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China — from Cultural Revolution to Industrial Revolution in one generation

Chinese economy

Executive Summary
For most observers China’s economy is landing, the only question being whether the landing is soft or hard. This is not surprising, given the long and remarkable trajectory of growth since 1978, when the giant country opened its doors to the world after 30 years behind the mysterious Bamboo Curtain. 

Since then, annual gross domestic growth (GDP) has averaged almost 10% per year, transforming the country and its people from a huge, centrally planned and impenetrable backwater to a modern-day manufacturing and consumption giant. China virtually leapt from a cultural revolution to an industrial revolution in one generation.

 

China’s success has remained an enigma and a frustration to many of its critics. Communism is not meant to succeed in the industrialized world, and China is still governed and controlled by the Communist Party of China, whose 80 million or so members form an elite that is revered and reviled in almost equal measure.

There is no doubting China’s success in taking on the global trading environment, and by 2009 it had become the world’s biggest exporter, while by January 2014 it had become the biggest trading nation in the world.

But China has always had bigger ambitions than trade, and in fact at a high level it has seen the 19th and early 20th centuries as a “Period of Humiliation”, and the rapid growth in its economy is a long-awaited recovery to a position as one of the world’s leading economies.

Chinese economyThe trajectory of growth in the past 30 years, and the long-term goal of achieving per capita income equivalent to the leading economies in the world, is the context in which China’s economic and industrial policy should be viewed. While economists and financial analysts tend to view economies and markets on a shorter horizon — months rather than decades — for China’s planners the project has a much longer duration.

It is also important to consider the social contract prevailing in China, a further source of frustration to those who view democracy as the only true goal, and who similarly argue that the purpose of growth is to achieve universal suffrage. In China, while there continues to be debate about the political system, and this will undoubtedly continue, the core social contract under which the Communist Party rules is that it can retain power as long as it continues to increase wealth for the population at large.

This has indeed been the case, with Chinese consumers now in the ascendancy, and providing the long-term basis for the continuation of the country’s remarkable growth story. China currently has 1.25 billion mobile telephone subscribers, approaching the 1:1 ratio, and an estimated 600 million internet users. The penetration rate of internet users is around 42% of the population, and is still more than double the US internet user population of 250 million, and a penetration rate of 85%.

China has embraced the web and modern media generally with gusto, and more than 80% of internet users access the web through mobile devices. The chase for the online Chinese consumer is gaining pace, with huge organizations such as Alibaba and Tencent expanding their offerings from e-commerce and online gaming to internet finance and social networks. Products such as Taobao and TMall are among the biggest e-commerce portals in the world, while Sina Weibo is the equivalent of Twitter and WeChat the parallel to WhatsApp, albeit with far more users than their US counterparts.

The China market for Western multinationals has shifted, and China remains a crucial component of many, if not most global supply chains, but China has become a great deal more than manufacturer to the world. It is rapidly emerging as one of the world’s great consumer markets, from high-end brands such as Ferrari, Bentley, Louis Vuitton, to a much wider consumer base for Coca-Cola, Ford, GM, VW and Apple, among many others.

Chinese economyIt would be naïve to deny that China has some severe challenges as it manages the transition from export colossus to being growth driven by domestic consumption.

Not least among these challenges is a need for a series of major reforms, probably the most far-reaching of which is the continued shift of the population from their rural roots to an urban environment.

This process of urbanization is already well advanced, as the urban population now represents more than 53% of the population, up from 26% in 1990. To put this into perspective, this means that more than 300 million people have moved to urban areas over the past 25 years, more than the total population of the United States. The intention is to increase the rate of urbanization to more than 70% by 2050, implying that a further 300 million-400 million will move to cities or urban locations in the next 35 years.

The logic of this urbanization drive has several dimensions. Urban workers in China earn more than twice that of rural workers. China’s farmland is labor-intensive, with the average farm size only around one acre (six mu). The drive for food security is part of the drive toward urbanization, together with a real and perceived need to shift workers from farm work to industrial work to help them realize their economic aspirations.

The opportunities in this urbanization process are huge, such as a continuing need for low-cost housing and enabling infrastructure, and the associated demand for white goods and transport. In its quest to achieve these goals China has tolerated an inordinate scale of debt, now estimated at almost 200% of GDP. However, to put that into perspective, it has been estimated that the 10 largest developed economies in the world — including the US and major European countries, as well as Canada and Australia — had total debt of 350% of GDP in 2012. China’s total government debt is around 50% of GDP, while the US and Europe are over 100%.

This is not to suggest there is no problem. A debt figure of US$20 trillion (RMB120 trillion) is a problem, and with half of that owed by corporations, there is a serious overhang on the stock market, though in corporate finance terms China is not really a bad bet. It has external reserves of US$3.5 trillion and estimated net assets in excess of US$50 trillion — which, translated into debt-equity, suggests China is conservatively financed.

The new government, which came into power at the start of 2013, has mapped out an impressive range of reforms, and so far has held true to these commitments by tackling corruption, guiding GDP growth at a lower (more sustainable) trajectory of 7%-7.5%, and facing down the state-owned enterprises (SOEs), which dominate the upstream supply of raw materials and key services, from banking to shipping and airlines.

The transition is proving painful, and perversely encouraging as a result of that, as economic reform everywhere requires discipline and focus, and the risk in China has been that it fears the response of the general population if it is perceived to be breaching the social contract. The most extreme example of the failure to hold the course of fiscal discipline came in 2008-2009, when in the face of the global financial crisis the government opened the coffers, pouring RMB4 trillion (US$650 billion) into a stimulus program that produced indiscriminate credit growth and misallocation of capital on a grand scale.

Will it be different this time? I believe it will be, and the performance of the new government so far suggests lessons have been learned, and that a period of slower growth is essential to consolidate the gains made over several decades, and also to prepare for a very different economic environment.

As the economy has grown, so too have the expectations of workers, and along with that wages and overall cost of production. China has moved up the value chain in a variety of products, it has embraced the internet and new technology, and its young and ambitious population has high ambitions.

For international manufacturers and service providers seeking to establish or expand their presence in China, the “billion Cokes a day” image has been replaced by a far more diverse and complex market, where the billion Cokes may include a range of other drinks; where basic passenger cars need to have a hybrid or pure electric option; and where leisure time activities and travel are accessible to much of the population.

China will continue to provide extremely competitive manufacturing options to a range of markets, but its economy has become multidimensional, and in some ways the domestic market is more attractive than its ability to sell goods competitively to the world. The metrics on consumption are relevant — 80% of mobile internet browsers in China are aged 35 or below; and 80% of consumers using credit cards are aged 40 or below.

Chinese economyChina is clearly emerging as a 21st century consumer society. It has embraced the internet and all of its market components, and with this a more sophisticated approach to consumption, as department stores are in decline even as e-commerce usage surges.

That being said, bricks and mortar need to accommodate 300 million new urban dwellers in the next 30 years. The continuing improvement in wealth for the country as a whole suggests that the opportunity in China has not faded, but is rapidly changing its nature, with  the “industrial” revolution now giving way to the “consumer” revolution.

 

Disclaimer
This resource has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained herein without obtaining specific professional advice. Competitive Capabilities International (CCi) does not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this resource or for any decision based on it.

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