China Business Blog and Podcast

Download this podcast

Audio clip: Adobe Flash Player (version 9 or above) is required to play this audio clip. Download the latest version here. You also need to have JavaScript enabled in your browser.

Full transcript of today’s podcast:

How the past few years in China will be described later in history is anyone’s guess. It is likely that variations on phrases like “the go-go years,” “economic renaissance,” and “Years of Plenty” will be thrown around with the sage-like wisdom that comes from perfect hindsight. However, this era in China is much more difficult to define from the inside looking out and, too often, voices of gloom, doom and panic rise above the din.

A recent article in the New York Times posits whether “Booming China Suddenly Worries That a Slowdown Is Taking Hold” and says that “Economists expect growth to slip from its recent pace of 11 percent or more annually to as low as 9 or 9.5 percent over the coming year.” The author goes on to note, correctly, that most countries in the world would give their left economic indicator for 9.5% growth (the U.S. didn’t even reach 2% growth in 2007 and, in 2008, is drifting into the oxymoronic “negative growth” territory). However, the several point drop is a reflection of reality in China – exports here are slowing, some factories are closing and people are losing jobs. So what is one country’s Dream Scheme is another’s nightmare scenario.

I think, though, that is critical that we fully admit that China is in a very different place from where it was 10 years ago. In 1998, China was coming up on the 10th anniversary of Tiananmen Square and, although the nation had made immense strides since the tragedy, the end game as a “world power” was not yet apparent. Investment in infrastructure was ramping up at an amazing speed and we had just started using the first elevated highway here in Shanghai – the lack of cars on the road made an incredibly smooth trip … until the highway unceremoniously ended and one was forced to dive back down into the sea of bicycles and horse carts. The auto boom had not started and personal purchasing power was still far from the tipping point of an average of $1,000 per person. Color TVs were a big deal as were VCRs, the 8-track tape of the X-generation.

Remember that we were still seeing double-digit growth here and, depending on which figures you believe, China was growing between 10% and 13% per year. However, that was growth off of a smaller base and, as an “emerging market”, we kind of expected it to grow like that. It was – in its own odd way – “normal.” We expected it. China’s stock market was not yet the butterfly who, when its wings flapped 9 years later, would cause a 2% drop in the U.S. markets and send Asian stocks into cardiac arrest. No, it was normal; small town of a billion people normal; cute, emerging market normal.

Now the time has come to recalibrate “normal.” China is no longer an “emerging market.” You can call it “developing,” “modernizing,” “maturing,” but the dragon is no longer a cute lizard, peering out from its den – it has emerged, full grown and breathing fire (as a side note, in over 20 years of writing about China, I have avoided using a dragon metaphor – now I am not sure why I was so reticent … that felt pretty good!).

China is the world’s 4th largest economy. Number one in population, internet uses and cell phone subscribers. It has more roads and rails than the U.S. and its newly-built Beijing airport puts the new Heathrow terminal to shame. It was built at China prices – 50% of what Heathrow cost to build – and, if my sources are correct, has more and better signs in English!

So “normal” can no longer be 11% growth. 11% is not sustainable. China has already been sprinting several marathons and is beginning to show signs of strain. Cities are bursting with a migrant population said by some to be as many as 200 million people. The 20 year old factories – many of them in southern China, the first area to reap the benefits of economic reform – are showing their age and, because they are making low cost, low quality goods, they are being shut down. Like the U.S. shipped commodity manufacturing to Japan who sent it to Taiwan who sent it to China, so China is passing it along to Vietnam and Cambodia.

You know what? This is “normal.” This is what SHOULD happen. There was a hue and cry last year when, in an onslaught of regulatory fisticuffs, the Chinese government pulled back VAT rebates, instituted a new labor law and raised the tax rates on foreign companies doing all but the highest value manufacturing in China. This is what the “Four Tigers” of Taiwan, S. Korea, Singapore and Hong Kong did in the 80s, shipping manufacturing off to China and started it growing in the 90s. And now that their GDP per capita numbers are nearing or even above the U.S. and several orders of magnitude above China, their average GDP growth numbers are many points below China’s. They have had their challenges in the last few years – closing factories, inflation, social unrest. And that is … well … “normal.”

The biggest question, then, is: “Can we all handle ‘normal’?” In a future Podcast, I will address what we see the Chinese government and private Chinese business doing here to get to normal. But what about foreign investors in China.? Should this “slowdown” be a cause for concern and, if so, what should we all be doing about it?

First of all, I think it is a mistake to think that the shuttering of low-value-add factories in southern China somehow constitutes a referendum on China, that it is no longer an attractive place in which to invest production assets. The growth that we are seeing in Shanghai, up north around Beijing and out in Western China – particularly around Chengdu and Wuhan – would suggest that we need to look a bit more carefully on just where the growth is happening and what “kind” of growth it is.

