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Is the rise of China good for America and Europe?

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Monday, May 30, 2011

Is the rise of China good for America and Europe?

The 1989 purchase of the iconic Rockefeller Centre by a Mitsubishi Group company was a telling example of Japan’s growing international economic might. Unocal may not be a household name but China National Offshore Oil Company’s blocked US$18.5 billion bid for the California-based oil company is nevertheless indicative of a cash-rich China flexing its muscles on the international scene in a similar manner.

Who doesn’t know the statistics? Few were surprised by headlines announcing that ‘China is the World’s No.2 Economy’ and no-one bats an eyelid upon reading that ‘Double-digit growth continues’. GDP per capita figures tell a slightly different story. China’s output per person is six times less than that of the average American. Even GDP per capita figures do not reveal the full picture. While the fruits of China’s development have largely accelerated growth in China’s urbanised coastal regions as well as the Pearl River Delta manufacturing hub, vast expanses of central China have not developed nearly as fast. And despite the Communist ideals of the Party, China’s Gini coefficient – a measure of inequality where a score of 0 is perfect equality and a score of 100 indicates total inequality – of 47 is disturbingly high. Nonetheless, the strengthening of wage laws, curbs on property speculation and active policies which have reduced the percentage of impoverished people from 85% to 15% between 1981 and 2005 should continue to improve the lot for the Chinese masses.

As far as Europe and America are concerned, China is a one-stop manufacturing shop. For now. Owing to the abundance of factors of production – labour in particular – China has quickly adopted the role Japan once had of being the world’s workshop. Consumers in Western countries benefit tremendously as low-cost goods increase their real income. Western retailers also gain greatly, though this fact is less well publicized. When a Chinese-made shirt lands in New York – duty-paid – for less than US$5 and is then sold for US$29.95 at a Target store, it is quite clear who makes the real profit from the sale.

Yet it is true that not all the stakeholders in the American and European economies have benefited. Because its firms have outsourced a large proportion of its manufacturing to developing countries like China, the West has suffered an increase in unemployment of the worst kind – structural unemployment. Edmund Phelps, a Nobel Prize-winning economist, estimates that structural unemployment may account for almost 80% of all unemployment in America. Similar figures have been produced for European countries. This type of unemployment is hard to shake-off as there are limited numbers of new jobs that these largely low-skilled workers can take on. Lower and persistent consumer spending has proved a drag on the recoveries of Western economies from the financial crisis, especially in the Euro area where growth in the last quarter of 2010 was just 0.3%.

This structural unemployment has been caused in large part by the winding down of manufacturing operations in America and Europe. The term ‘rust belt’ is increasingly being used to describe areas not just in North-east America but also in parts of Western Europe where manufacturing has stagnated. While the American trade deficit is notoriously large, all the major European economies – with the notable exception of Germany – run gaping deficits too. As a negative trade balance lowers aggregate demand, these deficits have impeded the growth of Western economies.

However, the formerly perennial Chinese trade surplus with the rest of the world can no longer be taken for granted. With mounting international pressure to allow the yuan to appreciate, China’s trade surplus growth has been tempered; in the first quarter of 2011, China recorded a rare trade deficit of US$1.02 billion. Some say that this was a blip, but I believe that this ‘anomaly’ could foreshadow things to come.

In fact the changes started happening a while ago. When 17 workers at a Foxconn factory – a firm that makes parts for Apple’s iPhones – took their lives a year ago, a chain reaction of strikes was initiated across China, the most widely reported of which was a mass strike at a Honda transmissions factory. These strikes were signals to the Chinese government that increasingly scarce workers could no longer be paid inhumane wages and so, early this year, minimum wages across China were raised by an average of 22.8%. Research by Boston Consulting Group, a management consultancy, has predicted that Chinese wages could double within the next four or five years. Some manufacturers have tried to combat rising wages by shifting their production facilities to the poorer inland regions of China where wages are lower. However, this is only a short-term solution. The low-margin, export-driven growth China has profited from over the last decade has been made possible, in substantive part, by the external economies of scale that manufacturers benefit from. By operating in ‘production hubs’ such as the Pearl River Delta, firms achieve cost-savings due to the well-established network of ancillary firms and the pool of migrant labour that is available in the area. Such savings are unique to these ‘hubs’ and not to be found in other provinces – setting up a garments factory in Guizhou, for instance, is difficult because of poor transport links: Guizhou has only 1,983km of expressways, which ranks third-lowest in the country on a per capita basis. With an ageing population, China’s spare capacity is bound to be used up faster than it is replaced and so its competitive edge may be lost.

