Understanding China's food systems

“Fashion is in Europe, living is in America, but eating is in China.” ¹

China is the world’s largest food producer, food consumer and food importer. Understanding the food systems and trading opportunities in this country is sensible for investors in agricultural assets. A good place to begin this task, is to consider the nation’s food culture.

Image: Rice fields among karst formations inthe Guangxi region of China

Food culture

As one of the world’s great civilisations, China has a long and well documented history − a history punctuated with periodic famine caused by floods, droughts, civil wars, foreign invasions and failed government policy. Millions have died from hunger in China within living memory. Food security, food safety and food quality remain to this day a core priority of government, so that food consumption can continue to bind families and foster friendships.

Food eaten with others in China serves social purposes. Sharing a meal with another is used to establish or maintain relationships. A formal family dinner, which will include close friends, will include 4−6 cold dishes and 8−10 hot dishes. Rare and expensive foods can be served on occasions to project wealth and high social status. The industries that now mass produce these rare foods have become huge, such as global birds nest production, made from solidified swiftlet saliva estimated to be worth $6.5 billion annually.

Cuisine and eating habits vary between regions, with rice a staple of the subtropical south and wheat flour, used in steamed bread and noodles, the staple of the temperate north. These habits have travelled with those that made up the diaspora of Chinese in the nineteenth and twentieth centuries and, more recently, with the massive migration of people from rural areas to often distant Chinese cities.

Like most cultures, food is used in celebration of events, with mooncakes for the Mid-Autumn Festival, dumplings for the Spring Festival and birthdays celebrated with noodles and peaches. Specific foods take on symbolic characteristics, such as peanuts for longevity, oranges and chestnuts for good luck and glutinous rice balls meaning the family will stay together.

Food consumption is changing

One-third of Chinese consumers in a recent survey rate freshness as their top priority, with only 4% saying “cheapest option available” was most important.² In Australia, only 9% prioritised freshness, while 17% were focused on price. In China, 90% of consumers said they would pay a premium for healthier food, while in Australia just 51% think this way (see Figure 1).

‍Figure 1: Consumers likely to pay a premium for better quality healthier food in the next 12 months. PwC survey, 2020.²

Of particular interest to readers may be the changes in consumption habits for beef. Two major events affecting this category have been the outbreak of African Swine Fever (ASF) in China, causing a big reduction in pork supply, followed by the outbreak of COVID-19, which changed where people eat.

The shortage of pork from ASF caused pork prices in China to double in late 2019 (see Figure 2). Consequently, demand for beef increased, with corresponding price increases. By the beginning of 2021, pork production recovered and prices dropped to prior levels, but beef prices have remained high. According to a recent Rabobank report,3 this may be because retail demand has formed a solid base, making beef pricing less dependent upon pork, the traditional staple meat protein.

Figure 2: China weekly pork and beef price, in renminbi (RMB) since January 2019 to November 2021.³

Prior to COVID-19, about 70% of beef was consumed outside homes, most commonly at hot pot restaurants, where diners cook sliced beef, beef balls and other meats in a hot pot of flavoured broth. With the onset of COVID-19 and lockdowns, sales in the food service industry dropped substantially, but hot pot revenue only declined 7.5%. This was a result of restaurants adopting home delivery and the supply of packaged instant products. Following the removal of lockdown restrictions, beef sales through supermarkets and e-commerce have remained robust, perhaps evidence of the consumers’ newfound mastery of beef consumption at home.

Beef sales, made direct to the consumer through online shopping, have been a feature of the development of Chinese e-commerce. A decade ago, beef was not consistently available in traditional marketplaces, which provided an avenue for developers of online markets to differentiate, through its offering. With the enthusiastic adoption of online shopping in China, it is thought that e-commerce is now more important than supermarket sales for the distribution of beef. And the future of this industry is bright, with the recent IPO prospectus for Dingdong Maicai, an aptly named fresh food delivery business, stating e-commerce will continue compound growth at 30% per annum through to 2025.

Land and water

Probably the most significant factor that drove China’s exceptionally large population was access to arable land and water supplies that were harnessed for irrigated food production. The consequent reliable and ample food supply enabled population growth, which paradoxically caused China’s land and water supply per capita to shrink.

Producing food for so many people is a challenge because arable land, the stuff on which food can be cultivated, is only 0.8 ha per capita or one-quarter of the global average. To make matters more challenging, two-thirds of China’s arable area is low-yielding fields on hills and mountains.

Image: Three Gorges Dam, Yangtze River, Yichang, Hubei province, central China.

Freshwater resources per capita are currently 1.9 megalitres (million litres or ML) compared to a global average three times higher, and an Australian resource ten times higher. In the more arid north, water scarcity is acute, with residents of Beijing, for example, restricted to just 0.18 ML per capita in 2020.

Infrastructure projects designed to address water scarcity have been constructed over the past two millennia, with the Three Gorges Dam on the Yangtze River, completed in 2012, being a recent example.

This hydro-electric dam includes the world’s single largest power station with 22.5 GW of capacity, six times larger than the whole of the Snowy Mountains Scheme in Australia. The dam can store up to 40,000 gigalitres (billion litres or GL) of water, about five times more than the Snowy Scheme.

As a consequence of being built on a geological fault and the massive weight of impounded water, the dam has caused thousands of earthquakes of low magnitude, with the largest being 5.1 on the Richter scale. These earthquakes were anticipated in constructing the dam, with an expectation of a maximum magnitude of 6.⁴ Perhaps relocating 1.24 million residents to construct a dam that holds back a 110 metre wall of water, with tens of millions of people downstream, is evidence of the nation’s determination and ability to command its water supply, despite the associated tremors.

