Another Revolution Coming in China

09/29/2009 9:53 am EST

Focus: GLOBAL

Jim Jubak

Founder and Editor, JubakPicks.com

The Beijing government plans a massive investment in social services, particularly health care. For investors, this will have a major impact on how to make money in China.

Health care spending doubled from 2002 to 2007.

Tens of millions of people aren't covered by any health insurance, and millions who had insurance have lost it as a result of the global economic crisis.

Despite the rise in health care spending, the population isn't getting any healthier. Infant mortality rates have stopped declining. Diseases once under control have re-emerged.

Too many people live in fear that they're only one illness away from poverty.

Yep, things sure are bad…in China. So bad that, in January, the Beijing government announced a plan to spend $124 billion by 2011 to provide some form of health insurance to 90% of the population.

That's a huge amount of money. Yes, the dollars being thrown around in our own health care debate are larger: The draft bill being debated in the Senate Finance Committee carried a price tag of $856 billion when introduced. But that would be the cost for ten years.
 
The Chinese price tag of $124 billion for two years is impressively large when you consider that China is still a relatively poor country. US gross domestic product hit $14.3 trillion in 2008, estimates the CIA World Factbook. The factbook puts the size of China's economy at $4.4 trillion, using the official exchange rate, or $7 trillion at what's called purchasing power parity. (Purchasing power parity attempts to adjust official figures to take into account what people in different countries actually pay for the same goods and services.)

A Radical and Profitable Change

Either way you look at it, spending more than $60 billion a year to improve health care in China has the potential to be revolutionary.

And I think it will be exactly that. Especially if it is, as I think likely, just the first wave of government spending in areas such as health care, education, and retirement pensions. We are looking at the beginning of revolutionary change in the Chinese economy.

For investors, that revolution will totally change how to make money in China.

Let me explain what's so revolutionary about spending $124 billion over two years.

The goals of the plan seem modest enough. The government wants to extend some form of health insurance to 90% of the Chinese population. "Some form" is the key. Each person covered would get an annual subsidy worth about $17 beginning in 2010. Medicines would be covered by the insurance. Some of the money would go to improving health centers in rural areas, and efforts would be made to reform the operation of public hospitals.

Now, $17 a year per person doesn't seem like much, and indeed it's not in the developed economies of the world. It's a much bigger deal in rural China, which is much poorer than the urban areas.

In the first quarter of 2009, according to a nationwide government survey, the average household in rural China showed an annual income of $237 at official exchange rates. Rural households average 4.5 people (or at least they did in 1995, which is the most recent data I could find). In a household of four people, the new plan would provide an annual budget of $68 a year. That's a big percentage on a household income of $237.

Cash and Apothecary

The effect, though, is even greater if you look at the way China's health care system works now. Everything requires a cash payment from the minute you walk through the door.

I'm going to take a few details from a description of a hospital visit by Bill Siggins, who had surgery in a Chinese hospital to remove his appendix. (You can read the complete account here.)

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The first charge was 10 yuan, about $1.40, to register. After a preliminary diagnosis, there were tests to confirm the diagnosis. Test costs totaled $100. Fortunately for Siggins, an operating room was available, but it required a $730 deposit. In recovery, a thermometer cost $1.40. Patients and their families are supposed to provide things like a bowl, a spoon, towel, and soap. Food tickets for meals cost about $2.20. (The system reminds me a bit of the last flight I took on a low-cost airline in Europe.)

This account doesn't take us down into the pharmacy, which in many ways is a much more wrenching economic experience than the hospital itself. With the end of much government support for the hospitals, the pharmacies attached to hospitals have become major profit centers. Pharmacies are allowed to charge a 15% markup over the wholesale prices of drugs.

That doesn't seem like much. But pharmaceutical sales provided 43% of revenue at China's general hospitals in 2005, according to a 2009 paper by Meredith Wen, "Averting Crisis: A Path Forward for China's Healthcare System." In that same year, government funding provided almost 7.4% of general hospital revenue. That figure had been 10.2% in 2002.

Siggins is very positive about the care he received—and frankly, it sounds remarkably good in comparison with much of the developing world and to many places in the developed world, including some in the United States. But that's not my point.

Think about living on a household income of $237 a year and knowing that a thing like an infected appendix could bankrupt you. And that without ready money—$100 or so—you can't get a diagnosis or tests.

Save or Die

What would you do? If you live in China, you save like you're life depends upon it. Because it does.

Do you really wonder why China's savings rate is something like 40%? In comparison, the Great Recession, which has caused US consumers to save more, has driven the US savings rate up to 4.2% in July, according to the St. Louis Federal Reserve.

But it's not just the health care system that works this way. Most Chinese workers now don't have meaningful retirement plans through their jobs or the government. Many Chinese—certainly the 200 million or so migrant workers who staff China's export industries, but who never get to be official residents of the city where they work—have to pay out of pocket to educate their kids.

It's actually remarkable that the savings rate in China is as low as 40%.

The government has known about this problem of social insecurity for years. It is a completely predictable result of breaking the iron rice bowl, the government-provided social services that formed the basis of Chinese society until the introduction of "it's all right to get rich" economics by Deng Xiaoping.

But the decision to devote tens of billions a year to improving health care and providing a minimal level of health insurance is a remarkable sign that the government actually intends to do something about social insecurity in China.
And the leaders in Beijing are also moving to put money into education and pensions.

If there's one thing we should have learned by now in the United States, it's that once you create an entitlement, such as Social Security or the Medicare drug benefit, it's very, very hard to end it. The Beijing leadership can indeed reverse course more easily than the US Congress or president can (there are some advantages in not running for re-election), but it looks like the entitlement genie is out of the bottle in China for a number of years to come.

Waiting to Buy the Revolution

What does that mean for those of us who constantly search for ways to invest in China?

It argues strongly that we should stop concentrating on the infrastructure and heavy industry and export company stock plays that have had such a high profile in China's recent development.

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And that we should start looking, first, at the companies such as Ping An Insurance or China Medical Technologies that will be direct beneficiaries of more government spending on social services.

And, second, at companies that will be the future beneficiaries of a Chinese consumer who isn't scared silly into saving 40% a year. Companies such as Ctrip, an Internet travel company.

I wouldn't rush out and buy these companies or any other name you can think of today. The Chinese stock market is ludicrously expensive at the moment. That will fix itself. Chinese stocks are incredibly volatile, and lower prices will come to he or she who waits.

And you're not in any hurry. This revolution in China's economy is just getting started, and it has a long way to run.

At the time of publication, Jim Jubak owned shares of China Medical Technologies.

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View the complete Jubak Picks Portfolio here

Jim Jubak has been writing "Jubak's Journal" and tracking the performance of his market-beating Jubak's Picks portfolio since 1997 on MSN Money. He is the author of a new book, The Jubak Picks, and he writes the Jubak Picks blog. He is also the senior markets editor at MoneyShow.com.

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