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China

Date 07/06/2004

Ray Heath

Ever since Deng Xiaoping told the Chinese in 1992  that to get rich was glorious, the eventual emergence of the world’s most populous country as an economic powerhouse has been assured. What was not immediately recognised was how rapidly  Deng’s vision of  “capitalism with socialist characteristics”  would mean a seismic shift in economic power throughout Asia, and the rest of the world.

The recent breakneck speed of China’s economic growth, its surging industrial production and powerful magnetic attraction for outside investment suggest that shift is now well underway, despite the obstacles that still have to be cleared before China emerges as a fully modernised economy.

In the eighties, economists talked of the Flying Geese theory of Asian development. Japan was then leading the flock as its aggressive global expansion built it  into the world’s second largest economy. In turn, it was supposed, the smaller economies of South East Asia would follow the lead, and the concept of the Pacific Century was born.

Instead, the geese crashed to earth. Japan’s bubble economy imploded  in 1989 sending the country into a deflationary spiral. In 1997, Asia reverberated to more bursting bubbles as Thailand, South Korea and the rest of the region paid the price of  reckless pump-priming, crony capitalism and irresponsible bank lending.

Now, once more the geese are flying, but this time it is China which is at the head of the flying wedge which has set out on a journey which many  economists believe will finally fulfil the promise of Asia’s economic development. What few factored into their calculations were the signs of a revival now appearing Japan’s economy which, if sustained would mean  Asia’s development would be driven by two powerhouses.

Measured by gross domestic product, Japan and China are ranked first and second in Asia, but at US$3.9 trillion, Japan’s GDP in 2002 was  three times that of its massive neighbour.

However the tables are turned when the economies are measured through purchasing power parity (PPP):  China’s $5.7 trillion easily outstripped Japan’s $3.5 trillion.

Yet, spread that amongst the one billion plus population and China remains  an also ran in Asia. In 2002, Japan’s per capita GDP led the region, at  US$28,000 , closely followed by tiny Hong Kong with $26,000. China was a lowly ninth –its figure of $4,400 putting it behind Thailand. (Figures based on IMF data).

2020 Vision

  China’s new younger leaders who moved into power in 2002 are all too well aware that one of the principal measures of their success is rapidly  moving China’s per capita GDP up the rankings – and in November 2002 the   16th Congress of the Communist Party of China unveiled ambitious targets through to 2020.

Reported the Asian Development Bank in its 2003 report on China: "The new Government's overriding goal is to maintain steady and rapid economic growth to improve living standards, and it intends to achieve this through strategic economic restructuring and continued opening up to the outside world."

The plan called for a  quadrupling 2000 GDP by 2020, which would make the China the world’s third largest economy, with a per capita GDP – in non-PPP terms – of $3,000. For a country where a large proportion of the rural population lives  below the poverty line, with at least 150 million without jobs, this is an ambitious target indeed.

How was this to be achieved? Outgoing  Party General Secretary Jiang Zemin set out a series  of measures  which included improving the market economy; accelerating modernization; sustained, rapid, and sound economic development; and steadily raising people's living standards.  The ADB reported that Jiang’s speech reflected a widening of the government  agenda beyond simple GDP growth, and it now also embraced reduced unemployment; sustainable economic growth; stable prices; and a favourable balance of payments.

Achieving these targets will not be easy, warned the ADB. The government  has to face the risks of social upheavals caused by massive unemployment and the lead weight of a universal social security system; fiscal issues; and improperly functioning markets. Corruption is a cancer which affects all levels of government and commerce; much of the country’s industrial areas are pure rust-belt, populated  by moribund Sate Owned Enterprises whose debts – most of which will never be repaid – have dragged the banking system under water.

AS well as unemployment, social stability is threatened by the massive disparity  in incomes in China – the highest in the world according to a report by the Chinese Academy of Social Sciences.

