Sunday, December 17, 2017

Automatic Job Storm Coming: James Mauldin


Almost every weekday, some arm of the US government issues some sort of economic statistic. News media and financial analysts review and report it. Then 99.9% of the adult population, and probably 90% of the financial industry, forget all about it. And they’re probably right to do so.
The monthly jobs report isn’t like that. Yes, any single month doesn’t tell us much. Yes, the Labor Department’s methodology has some flaws, both major and minor. But imperfect as it is, the jobs report is our best look at the economy’s pulse. Jobs matter in a visceral way to almost all of us, as you know well if you’ve ever lost one. Almost any survey that asked questions around employment would reveal the angst that many Americans feel about the possibility of losing their jobs.
Right now, automation tops the list of things that might threaten our jobs. Artificial intelligence and robotics technology are rapidly learning to do what human workers do, but better, faster, and cheaper.
I’ve use the following chart before, but it’s a compelling illustration of how technology is reducing employment. It shows the rising rig count in the oil patch since mid-2016 – and yet the number of workers on those rigs is actually still falling. This is the impact of a new robot called an iron roughneck: Tasks that used to require 20 people now need only five. And the iron roughneck is not even that widely deployed in the oil and gas industry – the trend will hit hard in the coming decade. Roughneck jobs are relatively high-paying; it takes a great deal of training and skill to be able to do them.
Today I’ll give you some quick thoughts on the just-issued November jobs report, then take a deeper look at the automation problem/opportunity. I use both words because automation truly can be either. And then we look at the failure of the Federal Open Market Committee (FOMC) to take into account the major technological changes that are going to come our way over the next 10 to 12 years (if a host of studies are correct). I think that failure is likely to lead the FOMC to make the mother of all policy errors. And right now, a major monetary policy error is the most dangerous weapon of mass wealth destruction facing the US and the world.
Before we go on, let me briefly remind you that our Mauldin Economics VIP Program is open until December 13. VIP is our “all you can eat” package. For one low price, you get all our premium investment services and a few extra benefits as well. I believe our information will be invaluable as we move into a highly uncertain 2018. You can learn more about the VIP program here
A Decelerating Job Picture
The jobs report for November was solid, with job growth above the recent average. But earnings were a disappointment, as we will see. Philippa Dunne’s summed up the report in a recent commentary:
Employers added 228,000 jobs in November, 221,000 of them in the private sector. Both are nicely above their averages over the last six months, 164,000 headline and 162,000 private. Almost all the major sectors and subsectors were positive. Mining and logging was up 7,000 (slightly above the average for the last year); construction, 24,000 (well above average, with specialty trades strong and civil/heavy down); manufacturing 31,000 (well above average, with almost all of it from durables); wholesale trade, 3,000 (slightly below average); retail, 19,000 (vs. an average loss of 2,000); transportation and warehousing, 11,000 (well above average); finance, 8,000 (weaker than average); professional and business services, 46,000 (right on its average, with temp firms particularly strong); education and health, 54,000 (well above average, with education, health care, and social assistance all participating); and leisure and hospitality, 14,000 (well below average). The only major down sector was information, off 4,000, slightly less negative than average. Government added 7,000, well above average, with local leading the way.
What’s not to like about this? The answer is that we really need to review the report in terms of the trend. And the trend in employment is deceleration. As Peter Boockvar explains,
Also, we must smooth out all the post storm disruptions. This give us a 3-month average monthly job gain of 170k, a 6-month average of 178k, and a year-to-date average of 174k. These numbers compare with average job growth of 187k in 2016, 226k in 2015, and 250k in 2014. Again, the slowdown in job creation is a natural outgrowth of the stage of the economic cycle we are in where it gets more and more difficult finding the right supply of labor.
The growth in wages is also decelerating. I was talking with Lacy Hunt this morning about the jobs report. He noted that real wage growth for the year ending November 2015 was 2.8%, while for the year ending November 2016 it was just 1%. The savings rate is now the lowest in 10 years. The velocity of money is still slowing, which means that businesses have to do everything they can to hold down costs, and one of those things is to rein in wages.
And yet the Federal Reserve has a fetish for this thing called the Phillips curve, a theory that was thoroughly debunked by Milton Friedman early on and later by numerous other economists as having no empirical link to reality. But since the Fed has no other model, they cling desperately to it, like a drowning man to a bit of driftwood. Basically, the theory says that when employment is close to being as full, as it is right now, wage inflation is right around the corner. According to the Phillips curve, then, the FOMC needs to be tightening monetary policy.  Later we’ll see how the FOMC’s faulty tool is likely to lead to a major monetary policy error.
Basically, the Federal Reserve looks at history and tries to conjure models of future economic performance based on it – even as everyone in the financial industry goes on intoning that past performance is not indicative of future results. But all the Fed has is history, and they cling to it. My contention is that the near future is not going to look like the near or the distant past, and so we had better throw out our historical analogies and start thinking outside the box. Now let’s look at some real problems that will impact the future of employment.

