization for Economic Co-operation and Development (OECD), still account for three-quarters of the world’s gross domestic product, as conventionally measured. Also, their demand for goods and services is the key driver of world trade, and their banks and stock markets are the principal source of the world’s capital.

Accordingly, their performance remains critical for the metals and mining industries. However, from the perspective of future demand for metals and minerals, the so-called “developing” countries, which represent a quarter of the world’s economy, are more interesting. For a start, these economies have been growing much faster than the developed countries. Furthermore, many of these countries are going through a phase of growth that is materials-intensive. This tends to occur in areas where annual income rises towards US$10,000 per person. Across developing countries as a whole, a percentage growth in GDP is typically twice as materials-intensive as a percentage growth in GDP in developed countries.

These growth patterns reflect several distinct influences. One is the emphasis given by countries to material-intensive infrastructure and construction spending during the early stages of their industrialization. Roads, bridges, ports, power stations and power distribution systems are voracious users of mineral raw materials, as is the construction of housing for a rapidly urbanizing population. A second factor is related to the increase in private incomes and the uses to which that income is put. Typically in developing countries, food and drink account for more than half of all expenditures; in the developed world, it is generally under a fifth. As incomes rise, and consumers are freed from a preoccupation with basic necessities, there occurs a disproportionate growth in discretionary spending and in demand for consumer durables.

In the case of incomes that exceed US$5,000 a head, typically more than half of any increase in income goes to discretionary spending. Asia (excluding Japan) has a population of some 225 million who fall into this category. These rising incomes, combined with demographic factors, are going to push huge numbers of people into the high-discretionary spending bracket over the course of the next 20 years.

The third influence on metal and mineral demand is the level and location of global industrial production. In the developed countries, industrial production has been growing more slowly than GDP, meaning that the share of industrial production in GDP has been shrinking. This has been particularly evident over the past two years. While OECD GDP grew 2.75% between 2000 and 2002, industrial production in these countries declined 3.7%. By contrast, in many developing countries, industrial production has been growing faster than GDP. Nowhere is this more so than in China, where, since 1990, GDP has averaged 9.7% a year growth while industrial production growth has averaged 13%. The result of the continuing liberalization of markets for capital and goods has been a tectonic shift in the location of global industrial production.

The centre of gravity of this production is moving eastwards, and this has significant implications for world markets, including mining.

In China, over the past decade, more than two-thirds of the growth in demand has come from the developing world. China may account for only 4% of the world economy, as conventionally measured, but the country has grown to account for around 16% of the world’s metal use. To a significant extent, this reflects the ongoing shift in the location of industrial production. To put some numbers on these things, China’s industrial production is now the fourth largest in the world after the U.S., Japan and Germany. It produces more than 20% of the world’s refrigerators, 30% of all air-conditioners and televisions, and 70% of all metal cigarette lighters. Moreover, it is rapidly moving upmarket into such products as laptops and digital video discs.

The factors driving this are not hard to find. Labour costs in developing countries are a small fraction of those in the developing world. In China, they are around one-twentieth of what they are in Japan. This is proving irresistible to Western companies with labour-intensive production chains looking to drive down costs.

But important as growing volumes of demand for metals and minerals are, they are not the whole story.

The high cost of labour relative to that of capital, combined with the perceived benefits of technical scale, has led Western miners and manufacturers to focus their production increasingly on larger and larger operations, and indeed to combine their production units into larger and larger companies. Until relatively recently, there was widespread presumption that growth in China and in Asia would follow a similar path. Clearly it has not: much of the growth is coming from small-scale operations.

There are various reasons for this. First, differences in relative factor costs point to different production solutions. Where labour is low-cost, it makes less sense to opt for capital-intensive production. Second, not all production technologies necessarily bring with them significant economies of scale. With a modularized technology such as aluminum smelting, a potline of five pots is not technically less efficient than one of 50. Economies of scale may arise in other factors, such as the permitting process, managerial efficiencies, or the availability of competitive supply contracts. Then again, these factors may not be so pertinent in a loosely regulated, low-wage, geographically dispersed economic context. Finally, cultural factors in Asia frequently tend to favour the creation and management of smaller, family-directed businesses based on personal contacts over larger legalistic forms of corporation and business relationships employed by Western producers.

Whatever the reasons, one of the characteristics of China’s demand growth for metals, minerals and their raw materials from fabricators and smelters is that it has often come from a large number of small-scale producers rather, as opposed to a few large ones. Nearly all the growth in iron ore demand last year came from smaller, provincial blast furnaces rather than from the four large integrated national steel mills. In time, there may be some rationalization among the smaller players, but in the meantime, the fragmented nature of demand and the informal nature of the customer base will pose major challenges for the marketing practices of mining and metals companies.

— The preceding is an edited version of a report published by London-based Rio Tinto in early May. The author is the company’s chief economist.