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Saturday, September 20, 2003

China the New Motor of Economic Growth

No-one apparently saw China as one of the 'big engines' that could drive the world economy out of recession. At least that's the view of the authors of this newsweek article. No.one?

Don St. Pierre sr. can recall the first Western deals in revolutionary China, which is why his perspective on today is so striking. As manager of the first major U.S. - China joint venture, Beijing Jeep, he arrived in 1985 when most Chinese still wore Mao suits and commuted on black bicycles. Socialist ideals were paramount. Entrepreneurship was shunned. Home was a Mickey Mouse room at the Lido Hotel.

WHEN ST. PIERRE asked for research on the number of private car owners, the answer came back: two. Now it’s 1 million and rising, and many automakers see China as the key to future growth in a slumping world economy. “All the things we were dreaming and scheming 20 years ago are happening. My God! Who would have thought?” says St. Pierre. “I didn’t imagine it would all happen this quick. I thought we would get here in 30 or 40 years, not 20.”
China now moves so fast that outside perceptions of it tend to lag increasingly far behind. Since the crash of 2000, economists have been agonizing over the rare simultaneous slump in the “three engines” of the world economy—Germany, Japan and the United States—and asking where the demand that drives growth will come from. Until recently, no one had ever seen China as an engine or an answer—even though it has continued to boom through recent shocks, is already by some key measures the world’s second largest economy and, in the first three months of this year, grew at a torrid 9.9 percent pace, before the SARS scare came and went. Last week Lehmann Brothers analysts concluded that “China is already emerging as an important growth pole, not just for the Asia region, but also for the world.”
This turns the China story on its head. Since the days of the British colonial traders in Canton, China has inspired vast commercial hope (the billion-consumer market), doubt (but they’re mostly peasants) and dread (how to compete with all that cheap labor?). Lately, however, the dread has overwhelmed the hope. The fear is that China’s rapid emergence as the “factory to the world” poses a threat to factories and jobs everywhere else, while the rising tide of cheap exports from China raises the risk of global deflation. Those supply threats are real, but they miss a dramatic recent turn in the data: demand in China is also booming, and in the early part of this year, imports have been growing faster than exports. The Asian Development Bank forecasts that China will become the world’s top importer by 2005, fully half a decade sooner than it is expected to become the world’s biggest exporter.
Not even China’s neighbors seem to have noticed. Bruce Murray of the Asian Development Bank says the Asians who most fear China as an export power actually have the most to gain from its rise as a consumer. In 2002 China’s imports from East Asia jumped 35 percent, and it is now expected to run a long-term trade deficit in the region. China last year surpassed Japan and will soon pass the United States as the region’s top customer, driven by a growing middle class that numbers more than 200 million. The World Bank says Chinese demand is fueling “an amazing expansion” in East Asian trade, and now provides “a partial buffer against recession in the rest of the world” that may propel East Asia to 5 percent growth in 2003.
Not only has China earned recognition as an economic driver, says Frank-Jurgen Richter of the World Economic Forum, but its share of the world economy is growing fast because the other engines are sputtering. China became the world’s largest consumer of mobile phones in 2001 and of steel in 2002, and will become the second largest buyer of personal computers by the end of 2003. In recent weeks investment-bank analysts have noted that the “inflationary force” of China is holding up world prices for commodities from steel to copper and chemicals. Last week the world’s largest steelmaker, Posco of South Korea, raised prices, citing strong Chinese demand. American investor Wilbur Ross says one reason he dared buy bankrupt Bethlehem Steel last month is that he sees China as a big-time buyer, not just a cheap seller of steel. “China is an engine,” he says.
If China is not normally recognized in that rank alongside America, Japan and Germany, it is because of the way economists read the numbers. In 2002 China accounted for just 2.6 percent of worldwide GDP, or just one third of Japan’s. But GDP underestimates the true wealth of poorer countries. An alternate yardstick is purchasing-power parity, which tries to measure real buying power by correcting for the low average price levels in poor countries. In PPP terms, China accounts for about 10 percent of world GDP, which puts it behind the United States in the No. 2 spot. Using PPP analysis and projected growth of 6 to 9 percent for the next two decades, Lehman figures that the People’s Republic already contributes more to global growth than Japan and could surpass Europe as early as 2008. Another reason China’s surge slipped under the radar: hyped fear of SARS, which Richter dismisses as “a small speed bump” in China’s growth path.
That’s not to say the “China threat” has disappeared. Indeed China is developing as an engine with a rattling effect on the global economy. One reason is that it puts very real pressure on rival exporters from Mexico to Pakistan. The other is that its own consumer markets are brutally competitive. It’s a good news/bad news story: China offers many multinationals an alluring market, but to survive there many have had to slash prices and compete on volume, to the point where many aren’t turning a profit.
Both sides of the story are unfolding in a bellwether industry: machine tools. Last year China overtook the United States as the world’s biggest market for cranes, forklifts, sewing machines, robotics and other products in this category. On May 7, Nomura Securities reported that what many investors mistook as a “temporary blip” in demand was in fact part of a long-term inflationary trend, as Chinese companies recycle profits and upgrade their plants. “It’s not so obvious or sexy,” says Sean Darby, head of regional strategy for Nomura in Hong Kong, “but machine tools tell the story of China’s economic growth.”
The impact is felt worldwide. Sales of machine tools to China have risen from under $500 million a year in the early 1990s to $5.5 billion today. For DP Technology Corp., a Los Angeles-based designer of software that drives computerized equipment, China is “one of the four markets that are strategic to us,” says founder and president Paul Ricard. America and Germany are sluggish, and Japan is robust only because DP software goes into machine tools bound for Japanese-owned factories in China. In other words, China is the key. “It’s huge,” says Ricard, “and growing by leaps and bounds.” The trick is turning a profit: in China, customers plead poverty or pit competitors against each other to secure better deals, and turn to pirated software if they don’t get the right price. With —much of the machine-tool industry now relocating into China, “all of a sudden you’re selling software at half price,” says Ricard.
In a new study called “Multinationals in China: Do They Make Money?” Merrill Lynch finds a pattern of excessive foreign direct investment, brutal price wars and a headlong rush to tap growth in China as demand slumps in America and Europe. While everyone talks about the importance of sales to China, “there is little data on profits and margins” other than anecdotal evidence from companies like Dell, Volkswagen, Unilever and Coke, which say they are making money, the report concludes. “Most multinationals are boosting production, admitting prices will fall and hoping that margins can be supported by cost cutting and scale economies.”
It’s not a bad bet. No matter how competitive the market, the boom in demand is huge. At headquarters in Japan, executives say China defines the usual emerging market pattern, in which consumers start on two-wheelers and work their way to luxury cars. In 1999 Honda took over a failed Peugeot plant in Guangdong and began making high-end sedans and minivans, expecting to sell mainly to the government on the assumption that the average Chinese was too poor to buy a $30,000 car. Instead, Honda made a profit in only its second year, and now expects that by 2005 China will surpass Europe as its third largest market after the United States and Japan. “The interesting thing,” says spokesperson Tatsuya Iida, “is that individuals now purchase over half the cars we sell.”
The ripple effects are increasingly broad, too. With companies rushing to set up shop in the world’s largest market, foreign investment in China spiked to $52.7 billion last year, surpassing the United States for the first time. Multinationals now account for more than half of all imports into China, as companies like Honda import steel to make cars, and the like. In a recent study, Berkeley economist David Roland-Holst shows that investment in China helps its neighbors in previously unrecognized ways, because its supply chain includes a growing network of contract producers across Asia. Every dollar spent in China is re-spent many times not only within the country, but also throughout the region, magnifying the effect of “a more liberal global trading environment,” says Roland-Host.