Robotic Wipeout
Last month I shared in Outside the Box a new McKinsey report on job automation. Actually, I shared an Axios article summarizing that report, which is 160 pages long. You can read it here if you have time. McKinsey does a good job pulling together data and forecasting its consequences.
Every year, reports like this reflect a process that’s occurred many times in human history. People discover or invent something useful: fire, the wheel, iron, gunpowder, coal, oil, the steam engine, electricity, the automobile, the airplane, the computer, etc. Life changes as the new knowledge spreads. People either adapt or they don’t. Those who don’t adapt fade into the background. In the last few decades of their working lives, they end up taking the very lowliest of jobs in order to get some food, clothing, and shelter; but it’s not a comfortable life. There was no government safety net for most of our history. But most people tried hard to adapt their skills to the new changes. And as we adapted to radically disruptive inventions like the steam engine, automobile, and computer, hardly anyone had the necessary skills, and so everyone had to learn.
Today, things are different. Fifteen percent of men between the ages of 25 and 54 – who should be in their most productive years of contributing to their families and society – don’t even want a job. That’s up from 5% in the mid-’60s, and the number has been steadily rising. Fifty-six percent of these people receive federal disability payments, averaging about $13,000, which is roughly equivalent to the pay for a minimum-wage job, after taxes – except that disability comes with free Medicare. Unless these people find ways to develop needed skills, there is not much financial incentive for them to look for jobs.
The rest of the people who don’t want jobs are mostly early retirees, homemakers, caregivers, or students. And roughly 1/3 of the 10 million+ men who have dropped out of the workforce have criminal records, which is often a barrier to work. Only about 3–4% are actually discouraged workers who might take a job if a job is available. That picture should be worrying. It is one reason why GDP has not increased all that much. Remember that GDP is proportional to the number of workers available times their productivity. Taking 10 million workers out of the workforce reduces GDP.
The problem for most of us now is that we don’t want to simply fade into the background like so many people have done with each major shift in technology; yet new knowledge spreads around the globe now in seconds instead of centuries. It’s easy to feel that the walls are closing in, because for many of us they are. The McKinsey report makes that crystal clear. They project that technology will replace as many as 800 million workers worldwide by 2030. Displacement is not just a US or developed-world phenomenon; it will show up in the emerging and developing markets as well.
McKinsey draws a distinction that we should all remember. The problem is less about jobsdisappearing than about the automation of particular tasks that are part of our jobs. In most cases, employers can’t simply fire a human, plug in a robot, and accomplish all the same things at the same or better performance level but lower cost. You have to zoom in closer and look at the tasks that each job entails, and ask which of them can be automated. The roughneck jobs in the oilfield are a good example: The Iron Roughneck doesn’t replace all workers on the rig, just some of them.
So when McKinsey says that 23% of US “current work activity hours” will be automated by 2030, that’s not the same as saying 23% of jobs. The shift will affect almost all jobs to some degree. That 23% figure is their “midpoint” scenario, too. In the “rapid” scenario it’s 44% of US current work activity hours that will be handed over to machines.
In other words, whatever your job is, some part of it will likely get automated in the next decade or so. That might be good news if the machines can take on the repetitive drudgery that you don’t enjoy. Automation could free you to do things that are more interesting to you and more valuable to your employer. But outcomes are going to vary widely. Here’s a chart on sector and occupation employment shifts from McKinsey. (This one is for the US; their report has sections for other countries as well.)
The circles on the right are the translation of those task-hours into numbers of workers. As you can see, in their rapid automation scenario, by 2030 – just 12 years from now – 73 million people out of a workforce of 166 million will have been displaced, with 48–54 million of them needing to change occupations completely.
In other words, a full third of the workforce may have to change career fields. That’s going to be a problem. Yes, Americans change jobs more frequently now than they used to, but the changes tend to be evolutionary: We gain new skills, find a better place to apply them, acquire new contacts, seek out new opportunities, and so on. The personal transformation happens slowly enough to be manageable. That’s going to change.
My friend Danielle DiMartino highlights another of the amazing charts in the McKinsey study, one that analyzes US job-market susceptibility to automation scale:
This chart demonstrates that it’s not just the low-skilled workers who are at risk. It’s also mid-level and even some high-level people. There is more job risk than many of us imagine. That is why I break the world up into the Unprotected, the Protected, and the Vulnerable Protected classes. The latter group doesn’t even realize their vulnerability.

