Monday, October 26, 2009

BW: China's Economy - Behind all the Hype

An interesting story in BusinessWeek in light of some of the comments we've received by some readers on recent entries regarding China - specifically long term competitive threats and lack of innovation. I think these issues in the story are very valid but people have a very short term time frame when viewing them.  What is lacking today can change over the course of 1-3 decades; it won't change overnight.  There is a reason China demands joint ventures if you want to do business in the country... knowledge.

In case you missed it China reported 8.9% GDP for the 3rd quarter last week but please take whatever is said from any government with many grains of salt. [Aug 5, 2009: China's Provincial Growth Figures Far Overstated versus National Figures]  And as we see in the U.S. there will be costs for today's gains.

  • China's economy grew 8.9% in the third quarter compared with a year earlier as massive government spending continued to lead the nation out of the global economic crisis.  Beijing has used a $585-billion stimulus plan and $1.27 trillion in bank lending this year to drive the nation's recovery.
  • China has seen modest improvements in exports and retail sales, but investment continues to constitute the overwhelming bulk of the country's growth. About 88% of the country's GDP growth in the first half is tied to investment spending

Via BusinessWeek:
  •  That sense of triumph permeates China these days. The mainland's quick rebound from the worldwide financial meltdown seems to have vindicated its brand of state-led capitalism. As the West struggles to recover, China is on track for 8% growth this year and is about to overtake Japan as the world's No. 2 economy and Germany as the No. 1 exporter. Now the mainland is charging ahead in new industries, unveiling homegrown airliners, electric cars, and high-speed trains
  • But delve beneath the muscular statistics and hype about advances in strategic industries, and China doesn't seem so prepared to catapult into a role of global economic leadership. Experts familiar with highly touted Chinese achievements such as commercial jets and high-speed trains say the technologies that underpin them were largely developed elsewhere. There is no Chinese Sony, Toyota, or Samsung on the horizon. 
  • While Beijing's $586 billion stimulus package and a 150% increase in bank lending have spurred impressive growth, "the question," says Morgan Stanley (MS) Asia Chairman Stephen S. Roach, "is the quality of that growth." 
  • By Beijing's own admission, the economic model that has powered China for three decades can no longer be counted on to move it forward. [Jan 8, 2009: NYT - As Trade Slows, China Rethinks Its Growth Strategy] [Dec 7, 2008: NYT - China's Economy, In Need of Jump Start, Waits for Citizens to Loosen Fists]  The mainland has prospered largely through construction and by exporting all manner of consumer goods churned out in low-wage factories; workers parked their savings in state-run banks, which then loaned the money to companies to make more stuff. But technology and managerial know how came mostly from multinationals, and the costs—pollution, decaying social services, and a yawning gap between the urban rich and rural poor—were largely ignored. Though that model has fueled phenomenal growth, Hu and others now call it "unbalanced" and "unsustainable." 
  •  So in recent years, Beijing has been heralding a new economic vision. The key elements: Grimy factories will give way to renewable-energy industries and a growing service sector; Chinese consumers, rather than stretched Americans and Europeans, will underpin demand; and instead of churning out me-too goods for little profit, Chinese companies are supposed to create innovative products based on home-grown technologies.

Are market oriented initiatives losing steam?
  • Over the past three years a steady stream of directives flowing from a raft of ministries and the National Development & Reform Commission—successor to the old central planning agency—have tightened the state's grip on the economy. In June, for example, the commission ordered that wherever possible only goods made by Chinese-owned companies be used in any project funded by the government. 
  • The state's comeback is easy to spot. The vast majority of new loans are now going to government-controlled enterprises, for instance, while less than 20% end up at small and midsize firms, which tend to be private, Standard Chartered Bank estimates. 
  • And in strategic industries from wind turbines to nuclear power generators, Beijing is favoring its national champions and trying to whittle down the role of foreign companies. "They are rolling up the red carpet," says Joerg Wuttke, president of the European Chamber in China, which recently released a 584-page white paper arguing that China has hit the brakes on opening its economy. Says a U.S. trade official: "China's focus seems to have shifted from accelerating market reforms toward a more state-controlled model. It is very worrying." 
  • Clamping down on the ability of foreigners to do business in China would make life easier for Chinese companies at home; the downside is that it would let them avoid honing the skills needed to succeed outside the mainland. And funneling funds to state companies and connected insiders leaves creative entrepreneurs starved for capital. 

Innovation Lacking...
  • China has a long way to go, though, in innovation. The mainland has dramatically boosted research spending and boasts the world's biggest pool of science and engineering graduates. But aside from Internet games, the country creates few breakthrough products, due in no small measure to the perennial problem of rampant counterfeiting.
  • Instead, most mainland companies mine existing technologies and compete on high volume and low cost in commodity goods.
  • Some Chinese industrial policies have flopped. Beijing has long viewed semiconductor manufacturing as a key industry, for example, and eight new silicon wafer plants—some heavily subsidized—have been built just since 2005. The aim was to start out competing as low-cost contract manufacturers for foreign chip design firms. But China's wafer factories rely on technologies that are at least two generations behind those of Taiwan, the U.S., Japan, and South Korea, and few have ever been profitable. At the nadir of the recession last winter, 60% of China's capacity sat idle. 

  • . "Japan and South Korea took 30 years to make a similar transformation" to an economy driven by innovation, consumer spending, and services, says Guangdong Academy of Social Sciences economist Ding Li. "Our expectations can't be too high."

It's an interesting article; that covers the first half ... see the link in the first sentence of this piece if interested in the main topics of the second half.

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