Urban  residents earn more than 2.8 times the average wages of rural people, and while a new generation of entrepreneurs and  professionals buy Gucci, Mercedes and smart flats, peasants still exist on less than $1 a day.

In February 2004, the United Nations warned that the 16th Congress targets  were  threatened by such social inequality as well as the  spread of HIV/Aids and  a crumbling environment.

Dire though the warnings may be, they look out of place when set alongside China’s recent economic performance, which has seen GDP race well ahead of a the  7.2 per cent annual expansion called for in the 2020 plan.

In 2003, the Chinese economy expanded by 8.5 per cent, with the fourth quarter recording a remarkable 9.9 per cent. How long that pace can be maintained is open to doubt. While investment bankers Goldman Sachs has  forecast 9.5 per cent for 2004, Morgan Stanley analysts warn that a tightening of monetary policy,  a slowdown in construction and doubts over the US consumer’s ability keep buying Chinese made-goods will lead to a cooling off.

Old  China hands also look back to the mid nineties.  The economic miracle  seemed to be in place them, with double digit GDP growth, but behind the apparent success, massive  production bottle necks were building up, and then economic Czar Zhu Rongji had to take drastic action to rein in an economy as the dials  went into the red with inflation running at annual rate of 22 per cent.

So far, this time it is different. Despite 2003’s blistering economic  growth, inflation was well under control at 1.2 per cent, although  by February 2004, there were signs of an acceleration. The People’s Bank of China predicted three per cent inflation in its annual monetary report, and warned that it would wield its power to keep price rises in check.

The big differences that ten years have made are China’s entry into the World Trade Organization, and the massive flow of foreign direct investments which is transforming the country into Asia’s and, increasingly,  the world’s, manufacturing base.

WTO membership, which took effect in 2001, was the catalyst for a wide range of reforms and a wholesale slashing of trade-strangling tariffs

In its first year report on China’s WTO  membership, the ADB found that  import tariffs had been reduced from an average of 15.3% to 11.0% by early 2003; laws and regulations modified to make them WTO-compliant;   the legal/regulatory framework improved to protect intellectual property rights; ) restrictions eased on foreign investment (e.g., telecommunications, insurance);   qualified foreign institutional investors allowed to participate in the domestic stock market; and  the removal of some restrictions on foreign banks doing business in the local market.

The easing of restrictions on foreign investment, the prospects of participating in what will be the world’s largest consumer market, and an abundance of cheap and willing labour has unleashed a flood of cash into China’s economy.

In 2002 the country overtook the US to  become the world’s largest recipient of foreign direct investment (FDI), and in 2003 promised investment jumped 40 per cent to $115.07 billion US dollars in 2003,according to the Beijing Ministry of Commerce.

The real take-up of investment dollars was considerably smaller – up just 1.4 per cent to $53.5 billion, but the numbers were slowed down by the outbreak of SARS epidemic which hit China and the rest of Asia at the beginning of the year. Yet by the year-end China’s  approval of foreign-funded companies had reached a  total of 465,000, with a contractual investment of $943.13 billion. Among the largest investors during the year were  Hong Kong Japan, South Korea, the United States, Taiwan, Singapore and Germany, the Ministry reported.

New sun or dark star?

China’s magnetic attraction for foreign investment has sparked  the biggest economic debate in Asia – is it a new sun whose light will nourish development in the rest of the region, or a black hole, sucking in scarce investment which would once have been destined for the tiger economies of North and South East Asia?

There is no doubt that FDI into Asia’s former favourites has slowed considerably. The impact of the 1997 crisis continued to take some of the blame, but the region’s economic recovery should have offset the effects of that shock, yet in 2003 FDI continued to contract.

The total flows into Indonesia, Korea, Malaysia, Philippines, and Thailand were estimated by the Institute of International Finance to have fallen from $5.8 billion in 2002 to $3.9 billion in 2003.

