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China’s Changing Economy And What It Means For You

Posted in China Business

Excellent economic analysis of China by Yiping Huang, a professor of Economics at Peking University and at the China Economy Program at the Australian National University and Barclay Bank Hong Kong’s Chief Economist for Asia.  His analysis can be found in an EastAsiaForum article, entitled, “China’s New Growth,” in which Huang talks of how the Chinese government is fine with China’s GDP growth slowing to between 6 to 8 percent per year and of how that is what we should expect going forward.  According to Professor Huang, the days of China needing GDP growth of eight percent and above merely to avoid increased unemployment are over.  Super high growth was needed in the late 1990s when China’s labor force was increasing by more than ten million people per year, but not now when its labor force is actually declining.

Huang goes on to talk of how China’s external account is balancing out, its currency is probably close to equilibrium and its gini coefficient is improving.  Perhaps most importantly, he talks of how the percentage of China’s growth from consumption has risen and is likely to continue to do so, much of it brought about by rising wages, which will soon be followed by rising capital and energy costs:

I have long argued that China’s reform approach can be characterized as asymmetric liberalization, that is, complete freeing of the product markets while heavy distortions are maintained in factor markets. The generally depressed costs of production have the effect of subsidies for the corporate sector but taxes on households. This was the key mechanism contributing to both strong economic growth and growing structural imbalances during China’s reform period.

This pattern has begun to change over the past several years, starting in the labour market. Rapid wage increases squeeze profit margins, slow economic growth and escalate inflationary pressure. They improve income distribution, since low-income households rely more on labour income, while high-income households depend more on corporate profits and investment returns. Rising wages also redistribute income from the corporate sector to households and, therefore, boost consumption as the share of household income in GDP increases.

China’s new growth model is still in its early stages. So far, we have only seen the first wave of cost shocks — changes in the labour market — which have a significant impact on labour-intensive manufacturing industries. The second wave of cost shocks — a rise in the costs of capital and energy — has just started. This could affect state-owned, highly leveraged and heavy industries more dramatically because they were previously built on a distorted cost structure. Consolidation of heavy industries could lead to the first recession of the Chinese economy since the beginning of its economic reforms.

This will not necessarily lead to a period of stagnant growth, as analysts such as Michael Pettis suggest. While cost normalization would shrink economic activity in the state sector, it should benefit the non-state sector, which accounts for 80 per cent of total industrial output.

I think Huang is right and I think what this means for foreign companies is what we have been saying on this blog for years:

  1. Yes, China is still the factory to the world.  But it is also a great and ever-improving market for goods.  And I don’t want to act like a TV ad pitchman, but for most products (both consumer and b2b), the longer you wait to get into China, the greater the odds that someone else will have established what should have been your market share.  For what it takes to sell into China, check out the following:

2.  China wages and other manufacturing costs are going to continue rising. This means that if you are making a product that can easily be made somewhere less expensive than China, you need to consider China alternatives.  For more on your options, check out the following:

3.  If Huang is right (and again, I think he is), we should expect the economic power of China’s State Owned Entities (SOEs) to decline and the economic power of  China’s privately held companies to increase.  Though I think Huang is right on the economics of this, I am not sure if politics will allow this to happen. But if Professor Huang is right, the value of doing business with China’s private companies has just gone up as compared to doing business with China’s SOEs.

What do you think?  Do you agree that China’s economy is changing?  What ramification do you see China’s Changing Economy having for you or for foreign businesses in general?

  • dan berg

    There is so much wrong with this article one wonders where to begin, so start with the low hanging fruit: “Alongside the slowdown of growth, China’s economic structure has also been rebalanced.” Click “rebalanced” and you find him quoting himself in an earlier, even more confused article refering to “China’s consumption share of GDP:
    “These figures could mean that China’s long-awaited economic rebalancing has already begun.” (2/12/12) Or they could mean something else. Quick reality check: first 3 months of this year investment increased 2.76 TRILLION rmb; social financing increased 6.16 TRILLION rmb, up 2.27 TRILLION over the same period last year; and GDP slowed from 7.9% 4th qtr. 2012 to 7.7% Q1 this year. Does this look like rebalancing? Or “rebalanced”? Does this look like consumption led growth?

  • Fan Wu

    “While cost normalization would shrink economic activity in the state
    sector, it should benefit the non-state sector, which …” I don´t understand how
    he reached this conclusion. The imbalance between the Chinese
    state-owned and privately owned sectors are based on preferential
    treatments of state-woned companies with respect to access to resources,
    capital, and market, as far as this policy does not change, the cost
    normalization will hurt the private sectors much more, if not
    exclusively.

  • dan berg

    this is retail sales in China; look like consumption led growth?

    • dan berg

      sorry; there was supposed to appear a graph of retail sales here; go to macrobusiness.com for it and others;

  • http://twitter.com/theeastasiaco East Asia Co.

    China is ” a great and ever improving market for goods.”

    Not for the likes of Home Depot which closed all its stores in China last year after a 6 year experiment. It turns out that the Chinese are not into DIY home improvement. They would rather hire local craftsmen. Best buy also turned over the “closed” sign on all its China stores becuase it just could not compete with popular local brands like Suning. Best Buy was just a complete unknown to the Chinese. And the others are struggling, Carrefour, Tesco, are just not doing well against local and Taiwan competitiors. Wal-Mart and Ikea have had major problems recently, Wal-Mart becuase of a food labelling scandal and Ikea becuase of well publicized unfair practices with its suppliers in China and also issues with tainted food in its cafes.
    If these behemouths – with their Wall St. consulting teams and millions of dollars of investment – cannot succeed in China, it means it is just NOT easy. Plain and simple.

    • http://www.chinalawblog.com/ Dan Harris

      Being a foreign retailer in China is extremely hard. But there are a whole host of other ways to get one’s product into China and most of those ways are better suited to smaller players.

      • http://twitter.com/theeastasiaco East Asia Co.

        So here is a baseball analogy for you. A fire-balling 6’5” right-hander is overpowering the best hitters in the league, but you say a career .250 hitter has a chance against him ? I don’t know if I buy that. All I know is that if I saw superior players striking out against this guy I don’t think I would feel too confident about taking my cuts against him.

  • Evan Schmidt

    You talk as if State Owned Enterprises will willingly give up market share to private enterprise, just like that. Dream on. Government officials with shares and vested interests – affecting all of China’s SOEs will simply not allow that to happen.