August 30, 2012

Hukou Reform is a key part of China's Future Urbanization and Economic Growth

Goldman Sachs has a 32 page report Hukou reform: a mid to long term goal, picking up pace (Feb 2011)

Migrant workers make about twice as much as people in the rural areas but only about half as much as city dwellers with full Hukou rights.

Summarizing - Urbanization will happen in China. There are economic benefits to having more urban people as they are about 3-4 times more economically productive. It will require further modernization agriculture and it will require each local area in China to develop a plan and social safety net and infrastructure to support the urbanization. It will cost about US$7000 per person over 10-15 years to enable the system for each person that is fully brought into the cities. The cost will increase over time as other costs increase and the economy develops.

Goldman Sachs Expectation on Hukou Reform

We believe that hukou reform progress will accelerate but vary by location. Given China’s size and diversity in relevant aspects (demographics, economic development, urbanization stage, etc), the need for reforms and capacity to fund reforms vary significantly. We believe that some key determining factors include:

* Urbanization need and talent demand: Some already quite urbanized areas have less need to retain or attract new talent (migrant workers, university graduates).

* Existing infrastructure readiness: Some areas have already prepared for a greater influx of population in their past urban planning, while others may lack the schools, hospitals, roads, housing etc to relax hukou requirements. Most first tier cities, for example, are already quite congested in terms of such resources and infrastructure.

* Financial capability to fund migrations and future infrastructure investment:

Hukou migration should be viewed as a city’s investment into its future – that it can bring a myriad of benefits over time (as aforementioned), but with significant upfront (and ongoing) costs to the local government as well as local enterprises. Overall, we believe that western/central provinces and third or fourth tier cities may be the key candidates in terms of urbanization need, talent demand and infrastructure readiness. However, individual cases will vary because the third factor, financial capability, may be lacking in certain areas. Cities like Chengdu and Chongqing are in the ‘sweet spot’ of hukou reform progress because they possess the motivation and the capability.

The Financial Times highlights a paper which indicates that lack of hukou reform will prevent urbanization from driving future higher GDP growth rates in China.





We believe hukou reform will affect three types of companies: 1) improving social benefits / safety nets will increase consumption and demand for services (healthcare, education, trading up, tourism, etc); 2) infrastructure investment will need to keep pace with population inflow and urbanization (machinery; commodities; property); 3) a smaller farming labor pool will mean greater demand for agricultural yield improvement (machinery, fertilizers, etc.).

Theme one: Improving social benefits equals more consumption; especially of services

We believe the overall improvement of social safety nets and benefits for a larger population in China will drive demand for a) safety net related products (healthcare/drugs, education/books products, etc.); b) more discretionary forms of consumption as income is freed up and a better sense of social welfare boosts purchasing confidence; c) service oriented industries in general as urbanization accelerates. Coming back to the earlier examples regarding healthcare and education behavior, hukou reform may drive consumption changes:

* Education: According to ifeng.com news, only 20% of migrant workers’ children are currently living with them in urban areas, while the rest remain in the villages back home. An equalization of benefits for migrant workers’ children would bring significant education opportunities to the cities where incremental demand for books, tutoring, etc may become more apparent.

* Healthcare: Similarly, as more migrant workers get urban hukou, they will be able to be covered under the urban national healthcare plan. This means the contributions
made by the government and their employers on their behalf will rise significantly, and they will no longer need to travel back to their home villages for medical treatment. As a result, consumption of drugs (on the essential drug list) should rise in volume particularly for the more ‘common’ ailments ie non-major problems.

The key sub-sectors that may be positively affected over time, in our view, include
healthcare, education, ‘trading-up’ consumption plays (mainly retail, apparel, etc.),
auto, lower-end tourism (scenic spots, economy hotels, etc.) and lower-end property.




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