Looking ahead, if we accept that China’s lopsided manufacturing miracle cannot last forever where does that leave China? If China is no longer capable of dominating the low-margin manufacturing sector, then it is left with two development options. Firstly, it could try to expand the tertiary sector of its economy. However, in order for China to truly join the global services industry, it will have to overcome the language barrier. Unlike in India, for example, where the business language is English, Chinese business is conducted in Mandarin: even in the most cosmopolitan mainland Chinese city, Shanghai, multinationals often struggle to recruit English-speaking staff. Besides the language barrier, China’s currently stringent regulations and restrictions will have to be loosened in order for imports of invisibles to rise. This too will take time.

So China is left with the second option: to build global brands and transition to higher-margin, more capital-intensive manufacturing. When Japan faced a similar problem in the 1960s, they allowed the labour-intensive manufacturing to shift to Taiwan and Korea, making for world leaders such as Toyota, Sony, and Panasonic in high-tech fields such as automobiles and electronic goods. According to a recent report by the Asia Society, China is on the verge of developing such world-beating brands. Notably however, this shift towards the development of sovereign brands is likely to happen more as a result of a great lunge overseas than through the slower, Japanese-style fostering of home-grown brands. The report predicts Chinese foreign direct investment to be between one and two trillion dollars in the next decade. These astronomical figures make Chinese outward investment to date - $230 billion, and on par with Denmark - look like small change. While China currently compares with New Zealand and Austria in terms of acquisitions in America, Lenovo’s $1.25 billion purchase of IBM’s Personal Computer unit and Geely’s purchase of Volvo are striking examples of Chinese firms’ growing appetite for international acquisition.

So are these Chinese investments good for America and Europe? It is very easy to suggest that the acquisitions of iconic Western brands will spell the end for Western manufacturers of capital-intensive goods. After all, what advantages do these manufacturers have over their Chinese counterparts? Out of the factors of production, the Chinese are at an advantage in terms of land, labour, and some may say capital too. The saving grace for Western manufacturers is enterprise: know-how. Chinese firms on the prowl will be able to side-step the laborious, costly process of research and development by securing Western technology and know-how through acquisitions. Parallels can and will be drawn between the current situation and how the rise of Japanese car-makers brought Detroit to its knees.

But while the 1990s did bring the fall of Detroit, it is often forgotten that, in the same period, Japanese companies like Nissan and Toyota invested over a trillion dollars in the American economy, creating 700,000 jobs in the process9.

The growth in Chinese acquisitions will not happen overnight. If one believes in free markets and in the principle that, in the long-term, firms exposed to competition will fare better than state-picked ‘winners’ mollycoddled with easy financing, then one can hope that the rapid development of Chinese firms large enough to acquire established Western corporations can only happen if there is greater economic liberalisation in China.

Liberalisation is a two-way street. Chinese brands profiting from the purchase of Western firms is only one side of the story. In December 2004, at the annual Central Economic Work Conference, the top brass of the Chinese government agreed to transition from growth led by investment and exports to a development path that relied more on domestic consumption. Higher wage costs, a strengthening yuan and a rising middle class are all factors helping China execute this rebalancing. In May, Coach, the American accessories brand, announced that it would halve its Chinese production operations, shifting the manufacturing to countries such as Vietnam and the Philippines where wages are lower. This may be an indication that, as mentioned earlier, the Chinese monopoly of low-wage manufacturing is nearing its curtain call. Perhaps more strikingly, Coach simultaneously announced plans to increase revenues from sales in China to $500 million in 2014. Over the last year alone, Coach has doubled its revenues from sales in China to US$100 million. Coach is just one of several American and European firms expanding into China to grab a chunk of what promises to soon be the largest consumer market in the world.

It is increasingly clear that economic liberalisation will lead to the interdependence of the Chinese and Western economies. The tremendous Chinese appetite for American Treasury bonds only increases the extent of this mutual dependence. Large Chinese corporations should compete with established American and European brands on the global stage, bringing benefits of lower prices and greater choice to consumers around the world. Yet it should not be assumed that it will all be plain sailing. The conflicting political philosophies of China and the West, for instance, may pose problems. The Chinese government is often lambasted for its hostile attitude to foreign firms doing business in China - a criticism underscored by Internet search giant Google’s retreat from China early last year. Indeed the Chinese establishment must recognise the merits of free competition – more efficient firms, greater choice for the consumer, and less corruption, to name a few. But the West, too, should relax its protectionist mentality. The difficulties faced by Anshan Iron & Steel’s bid to invest in a Mississippi steel mill contrast sharply with Tianjin Steel’s smooth billion-dollar investment in Texas. This nervy politicisation of issues of foreign investment is hindering bilateral trade relations. But these security concerns should die down once the West realises the fruits of mutual dependence. The acquisitiveness of Chinese firms opens originally Western firms to new markets in China and neighbouring countries just as the liberalisation of the Middle Kingdom and its citizens’ new-found wealth unlock doors for American and European firms. Though all three regions should approach intertwined growth with caution, they should realise that the global economy is not a zero-sum game.


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