Superhuman Level
Worse, I think the shift to automation may come even faster than McKinsey’s rapid scenario suggests. Recently I ran across an artificial intelligence story that’s almost terrifying. You might have heard about AlphaGo, the AI system created by Google subsidiary DeepMind. It plays the very complex board game called Go.
In 2015, DeepMind became the first computer to beat a human professional Go player. It learned how to do this by analyzing many thousands of games played by humans. Impressive, but only the beginning.

This year, DeepMind introduced AlphaGo Zero, a new system that quickly acquired the same skills with no human help at all. The programmers simply gave it a blank board and the rules of the game. It then played millions of games against itself. Here’s the chilling quote from DeepMind CEO Demis Hassabis:
The most striking thing is that we don’t need any human data anymore.
It gets more unnerving. On December 5 (yes, last week), DeepMind published a scientific paper that sounds straight out of science fiction. I added the bold print.
The AlphaGo Zero program recently achieved superhuman performance in the game of Go, by tabula rasa reinforcement learning from games of self-play. In this paper, we generalise this approach into a single AlphaZero algorithm that can achieve, tabula rasa, superhuman performance in many challenging domains.
Starting from random play, and given no domain knowledge except the game rules, AlphaZero achieved within 24 hours a superhuman level of play in the games of chess and shogi (Japanese chess) as well as Go, and convincingly defeated a world-champion program in each case.
That’s startling, so let me repeat it slowly. In one day, starting from nothing at all (“tabula rasa”), AlphaGo Zero learned to play chess, shogi, and Go at a superhuman level, beating the same systems that had beaten the best humans in the world.
That’s how fast the technology is evolving. I suspect some of the rapid acceleration came from faster processor chips – Moore’s law says they should double in power every two years. But this was far more than a doubling; this was exponential.
Systems like that are coming for your job. So if you think you’re safe because you aren’t an assembly-line worker or a retail cashier and don’t work at the level of rote repetition, you could be wrong. These systems will only get better and take on ever more complex jobs.
Could DeepMind build a system that reads my archives, monitors my email, and then writes Thoughts from the Frontline at a level where you couldn’t tell the difference between it and me?
How do you know it hasn’t?
Perfect Storm
Those who control the tech are intent on bringing the era of superautomation forward as fast as possible. I talk a lot about incentives and the way people and businesses respond to them. Identifying incentives is a key tool in analyzing trends and forecasting what different players will do next. Well, between dicey Federal Reserve policies and possible tax reforms, businesses are getting new incentives to automate sooner rather than later.
 First, the Fed. I’ve made the case before that I think they waited too long to end quantitative easing and begin normalizing interest rates. Their delay created our present weird situation where we have little or no inflation according to the indexes, but the cost of living for people at the median income level and below is outpacing wage growth and leaving the average household struggling to stay even.
Real wages, that is wages after CPI growth, have advanced only 0.2% a year since 1973. And as I noted above, real wage growth is now decelerating.
Diminished earning power has, in turn, robbed businesses of pricing power and forced them to cut costs ruthlessly. One way you slash costs is by automating. In this week’s Outside the Box I shared a story about how Amazon is now hiring robots faster than it is human employees. Amazon is in the lead, but other companies aren’t far behind. This trend limits wage gains even more, and the situation is getting worse as the technology gets better and cheaper. (The fact that San Francisco has limited the number of robots per company and limited the speed of robotic delivery simply ensures that San Francisco will be behind the rest of the country in terms of growth and productivity within a few years.)
Of course, there’s absolutely nothing wrong with making your business more efficient. You have to survive against the competition. But in this case the competition is not happening naturally or according to market forces. The Fed has kept market forces from working and has created an environment that would never have occurred otherwise. You can argue whether a laissez faire market would have worked better or worse, but it’s pretty clear we haven’t had one.
Now add in tax policy. I explained early this year in my open letters to the new US president that we would all be better off with a consumption tax like a VAT rather than we are currently with the income tax. Alas, I did not get my wish. Congress is right now “improving” the tax code in ways that may actually accelerate the automation trend.