When Japan was leading the region, its search for competitive labour costs resulted in a steady flow of investment in manufacturing  plants among its neighbours. But now China has become the  major source of low cost labour, an advantage which it will hold for many years to come, given its vast population and the millions who have become unemployed as moribund SOEs have shut their gates.

Many politicians fear  China is emerging as a competitor to its neighbours not only for FDI but as an exporter in almost every sector, from textiles and shoes to motor cars and semiconductors. China was also seen as a threat to employment as multi-nationals shifted their plants and factories to the new low cost location.

Their fears were compounded by a United Nations report in 2002 which found that many Japanese corporations were contemplating closing their operations in the ten countries of the Association of Southeast Asian Nations (ASEAN) and moving North.

That forecast  has been confirmed as Asian corporations looking to boost  their profit and loss accounts have moved to take advantage of China’s cheap labour and long term market potential. Japan’s auto-makers have been among the leaders in this drive, as they race for a major share of China’s exploding motor car market as well as establishing low cost production centres to export to the US and the rest of the world.

Toyota Motor, Honda Motor Nissan Motor are all setting up plants in the Pearl River Delta, which in two decades has been transformed from sleepy farming country into the world’s workshop. Guangzhou, the city on which most investment is centred, has voiced its ambitions to become the Detroit of China, producing more than 1.5 million cars a year by 2010.

As with motor cars, so with other consumer goods. Reported the ADB: “During the last decade, the PRC's impressive export performance and ability to attract substantial FDI have turned it into the world's factory. The country now makes more than half of the world's cameras, about a third of its air conditioners, one fourth of its washing machines, and nearly one fifth of all refrigerators.”

Electronics, and particularly semiconductors represents a major opportunity which China is grabbing, possibly presenting  a major threat to other counties such as Taiwan, Korea and Singapore  which have pinned their economic development  on this sector.

China's electronics exports grew by 16.9 pr cent year on year in 2001, while those of the rest of Asia fell by 18.8 per cent.

In 2003, China's five semiconductor foundries had around  nine per cent of world capacity, but that is expected to surge to 20 per cent by end-2005, an expansion which industry insiders say will lead to massive overcapacity.

Yet investment in electronics continues to pour into the country, much of it diverted from current leader Taiwan, whose own leading manufacturers are joining the rush to set up plants on the mainland.

According to the Economist Intelligence Unit, the cumulative effect of this investment is to have made China  the fifth largest exporter after the US, Germany, Japan and France. In 2002 it  accounted for 5.1% of world merchandise exports, as export revenue grew by an impressive 22% from the previous year.

The bright side

China’s lengthening list of economic achievements may be raising concerns that they are being won at the expense of its Asian neighbours – but even if that is a long term threat, the recent economic performance shows little sign of a hollowing out of the region’s other economies.

GDP growth in East Asia accelerated 4.1 per cent in 2001 to 5.7 per cent in 2002, and, according to ADB estimates was 5.3 per cent in 2004, and should hit 5.9 per cent in 2004.

In its most recent report on Asia’s economic development, the ADB took a decidedly benign view on the overall impact of China’s entry into the WTO and its economic advances – an impact which also will be favourable to further flung economies.

“The PRC's economic development and membership of WTO will present many opportunities for East and Southeast Asia. The PRC will be those sub-regions' largest trading partner in the long term. While the country will be developing Asia's largest exporter by 2010, it will become the largest importer 5 years earlier, by 2005. The PRC is likely to develop, by 2020, a structural trade surplus with Organisation for Economic Co-operation and Development (OECD) countries and a trade deficit of about the same magnitude with East and Southeast Asia. The spill-over effects from the PRC's growth and trade expansion will outweigh trade diversion effects on East and Southeast Asia,” reported the bank, which forecast that this shift would mean “unprecedented market opportunities.”.

The unexpected strength of the global economy in 2003 can be partly put down to China’s rapid expansion, according  to investment bankers Morgan Stanley.

