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Saturday Feature
Preparing for the future

          China's economic takeoff since the launch of its economic reforms bears no comparison with the "economic miracles" of other Asian countries. Over the last 25 years, China's wealth in terms of purchasing power parity has grown from 4% to 14% of the world total. Cement production has grown eightfold, power production fivefold and steel output has quadrupled. Despite China's population growth -an increase of 320 million people since 1978per capita wealth continues to rise 7% to 8% annually. In 2004, China's gross domestic product (GDP) already stood at some $1,900 billion, placing it in sixth place worldwide. By 2005, this figure had risen to $2,226 billion, overtaking France and the UK to make China the world number four.
Yet the country's impressive growth should not over- shadow the sweeping changes that have both accompanied and driven economic development. The fact that China is riding the top of wave of glolbalisation is not so much due to its competitive edge (abundant and disciplined manpower, domestic market potential, etc.) as its ability to use market forces to gradually transform and modernise its economy. Over the last 25 years, China's economic structures and mechanisms have evolved so much that the country is now seen as exceptionally open given its huge size. And although China is still far from having a true market economy, it has come a long way since the Statecontrolled, planned economy that was still dominant just ten years ago. This is evident from the three major transformations that the country has undergone.
In recent decades, Chinese industry has Surged ahead in leaps and bounds of diversification and upgrading. But even more remarkable has been China's ability to forge ties, both upstream add downstream, with other countries to improve its productivity and boost its market share. A key factor in this process ,vas the arrival of large numbers of foreign companies starting in the mid-1980s. At first, most incoming firms hailed from nearby neighbours (Hong Kong and Taiwan), and then from countries the world over (Japan, the United States, Europe, Korea and Singapore), This foreign investment boosted China's production capacity, but more importantly developed the local fabric of suppliers and helped it improve both its manpower skills and production techniques. This gave the country the wherewithal to swiftly develop its know-how and boost its competitiveness without going into debt. Large multinational retailers moved into China, driving the nation's economy further by opening up new outlets and giving local businesses a strategic incentive to become accredited suppliers. All of this helped Chinese industry to climb the value-added ladder, In the 1980s, China was producing ready-to-wear clothing, toys and general household goods. By the 1990s, its factories were turning out TV sets and other household appliances, and today China has moved up another rung to manufacture consumer electronics (telecoms and IT equipment).
All of this has made China's volume of trade grow faster than the economy as a whole. From 1978 to 2005, total foreign trade soared from $21 billion to $1,410 billion (leaping from 10% to 70% of GDP). In the same period, Chinese exports increased from 2% to nearly 7% of the world total. But this rise to trade prominence has a downside: foreign-owned companies now generate 57% of China's foreign trade and 31% of its industrial valueadded. And it seems the more buoyant the industry, the greater the foreign presence: 70% of total turnover in telecoms and electronics, 45% in transport equipment, 47% in clothing and 44% in the plastics industry.
Right from the start of China's reforms, the decision to allow numbered bank accounts and cash transactions, even for large amounts, was a crucial factor. The money in circulation in the economy immediately shot up and the banks began to play a central role, which they still play today (bank assets currently amount to 210% of GDP). Household savings, virtually non-existent in 1980, grew steadily to 87% of GDP by 2004. This is not so much due to the rise in living standards. China's household savings rate (25% of disposable income) is one of the highest in the world largely due to the disappearance of the old social security systems (only 20% of the labour force is covered by some form of social security, and even this is often inadequate, especially when it comes to pensions).
This means that tax and social security contributions are low, but workers have to make their own financial arrangements for retirement and their children's education. Moreover, this money has to be invested in China (there are still numerous restrictions on transferring capital offshore), which usually means investing via banks to avoid China's floundering financial markets. This pool of investment funds has been a Source of cheap financing for economic takeoff and restructuring without creating government indebtedness (unlike the situation in Russia and other Eastern European countries). This is why China's public finances appear to be healthy and put to good use: total public debt is just 23% of GDP and the budget deficit is gradually being reduced (to a forecast 1.5% of GDP this year). Admittedly, the need to make provision for the local authorities' hidden debts and the banks' had debts (which are also, in a sense, part of the downside of Beijing's healthy finances), as well as for unfunded pension commitments, could well place a huge burden on future purse strings (probably 50% to 100% of today's GDP). Yet strong growth in China's future revenues should free up plenty of room for manoeuvre to meet these commitments.