(Incidentally, I’m getting many emails with questions about the new Republican tax plan. I’ll have more detailed thoughts after we see what, if anything, gets through the conference committee and becomes law. At this point it’s still a guessing game, and I would rather comment on what is actually extruded from the sausage grinder. Let me just say that there’s something in the bill for everybody to hate.)
For instance, one proposal is to allow equipment purchases to be expensed immediately instead of amortized over time. That’s not a bad idea on its own. However, it effectively subsidizes companies to upgrade their equipment and technology to the latest state of the art. And, as we saw above, the state of the art is automated devices that need little human help.
The accelerated shift to automation may help explain a Business Roundtable survey that showed some odd results. As reported by the Wall Street Journal last week, CEOs say their plans for capital investment have risen to the highest level since the second quarter of 2011. That’s good news: Businesses see growth opportunities and want to add production capacity to meet them. But the same survey shows CEO hiring expectations going in the opposite direction. Hiring is not plummeting by any means, and many do plan to increase hiring over the next six months; but the majority say they will keep their headcount where it is or lower it. General Electric will cut 12,000 jobs from its power business, roughly 18% of that division’s total employment, in order to cut costs and reduce overcapacity.
How do we explain a situation in which capital spending rises but employment stay the same or falls? Automation is one answer. It lets you increase capacity without increasing headcount and expenses – you may even reduce them.
Not coincidentally, the new tax bill may remove the Obamacare individual mandate, but the employer mandate is staying in place – and healthcare costs are still rising. That too incentivizes businesses to use machines instead of people wherever possible.
So where do all these factors leave human workers? The McKinsey forecasts fall more or less at the midpoint of those in other reports I am reading. We’re facing a perfect storm: Technological, monetary, and political entities are joining forces to stir up a maelstrom of change that is going to bombard all of us. I’m not an exception, and neither are you.
We can’t control these giant forces, but we can control our responses. Whatever your job is now, you need to think about how vulnerable it may be and what else you might do. If you need to acquire new skills, start doing it now. If you have young adult or teen children, help them with their education and career choices. That art history degree may not be much in demand in 2030. Or even in 2020.

Wednesday, December 13, 2017

Kellogg Is Going All In on Cereal Cafes


Kellogg Co. is hoping that Instagram-obsessed millennials can help make cereal cool again.
The food giant, struggling to break out of a four-year sales slump, is opening a cavernous new cereal cafe in Manhattan’s Union Square -- doubling down on a concept that it started in Times Square last year. 
The cafe will be about fives times larger and feature an Instagram station with props and professional lighting, designed to help customers perfect their social-media posts. There’s a full cereal bar, giant murals of Kellogg characters like Tony the Tiger, a station to heat up Pop-Tarts and a special iron to cook fresh Eggo waffles.
“We want cereal to be seen as modern,” said Aleta Chase, a marketing executive at the Battle Creek, Michigan-based company.
That’s no easy task. Many consumers view breakfast cereal as too sugary and processed -- attitudes that have dragged down the industry’s sales for five straight years. Cereal is projected to finish 2017 down 1.6 percent, according to Euromonitor International.
As the world’s biggest cereal maker, Kellogg has suffered the brunt of the downturn. Sales of Special K, one of its top brands, have slipped 26 percent since 2012.
Kellogg has argued that cereal declines are easing as younger customers embrace it as an all-hours snack. But the turnaround has been elusive, and the cafe in Union Square is an attempt to generate some foodie buzz. In fact, it was the slew of pictures posted by visitors to the Times Square location that helped convince the company it needed a bigger space.
“We needed something that was more experiential,” Chase said. “There’s a more lasting emotional connection if they experience it firsthand -- that’s hard to do with a TV commercial.”
The cafe is operated by Sandra Di Capua and Anthony Rudolf, two fine-dining veterans who have worked at New York institutions such as Per Se and Eleven Madison Park. They said a flexible lease in Times Square, where the rent was roughly equivalent to a much larger space on East 17th Street, allowed for the relocation.
And while Kellogg sees the restaurant mainly as a marketing tool, the operators are trying to make money off the concept. The Times Square location was profitable, showing it can be done.
“It has to be a viable business,” Rudolf said.