I was meeting with a client the other day for whom we are doing some market entry strategy work. In our day long session, we looked at the market intelligence we had been gathering for several months and some of the conclusions we had drawn. Our client is in a rather traditional consumer market which is quite large in China – nearly 20 billion US dollars. Our forecast of the market size said that the growth would be slowing down, from a rapid 12% to less than 5% in the coming five years. That was a sign, we said, of a “maturing” market – the outside of the pie chart would not be expanding all that fast any more. However, the interesting part – particularly for our client, a supplier of high-value and design-intensive products – was that the inside of the pie chart would see very rapid and dramatic changes with a large, high-value segment becoming very apparent as Chinese consumers started to gain experience, feeling more comfortable choosing between alternatives and forming strong opinions and brand loyalty.

In the same way, while the overall Chinese economy might be “slowing” (again, if 9.5% growth can be called “slow”), then foreign companies need to look to what is happening inside the market and spend the time parsing out the segments in which they can find some real and sustainable growth. In most cases, these are segments that are moving up the value- and quality curve. China is no longer willing to be the manufacturing capital of the world – rather, they want to be the value added production capital of the world . If foreign companies have products, technology, processes, distribution channels and customers that they are willing to invest, there are plenty of opportunities here to invest it. Don’t get me wrong, there are also plenty of opportunities here to LOSE it and, we foreigners being the naïve and power-of-positive-thinking people that we are, we are going to get suckered. But do your homework, identify that specific part of the market that needs what you have, and, with hard work, blood, sweat, tears and a few starter ulcers, you should be just fine.

So should, as some suggest, that we respond to this so-called “slowdown” by moving manufacturing from China to other, lower-cost environments? I tell you, I get asked this question EVERY day (journalists love the yes-no dichotomy of it). However, it is not that simple. I hate to sound like such a consultant, but my answer is “it depends.” It depends on where your products are being shipped to. If you are going after those segments of the China market that are still growing at unbelievable rates (like automotive, aerospace, chemical, medical products of all kind, some consumer segments) then you are going to want to be producing in China – what is often called “local for local.”

However, if your operation is going to be primarily for export, then looking outside of China might not be a bad idea. A client of ours – in the home furnishings space – did the calculations on a new export-only facility originally intended for China and we are thinking now that Vietnam might be a good opportunity – it is still hungry for low-value manufacturing, has good investment incentives, a cheap labor force (you see, Vietnam is still an emerging market … they are just like that!). The factories that are closing here in China are those that are already export oriented and are so inefficient and poor quality that they could not survive without being propped up by preferable VAT rates and a regulatory environment that would turn a blind eye to employee abuse.

In the emerging market days in China, we were operating in a zero-gravity environment and congratulating each other on how high we could jump! Now China has been moving towards a “normal” environment – albeit a “China normal” – and our feet feel like two slabs of cement bolted on to our ankles. The one thing that “reduces gravity”, if you will, is to find a local market for your products, so not only are you getting a lower manufacturing cost when compared to the developed markets of the U.S. and Europe, but you are also getting some “lift” from the local sales. In previous Podcasts we have called this the “dual strategy” – to look at a market as both a site for low cost production AND as a place to grow your top line revenue through new sales – and this is never more crucial to adopt than in a “normal” environment.

So, to return to our original question: should the so-called “slow down” be a cause for concern and is it a signal for something – maybe an ominous something – on the horizon? I would answer a qualified “yes” to both halves of that question. Yes, it is a cause for concern, both for the Chinese government and companies here, because factories closing and consumer costs rising have a real impact on real lives. And no one can afford the ramifications of social unrest should things get out of hand. It is also a cause for concern for foreign investors to have been so used to zero gravity that they feel like a lead balloon.

And yes, it is a signal for something – but that something should be called “normal.” This is what China should be doing as it matures and changes. We should not be surprised. Does it bode ill for the future? Well, remember that so-called “normal” in China is still a 9.5% annual growth with a population of over 1.3 billion people and a middle class of a quarter billion people with an increasing global consciousness and money to burn. That “normal” still swings a pretty big stick in global markets and, if not met head-on and with deep intelligence to its inner workings, could cause companies in the West some major trouble.

Will China be able to make this transition successfully? Will we foreigners provide the proper mix of encouragement and in-your-face pressure to help them along this path. I don’t know. Ask me in 10 years and I recount, in minute detail, what happened and will assure you that I knew that it would happen this way.

Thanks for listening. Remember, in China everything is possible, but nothing is easy. We’ll see you next time on the China Business Podcast.

This entry was posted on Friday, August 8th, 2008 at 9:43 am and is filed under China, economy, podcast. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.