In short, China now looks like the supercharged engine of the world’s only dynamically growing region. In 2002, East Asian exports within the region rose 13 percent, mostly to China, while exports to the rest of the world rose only 3 percent. That will force East Asian nations to be more aggressive in “exploiting fast-growing opportunities in the China market itself,” says the World Bank. Its rather surprising conclusions are that South Korea’s advantages in the China market are low tech (steel, bulk-made microchips), Japan’s are in midrange technologies (machinery) and, biggest surprise of all, the Philippines’ are in high tech. “Not a lot of people know this, but we make a lot of the basic building blocks that go into remote controls, phones, watches and other things that are made in China,” says Jaffy Jurado, technical officer with the Semiconductor and Electronics Industries trade association in the Philippines. Two years ago Philippine businessman Arthur Young Jr. worried that Chinese competition would kill his chip-testing company, PSI Technologies. Today most of his chips end up in China, and Young sounds a bit stunned when he says, “China has been good for us.”
It could get better, too. For all the talk of China’s “globalization,” it still has many industries, particularly in services like insurance and finance, that are only now beginning to open to world trade. Perhaps most important, Beijing knows it cannot tie the value of its currency forever to the dollar, particularly not now, when the dollar is falling rapidly and taking the renminbi with it, making already cheap Chinese exports even cheaper from Germany and Japan. So far, a weaker currency has done surprisingly little to slow China’s appetite for imports. But when Beijing lets the renminbi float freely—and the issue is when, not if—it is expected to rise by perhaps 50 percent against the dollar, giving a huge boost to the import-buying power of 1.3 billion Chinese. No, China is still not widely recognized as an economic engine, but it could prove to be the fourth engine that saved the world.
Source: MSNBC

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