Tuesday, December 12, 2017

As entry-level bike segment roars back to life, it’s advantage HeroMotoCorp


A revival in the entry-level bike segment has helped Hero MotoCorp, the country’s top two-wheeler maker, grow its share of the motorcycle market marginally amid intense competition.
Sales of 75-110cc bikes, a major volume segment in motorcycles, had dropped after demonetisation.
The current fiscal has seen a decent run for the motorcycle segment, reporting a growth of 6 per cent at 7.61 million units in the first half.
The growth was led by the 75-110cc segment, supported by an improvement in rural demand.
The entry segment accounts for 59 per cent of the overall motorcycle market in India.
Hero’s sales in the segment grew 10 per cent at 3,299,849 units in April-October, while the overall segment grew 7 per cent at 4,489,912 units.
The company improved its market share marginally by 100 basis points to 51 per cent from 50 per cent in the year-ago period, driven by its popular models such as Splendor and Deluxe.
Rural markets improve
“Urban markets began to improve in the first quarter. In the second quarter, the rural markets improved. Going forward, we expect the momentum to continue,” Ashok Bhasin, Hero MotoCorp’s Head - Sales, Marketing and Customer Care, told a recent earnings conference call.
“Hero MotoCorp benefitted from the channel-filling measures undertaken post the transition to BS-IV and GST in April and July 2017 respectively, and also the uptick in rural demand sentiment during the current fiscal,” said Subrata Ray, Group Vice-President, Corporate Ratings, Icra.

Monday, December 11, 2017

Why Gas Could Be The Future Of India’s Transport


India’s push for cleaner fuels will not just trigger an electric car boom. It will also drive consumption of natural gas as the nation weans car owners away from polluting fuels like petrol and diesel, among the largest contributors to Asia’s third-largest economy’s import bill.
Gas will offer cheaper mileage, especially after the stricter Bharat Stage VI emission standards are rolled out in April 2020. Which means, city gas distributors like Mahanagar Gas Ltd., Indraprastha Gas Ltd. and Gujarat Gas Ltd. stand to gain.
Investors are betting on the potential growth. Shares of Gujarat Gas, Indraprastha Gas and Mahanagar Gas have gained between 40 to 77 percent so far this year.
Here are the five reasons why gas may be the future of India’s passenger transport...

Cheaper

Natural gas lowers your car and kitchen fuel bill.
Compressed natural gas increases car mileage and lowers costs. In all, it’s 59 percent cheaper than petrol and costs 41 percent less than diesel, according to BloombergQuint’s analysis. This doesn’t factor in the price of the car, and maintenance and insurance costs.
As a kitchen fuel, piped natural gas is 26 percent cheaper than a subsidised liquefied petroleum gas cylinder of 14.2 kilograms. And it costs half the price of a non-subsidised refill.

Greener

Natural gas is cleaner and less polluting than other fossil fuels. New Delhi already uses CNG for public transport. Mumbai has been increasing the fleet of its gas-powered passenger vehicles and other cities may follow suit.
Demand from industries is expected to rise after the Supreme Court banned the use petcoke and fuel oil in Rajasthan, Uttar Pradesh and Haryana, in addition to the existing curbs in Delhi. Highly polluting Petcoke is a key fuel for cement makers. The ban is expected to boost gas demand further, ES Ranganathan, managing director of Indraprastha Gas, told BloombergQuint in an interview.
The judiciary’s curbs on oil and petcoke could propel the growth of city gas distributors, brokerage Motilal Oswal said in a report.

