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“China’s Business Outlook in the Midst of Economic Downturn”

Post Series: 2009: Volume 8, Number 1
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China’s Business Outlook in the Midst of Economic Downturn

As China celebrates 30 years since the starting point of Deng Xiaoping’s economic and political reforms, the Southern Center for International Studies and the China Research Center held a joint program to review China’s economic situation and future projects. The program consisted of an open panel discussion followed by a not-for-attribution discussion between the panelists and a number of business executives whose companies were deeply invested in China.

The conclusions reached were a mixture of significant concern over the substantial challenges the country now faces and guarded optimism because of its huge achievements. China now has the world’s third largest economy and substantial resources to deal with the difficulties ahead.

The problems are only partly due to the severe global recession and the resulting collapse of its world export markets, on which its economic growth has been based. In fact, these challenges are even more a result of its rapid economic growth and its political and economic structures. In response, to the contraction of private and state owned enterprises, the central government will be forced to take strong actions and commit huge resources to maintain political social stability.

The Challenges: China faces a number of broad challenges to its business outlook, such as tremendous environmental concerns (air pollution, water shortages, etc.), an almost non-existent social safety net, an aging population tied to the one-child policy, a potentially volatile sex-ratio imbalance, a cash-in advance medical system, a lung cancer crisis, etc. Within this “fragile” context, the country also faces a number of immediate issues tied to the current global recession, including:

  • A drop in economic growth, possibly from 9.3% to 7.3%, but the actual figure is debated. The growth in industrial production has fallen to 4.4%, which has led companies to destock inventories. [Subsequent reports indicate that year-on-year for the 2008 4th quarter was 6.8% and seasonally adjusted output was flat]
  • Some 20 million migrant workers are out of work, and significant numbers of college graduates and discharged soldiers are not finding jobs.
  • Some foreign-tied businesses—which work on small margins and produce for export—are having a hard time because they have to pay a month’s severance for every year worked at the company to their laid off workers, but they do not have the cash. Some Chinese owners/operators just disappear, and when workers show up, their jobs are gone; looting can be the result. At a factory whose largest customer was Mattel, the owners left and took the tools; the police had to surround the building. The supply chains tied to these factories are also feeling the effects.
  • Foreign businesses are doing a lot of risk management, such as putting their products and their machine tools/dies under lock and key until orders come in, and calling their suppliers (and their suppliers’ suppliers) to make sure all is going well.
  • China also has rising labor costs compared to other East Asian countries, such as Vietnam, due to new laws and social protections. Some businesses have started moving their operations to take advantage of the cheaper labor.
  • While the world economy is interconnected and China is an important and increasingly responsible actor, the country has made it clear that it has no will or capability to challenge the United States for global leadership. It was emphasized that if you talk to Chinese officials, you understand that the Chinese economic situation is grim partly because it is “coupled” with the United States.
  • At the same time, Secretary Geithner’s statements about China manipulating its currency are sparking friction and nationalism. Another example of the nationalist response has come with recent coolness toward French President Sarkozy because of his meeting with the Dali Lama.
  • On the domestic front, growing unemployment and increasing protests are also pushing the government toward overt nationalism as it tries to drum up its legitimacy. To this end, this year there will be a big military parade in China, as many anniversaries are coming up (30th anniversary of the onset of economic reforms, 20th anniversary of the Tiananmen Square “incident,” 10th anniversary of bombing of the Chinese Embassy in Belgrade, etc.).
  • The Olympic games, the governmental response to the 2008 earthquake, and the 2008 crackdown in Tibet all fit into the nationalist/legitimacy equation.
  • Partly because of nationalism, China will not depreciate its currency. The country will rather reinstate export tax rebates as it looks to what actions might stimulate exports and help address the current economic downturn.