Another large water project is the South to North Water Diversion Project (SNWD), a multidecade project that aims to ultimately divert 45,000 GL annually – about twice the average discharge of the Murray Darling Basin if no water was extracted. The project consists of three routes using canals, pipes and pump stations, to enable the transfer of water from the reliable Yangtze River in the south to drier northern regions.

The eastern route, begun in 2002, incorporates the Grand Canal, a network of interconnected canals completed in AD 609. By 2013, the eastern route was delivering water with additional construction due to take water delivery further north. At completion this route will be 1,150 km long, with 23 pumping stations to keep the water moving along the coastal plain.

The central route began providing water to Beijing from 2014, with further expansion under way. At 1,264 km in length, the completed canal can deliver around 12,000 GL annually, an amount equal to the entire annual extractions from the Murray Darling Basin in Australia. The canal utilises gravity to transport water along its route, which includes two massive tunnels that cross 70 metres beneath the Yellow River.

Small farms and Hukou

While China’s ability to build infrastructure is beyond doubt, its agricultural sector is challenged by two additional and connected characteristics. China’s farms are among the world’s smallest and are possibly getting smaller as a side effect of the nation’s unique household registration system, called Hukou.

It is estimated that there are 200 million farms in China (see Figure 3), with an average size of just 0.43 ha (see Figure 4) and with 92.5% being less than 2 ha.5 Most of the people who operate or depend on these enterprises for their livelihood are poor and uneducated. Yet this is the group of people tasked with providing a nation of 1.4 billion people with sufficient fresh and safe food to eat.

Figure 3: Top five countries by number of agricultural holdings and agricultural area.⁵

Figure 4: Average farm size in China and Australia,2000.⁶

The combination of the requirement for increasing farm productivity and a poorly educated workforce means that China’s agricultural sector is an exceptionally high user of agricultural chemicals. Despite farming just 9% of global cropland,⁶ Chinese farmers are consuming around 30% of the world’s synthetic fertiliser and 43% of global pesticides.⁷ It is estimated that over 60% of these agrochemical inputs are wasted,⁸ causing economic inefficiencies and environmental problems.

Studies have found that increasing farm size would provide a reduction in agrochemical use, while increasing farm productivity.⁹ However, the Hukou household registration system is impeding progress in this regard. While decades of rural migration to the cities has reduced China’s rural population to 40%, 64% of the national population remains registered as rural.

Hukou is a citizen registration and identification system operated like an internal passport system. It is used to control the rate of internal migration of rural residents to cities by requiring permits for registered rural residents who wish to stay and work in cities. The system denies immigrants access to government services in the cities, such as education, health care and social security. Because rural immigrants residing in cities lack certainty or permanent residency, they have an incentive to retain the family farm, in the event they are forced to return.

An additional feature of China’s agriculture is that land cannot be owned by farmers; instead it is leased for periods of around 30 years. Given this finite tenure and the fact that land is frequently resumed for urbanisation, farmers lack both access to finance and long-term incentive to invest in development of what are very small farms anyway.

Reforms to the country’s Hukou system and rural land tenure have occurred from time to time over the past decades, and further reform is required if the country is to achieve greater efficiencies in food production. These requirements are however being balanced by a determination to control migration to a rate that matches urban services and job creation.

Trade

‘I set no value on objects strange or ingenious, and have no use for your country’s manufactures.’ - Emperor Qianlong’s response to British demands for greater trade, 1793.¹⁰

In the same year that the 80-year-old Emperor Qianlong rebuffed British trade demands, the British Parliament formalised a monopoly for the East India Company over the opium trade between India and China. This Act accelerated the shipment of opium to China, which began a chain of events and wars that caused more than a century-long national addiction to opium, two opium wars that forced the drug into the country and the denial of tariff autonomy because of the creation of treaty ports. So began China’s Century of Humiliation. Having experienced trade with western characteristics, it is little wonder that China seeks autonomy today in its trade in food.

Following accession to the World Trade Organization in 2001, China’s imports of agricultural commodities have grown and changed. During the first decade following this key event, imports of land-intensive bulk commodities such as soybeans, corn and cotton grew ten-fold to around $90 billion per annum but have since flattened. Meanwhile, imports of consumer-oriented foods such as dairy, beef and tree nuts have risen twenty-fold to $80 billion in the past 20 years, with many categories still increasing at rates of around 20% per annum.
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Image: Longji Rice Terrace (Dragons Backbone) in Longsheng County - Guangxi Province, China.

Despite impressive growth in imports, sudden changes in trade policy have adversely effected shipments of food to China for a range of reasons. The recent restrictions on several Australian food exports are an example of seemingly arbitrary change, while changes in the structure of the infant milk formula (IMF) market is an example of a nation determined to create a level of self-sufficiency in its own food systems.
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Image: An aerial view showing a patchwork of small fields in rural China.

Manufacturers of IMF have until recently been one of the fastest growing groups of ASX stocks that could be considered agricultural. However, in recent times sales to China have slumped as a consequence of a 2019 Chinese government plan to increase domestically produced IMF to a 60% market share. In addition, China’s births have declined from 17.5 million in 2015 to a forecast of 10 million in 2021.¹¹ While some trade restrictions may appear arbitrary, in hindsight the growth and subsequent slowdown in the IMF market was probably predictable.

Conclusion

As a country with enormous resources, not the least being its people, China is rightly determined to choose whose ‘manufactures’ it has use for. It is a country with many poor people, whose economic development is a genuine concern of capable technocrats and party leadership. Reform of its agricultural sector will take a long time and regardless of the success or extent of these reforms, demand from an increasingly prosperous urban population will continue to grow.