“In  China, industrial output surged at about a 17% annual rate in the final six months of the year — an equally impressive boost to the supply side of the global economy. The rapid growth of the Chinese production base pushed imports up at nearly a 40% annual rate in the second half of 2003; that provided a major growth impetus to China’s trading partners — a key factor behind the impressive growth performance in Japan and an increasingly important driver of economic growth in Korea and Taiwan, as well,” found the bank.

While many of East Asia’s more developed economies have spent two decades working their  way up the value chain in exports, with huge investments in electronics, motor cars and other high added value goods, China’s exports are still dominated by commodity items where its comparative advantage in labour costs – less than 10 per cent of those in East Asia – continue to provide it with an edge.

About 70 per cent of the PRC’s exports are of labour-intensive goods, and it here  that its firms can potentially  out-compete its neighbours, reported the ADB. Its massive labour surplus will ensure that the edge will continue into the foreseeable future.

“It is unlikely that the PRC will rapidly lost its cost advantage given that the large transfer of workers from rural to industrial areas will prevent wages from increasing faster than productivity,” said the bank.

There is no evidence that China’s increased share of world exports since the 1980’s has hurt the countries  of South East Asia, pointed out the bank. From 1990 to 1995 ASEAN’s share of total exports to the OECD increased -  it was other newly industrialised countries that felt the pinch.

The trade equation has been in favour of many South East Asian nations as China opened up to imports. Between 1999 and 2001, Singapore’s exports to China grew by 14 per cent per annum, reported the ADB. Imports from Japan have been rising at the rate of 50 per cent a year, and Korea, Malaysia and Thailand all run substantial trade surpluses with their large neighbour.

While physical goods dominate trade between China and its neighbours, there will be growing  potential for service industries as affluence spreads. Already China is the largest source of tourists for Malaysia, Singapore and Thailand.

The opening up of China’s financial services under WTO rules will also offer opportunities for the region’s banks, insurance and asset management companies.

The Red shift

Some economists now believe that the real China story in Asia will not be one of winners and losers, but rather of a major shift in economic power as the traditional dependence on the US and Europe export markets is replaced by growing intra-regional trade.

One of the stand-out trends in Asia, according to David Burton Director, Asia and Pacific Department, of the International Monetary Fund, has been the steady rise of trade within non-Japan Asia since the late 1970s. This reached about 40 per cent of that group's total trade in 2002, and of that, around  40 per cent of the increase was accounted for by increased  trade with China.

Putting the IMF’s view to Foreign Correspondents in Singapore last year Burton said, “At this stage, intra-regional trade provides only a limited counterweight to demand from outside the region, and the global economic environment remains the key driver of regional activity.

“Looking forward, however, demand from within the region will almost certainly become an increasingly important factor, given the rapid pace of economic growth in Asia, and spurred by regional trade initiatives.”

These  initiatives have included the creation of the ASEAN Free Trade Area,  in which the ten members of the association, frustrated by the lack of progress by the  WTO, agreed to dismantle tariffs.

The  inclusion of China, Japan and Korea into the informal ASEAN+3 has also produced some ambitious proposals, although  few went as far as those of former China premier Zhu Rongji, who in 2001 suggested that the 13 should create a powerful free trade zone with unimpeded service sector access.

The proposals remain just that, but have been given serious consideration by senior ASEAN ministers who recognise that the emergence of China as Asia’s catalyst for change will require their own   structural changes at the corporate as well as policy level if the emergence of a new global economic giant is to be an opportunity rather than a threat.

Looking back from 2020, it is likely that 2003 will be seen as the year that the seeds that Deng sowed in 1992 began to take flower. Said Andy Xie, economist with Morgan Stanley, “2003 was a year when the world finally woke up to the ‘China factor’. While China is still a very poor nation its outward-focused growth dynamic has become a critical force in reshaping Asia and the broader global economy.  The world learned that it must take China seriously. I suspect that there will be a good deal more to learn on this front in 2004.”