The Opportunities: Despite the challenges, there are also some important positives, including:

  • UPS still has significant business growth in China. 18% of product costs in China are tied to logistics; the figure is 10% in the United States, so there is still room for improvement in line with 2 big logistics concepts, Just in Time and Pool.
  • China is currently making big stimulus investments in infrastructure, supply chains, etc. It is also important to note that China could markedly develop its domestic consumer market, with UPS moving goods into China as opposed to out of China. UPS has a big new hub in Shenzhen and invests in significant numbers of local employees because of the importance of local market knowledge.
  • China’s stimulus is not just focused on infrastructure, but also health care, education, etc. There is some movement toward a renewed focus on rural areas, which have been neglected in the post-Mao era.
  • It was pointed out that China bounced back from the 1997 Asian financial crisis rather fast.
  • The situation in China today was compared to a brushfire, with weak factories (the undergrowth) being cleared out.
  • The 20 million unemployed migrants are 15% of the labor force. However, there is little debt and huge savings in China as a result of having no social security system, among other factors.
  • Some sectors are still doing well, such as industrial motors and high tech products.
  • It was suggested that China has the opportunity to overhaul its economic model, shifting away from growth based on cheap labor/land and environmental neglect. The downturn is a golden opportunity to change its exploitative authoritarian capitalism and move up the economic food chain, as has been done by other East Asian countries. The government has manipulated its VAT tax (and refunds) to this end.
  • Also, with China’s aging population, productivity will have to rise (i.e., the country has to move up the food chain).
  • It was emphasized that stability is important, and there were 80,000-plus popular protests last year. There is also male-female ratio imbalanced, which adds to social volatility. To this end, the U.S. needs to avoid protectionism and not place too much pressure on the Chinese. There is an opportunity for North Americans, Europeans, and Japanese to work as a team on some of the issues China presents, but they have to be careful because of the country’s cultural traditions and historical memory.
  • It was also pointed out that North Korea remains the biggest issue in Asia today and China has been important in dealing with this issue. At the highest levels in China, political decisions will be made for economic reasons, as Chinese are very pragmatic. The owners of the economy are from the CCP and their families.
  • While there are 20 million migrant workers that are out of work, they can still go home because they still have family in the villages (though this causes its own tensions). This advantage won’t exist in 20 years as traditional village life changes and urbanization continues. Another cushion to the downturn is that government and citizenry have lots of cash. Investments in the stock market are at the margin, rather than representing the savings of society.
  • While corruption exists, it has gotten more regularized and predictable. Also, in the biggest cities the government can no longer just move people out of their homes as development occurs. Land can be 50% of the cost of a project.
  • More development is occurring through the tender process, rather than just through personal negotiations. The Chinese have gotten better at getting a reasonable market price and the right builder. It is still often advantageous to have Chinese partners, even if 100% foreign ownership is allowed. While there has been a clear evolution in relationship building, protectionist moves by the U.S. would spark a tit-for-tat battle, with wrenches thrown into business deals.
Other Observations and Anecdotes:
  • It was pointed out that education is highly valued, but if your child doesn’t get into the national university, you must go to lesser schools with high fees. There are 1 million school children dropping out of the system because of the high fees annually.
  • Chinese leaders live with the specter of political liberalization in the USSR. Any leadership changes in the coming years will probably not dramatically further political liberalization. Still, there can always be unforeseen episodes that can spark unforeseen consequences.
  • Two areas where the Chinese government policy is unlikely to change are Taiwan and Tibet. The people support governmental stances on both of these issues. For the West to keep loudly pushing for the government to see the light is not conducive to positive relations.
  • Anecdote on nationalism: At a Chinese chain restaurant after the 2008 earthquake, one participant tried to order a Coke, but was told that since Coke did not adequately come to the rescue of the people, they were being boycotted. In actuality, Coke had offered significant aid and had nothing to do with the earthquake. Another example: Walmart is now the number #1 retailer in China and is being watch very carefully.
  • Broadly put, rumors can get started that are not true, but are hard to stop. It’s important to have contingency plans if you run afoul of the government, like having access to another airport if the one you’re using is blocked.
  • China is different from Nigeria or Brazil; you have to know these differences, and they are evolving.
  • There are Chinese companies that want to work with U.S. companies as opposed to Chinese ones because of perception. But you have to know the system, find local partners, and be wary of the fact that each city is different in China, though this fact is offset by nationalizing experiences (ex: national TV).
  • For the central leadership the priority is stability; for regional leaders its sustainability (regional leaders want to move up supply chain, while the national government wants employment and stability).
  • The social safety net is a big factor. Chinese companies now must increasingly contribute to health care and pensions, but it’s not portable, so workers can be stuck. Still, it’s evolving and adding a social safety net boosts consumption over savings.
  • The 1980s generation will protest not having a job, because this is what they see they get out of the social bargain. But the market has only gone up for them to this point, and inequities in the development transition can spark protest.
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