Stricter Emission Standards

The stricter BS-VI standards will be rolled out from April 2020 in a bid to reduce sulphur emissions. In Delhi, the government decided to bring BS-VI fuel two years earlier than planned. That came after the national capital remained blanketed in a toxic fog, which doctors said was equivalent to smoking 45 cigarettes a day, for about two weeks earlier this month.
Motilal Oswal said the new standards would increase the costs of trucks and buses running on petrol and diesel. That could make CNG more cost-efficient, it added.

GST Push

Natural gas, like other petroleum fuels, is out of the ambit of the Goods and Services Tax. Which means, city gas distributors don’t get credits for inputs that can be set off against future liabilities, a key element of the new nationwide sales tax.
Companies don’t get input tax credit for the GST they pay on equipment, gas infrastructure and transportation charges. That increased cost of operations, warranting gas price hikes. Indraprastha Gas lost close to Rs 14 crore in the three months ended September as it failed to pass on the hike to consumers for 25 days, Ranganathan told BloombergQuint.
So, including natural gas under the GST would bring down retail prices, Oil Minister Dharmendra Pradhan said recently.

Expansion

Petroleum and Natural Gas Regulatory Board has been mandated by the government to expand the gas grid and improve city distribution network by inviting bids from interested developers. The board identified 223 areas and will invite bids through multiple rounds, according to Motilal Oswal. Even the government’s think tank NITI Aayog has drafted a plan to expand the network in 326 cities by 2022 from existing 87 regions.
That would throw up new opportunities for gas distributors.

Maersk Sees Falling Freight Rates in Bearish Sign for Trade


The world’s largest container shipping line says international freight rates are reversing after climbing for most of this year, raising questions about the sustainability of the global trade recovery.
Decade-old oversupply issues swamped demand for containerized sea trade in the third quarter, a senior official at Maersk Line Ltd. said in an interview last week. Over 90 percent of trade is routed through ships, making the industry a bellwether for the worldwide economy.
"We have started to see some pockets of downward pressure," said Steve Felder, Mumbai-based managing director of Maersk’s South Asian unit. The global trade order book at around 13.5 percent of capacity isn’t high, "however, given that freight rates are largely determined on the basis of supply-demand balance, they remain fragile," he said.
The International Monetary Fund forecasts growth in world trade volume will slow to 4 percent in 2018 from a projected 4.2 percent this year, though that’s still higher than the seven-year-low of 2.4 percent hit in 2016. Concern about U.S. protectionism and China’s attempts to rebalance its economy away from exports toward domestic consumption pose risks to the revival.
Maersk isn’t alone. Drewry Shipping Consultants expects the container-shipping freight growth rate to drop to less than 10 percent in 2018 from around 15 percent in 2017 as a supply glut hits home. CMA CGM, the No. 3 container shipping company, recently signaled slightly lower rates for 2018 in early negotiations of Asia-Europe contracts, analysts at Credit Suisse Group AG wrote in a Nov. 29 note.
"It remains very early in the negotiation period, but this uncertainty is plainly unhelpful to investor confidence,” they said.
Fitch Ratings expects supply of shipping containers to grow more than 5.5 percent in 2018, outpacing an over 4.5 percent expansion in demand.

Air-Freight Buoyant

In contrast, the air-freight market is buoyant after years in the doldrums, International Air Transport Association said last week. The development of e-commerce should mean growth rates remain ahead of the pace of expansion in world trade.
Global trade volumes are recovering from a 2015-2016 slump with demand for goods and services rising 5 percent to 6 percent on Transpacific and Asia-to-Europe trade this year, according to Rahul Kapoor, an analyst at Bloomberg Intelligence.
Nevertheless, Felder, whose company is looking to negotiate higher prices in client contracts for next year, says much depends on how the supply glut pans out.
For India, Felder was optimistic. "Given containerized trade growth in the first half was somewhat subdued, it is possible that full-year growth will fall short of double digits," he said. "Much will however depend on fourth-quarter growth levels, which so far look positive."