In the medium term, three major changes are likely to affect the way the Chinese economy generates and sustains growth.
Firstly, the service sector looks set to develop. The Chinese authorities have recently woken up to the value of services as a source of employment and productivity gains. A future boom could be driven by strong demand, particularly from middle-class city dwellers as people continue to flood into the cities (12-15 million people per year) and the middle class becomes more well-off (at least +8% per year in earnings at constant values). Both these trends are clearly shaping up. As living standards rise, Chinese households are naturally inclined to demand more sophisticated services and spend a larger share of their budget on them. So the demand for services should increase both in the "traditional" segments (restaurants, hotels, retailers, estate agents, etc.) and the more sophisticated segments (education, health care, financial services, etc.). Another growth trigger here will be the liberalisation of the service sector. The Chinese authorities have made firm commitments to this, especially in their negotiations with the World Trade Organisation (WTO).
The second change is the forecast growth in household consumption. As the authorities clearly stated in China's 11th Five-Year Plan (2006-2010) -which although now merely guidelines, is nevertheless indicative of the country's priorities- the main concern for China is no longer to maintain GDP growth but to improve common prosperity for all. This is an enormous undertaking that could take years to accomplish. The programme will have two main thrusts, The first will be to increase purchasing power in the countryside. In addition to the tax policy already announced by the authorities, this will involve a number of sensitive and delicate reforms (opening up some remote regions, price control for farm produce and restrictions on moving to the cities). Secondly, it is fundamentally important to set up a broad-based social security system based on universal contributions (for health care, pensions and unemployment) in the towns and a minimum safety net for farmers and the cities' underprivileged ("peasant workers" and redundant public-sector workers). Only by providing a sense of security will the authorities reduce precautionary savings and enable households all over China to spend more of their income on actual consumption.
The third change is that Chinese companies will be increasing their value-added. Chinese industry's valueadded currently averages barely 26% of turnover, compared with a value-added rate of 49% in the United States, 48% in Japan and 38% in Germany. A good example of China's situation here is the telecoms and IT equipment sector. In the space of just six to seven years, China has become a world-class manufacturer and exporter of these goods, but its factories still have a value-added rate of just 22%, compared with an average of 57% in the industrialised countries.
China is now pursuing a three-pronged strategy:
* to add greater value during production, by attracting more foreign technology and devoting more of China's resources to R&D. China could hence benefit from the growing internationalisation of today's R&D just as it has capitalised on the globalisation of production networks for the last 20 years. Foreign companies have recently set up some 400 R&D centres in China.
* to achieve technological mastery at source, either by acquiring foreign companies or developing Chinese standards in areas such as video and telecoms. Most of China's recent acquisitions or bids (Rover, Unocal, Alcatel, etc.) have been motivated by this huge drive to catch up technologically.
* to enhance China's national brand image and gain a good command of distribution channels through to the developed countries.
A study by the Economist Intelligence Unit (EIU) reports that most of China's top-performing companies regard raising their profile as their priority strategic objective. They are therefore investing in innovation and communication, but half of these companies are also entering into partnerships with foreign companies (alliances, joint ventures, mergers & acquisitions) intended to bolster their position in the value-added chain. Such is the reasoning behind a number of recent initiatives by Chinese firms: TCUs acquisition of the RCA brand from French company Thomson, Lenovo's acquisition of IBM's PC division, and Haier's bid for US company Maytag. This is undoubtedly a necessary development step if Chinese brands are to become high-profile and firmly established in an increasingly competitive world market.


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