World’s Largest Water Diversion Plan Won’t Quench China’s Thirst


Autumn rains came too late to save the stunted stalks of Shu Xinguo’s corn crop, withered by a dry July growing season.
"We rely on the weather for our living," said Shu, weary and resigned, his tanned hands hoisting bundles of his remaining crop -- green and yellow tobacco leaves -- onto a three-wheeled tractor. “There’s no water for irrigation, and the well in the village has no water either.”
Sixty kilometers away, China’s largest aqueduct transports as much as 18.3 million cubic meters of fresh water a day through Shu’s province to quench the growing thirst of Beijing in the north. None of it comes to Shu’s village or any of thousands of farms in the region.
It’s China’s age-old dilemma: a tug of war between the farms that help feed the nation, and the soaring demands of industry and city-dwellers in the parched northern plains.
With an excess of rain in the south and not enough in the north, China’s solution is as simple as it was expensive: Build three massive aqueducts to divert the water for an estimated cost of more than 500 billion yuan ($76 billion).

It isn’t enough.The result is the world’s most ambitious water transfer program, the South-to-North Water Diversion project. Its middle channel -- from the Danjiangkou reservoir to Beijing and Tianjin -- was finished in 2014. Proposed in the time of Chairman Mao Zedong, it is a stunning engineering feat. Some 11 billion cubic meters of water has traversed the 1,432-km-long waterway, supplying factories, businesses and 53 million residents.

“As the country’s economy develops, industries are using more water,” said Huanguang Qiu, a professor with the School of Agricultural Economics and Rural Development at Renmin University. “And the competition will become even more fierce."
Beijing, which gets about 70 percent of its water from the South-North diversion project, is expected to add another 2 million people before the government caps the city’s population at 23 million.
President Xi Jinping announced plans in April to build a new city, Xiongan, about 100 kilometers southwest of the capital. With an estimated 5.4 million people, it would also be fed by the aqueduct.
Even when the waterway reaches maximum capacity in 2019, China’s demand is growing so quickly that other solutions will be needed. Rivers and aquifers poisoned by years of poor control over fertilizer use and factory effluent need to be cleaned up, waste reined in and offenders punished.
The result is a revolution in the ways China uses, monitors and allots its most precious resource. Farms are changing crops and embracing technology to conserve irrigation, industries are being forced to clean up effluent, citizens are taking to social media to report offenders and the government is adapting a long-held food security policy to rely more on imports of water-hungry crops.
Part of the problem is that China doesn’t just need to find enough water to supply its rising demand, it also needs to replenish aquifers that have been depleted for years.
“Industries and cities had been drawing down underground water as deep as possible, which took away water from farming,” said Yu Hequn, director-general, Construction and Administration Bureau of the South-to-North Water Diversion Central Route Project. “Now we are returning water to agriculture and the ecosystem.”
By 2015, 230,000 square kilometers were being affected by over-extractionof groundwater, mostly in the north, leading to land subsidence, sea water intrusion and other problems, the Ministry of Environmental Protection said.
The depletion is worst in northern provinces like Hebei, which surrounds Beijing, and neighboring Henan. At least seven giant sinkholes have been reported in Hebei, where farmers have drilled ever-deeper boreholes. The government has promised to divert billions of cubic meters of water from the Yellow River to farms to ease the shortage. Even so, Hebei could still face a water shortage of 1 billion cubic meters by 2030, Zhang Tielong, deputy head of the provincial water resources department, said when the South-North waterway opened in late 2014.
One way to stem the reduction in groundwater is taxes. Last month, the government expanded a water resource tax trial to cover nine municipalities and provinces, with duties ramping up if quotas are exceeded. Regular water tax rates were highest in Beijing and Tianjin, according to China’s finance ministry, and water from underground will be taxed at twice the rate or more than for surface water.
Another option is to import food that requires a lot of moisture to grow -- nearly half of China’s farmland has no irrigation system. That’s not straightforward, as China also has a long-standing food-security policy that aims to be largely self-sufficient in staple grains.
"We should make full use of international markets to increase supplies and should not worry too much over rising imports," said Fang Yan, a researcher with China Institute for Rural Studies at Tsinghua University. She said the government has asked some wheat farmers to shift to water-saving crops.
Each ton of imported wheat saves China about 500 cubic meters of water and 0.4 acres of farmland, Fang said. The country is already the world’s largest importer of soybeans, but could buy more, as well as meat and dairy products, she said.
But an increase in grain imports would put a further strain on global food markets. China’s soybean demand has prompted farmers in Brazil to turn over some 13 million hectares of farmland and forest to growing the crop in the past 10 years, an area about the size of Germany.
In China, urbanization has reduced the amount of farmland in the water-rich south while provinces in the north, which get only 20 percent of the country’s rain, grow more than half the nation’s grain thanks to increasing use of irrigation, she said.
Scientists are breeding wheat seeds for the north that need 20 percent less water, said He Zhonghu, a researcher with the Chinese Academy of Agricultural Sciences.
With urbanization sucking up most of the supply from the water transfer project, China is turning its focus to better use of the water it has. Some of its biggest technology companies are leading the way.
Internet giant Tencent Holdings Ltd. is working with local governments including Shenzhen to encourage the spread of so-called sponge cities -- underground reserves and pools on the tops of buildings that catch and store rainwater.
The idea was raised in 2015 by the State Council, China’s cabinet, and was mentioned in Tencent Chairman Pony Ma Huateng’s National People’s Congress proposal in March. Tencent is using its three new skyscrapers in Beijing, Shenzhen and Wuhan as pilot projects.
Another solution is better irrigation. More water goes to irrigation than any other purpose in China -- about 55 percent of the total. Irrigated land produces 75 percent of China’s grain and over 90 percent of cash crops such as cotton and vegetables.
Bigger farms are trying new techniques, like Xinjiang Tianye Group’s system that can reduce water usage by as much as 50 percent, according to Chen Lin, the company chairman. Its machines dig rows, lay pipes for drip-irrigation, cover the soil with plastic film to reduce evaporation and punch holes to plant the seeds, all in one sweep.
While the technology helps farmers grow everything from cotton to rice, it comes with a hitch: the plastic sheets don’t break down in the soil, leading to widespread pollution.
Not far from Shu’s farm in Henan province, Muyuan Foodstuffs Corp. and the local government are building a pilot farm to demonstrate a drip technology from Israel.
“Normally, we flood fields with water during irrigation,” said Pang Bo, a manager with Muyuan, as he walked through a white plastic greenhouse that will be used to grow tomatoes. “The drip technology can save water by more than 60 percent.” The facilities cost about 3.3 million yuan for one 0.33-hectare greenhouse with a ventilation and cooling system.
Still, in many cases there’s little incentive for farmers to save water. Agriculture uses 62 percent of China’s water, but crops have a relatively low marginal value. So the government bans the sale of agricultural water to industry, which pays 10 times the price, to ensure food supply.
With that barrier, Chen asks, “What are the incentives for saving water?” 
To address this, the State Council in January 2016 began to reform the country’s agricultural water tariffs to encourage more efficient use. A national China Water Rights Exchange was set up in June 2016 and a water-rights trading system will follow. The government has set a cap for irrigation of 372 billion cubic meters by 2020.
It also has plans for a third canal, supplementing the Danjiangkou-to-Beijing route and the first channel, which largely uses the old imperial Grand Canal system to move water along the eastern seaboard. The western one would divert water from three tributaries of the Yangtze River to help replenish the Yellow River. It is the most controversial and difficult of the three, channeling water across the vast Qinghai-Tibet plateau that could diminish supplies for rivers that flow through neighboring countries to the south.
Even as China contemplates such a technological and political challenge, another specter is looming. Recent measurements suggest China’s water distribution may be made even worse by climate change.
The flow of the Han River, which fills the reservoir at the start of the giant aqueduct, shrank by 7.18 billion cubic meters in the decade to 2010, according to Liu Changming, a water scientist at the Chinese Academy of Sciences.
In the nation’s Third National Assessment Report on Climate Change in 2015, the government said rising temperatures and changing rainfall patterns were putting greater stress on agriculture, especially staple crops like rice, wheat and corn.
That’s one more problem for Cheng Mingzhen, 66, who grows corn on a small farm in Henan province. She said she can virtually smell the water from the Beijing aqueduct, which passes through her village of Dazhuang.
"There is no outlet from the canal,” she said, looking toward the high wire fence that keeps trespassers out. “We can hardly get close to it, let alone get water for the crops."