Is China Underestimating Its Growth?

Now here's a strange one, a very strange one. It has become extremely fashionable recently, and especially in the pages of the WSJ (which I'm proud to say I don't read, but which they do tell me about - this reminds me of a piece of UK Wittgensteinology, he reputedly used to start his lectures with things like: they tell me Kant said.......Ok, Ok, so they tell me the WSJ says..........), as I was saying it has become extremely fashionable to say that China's growth is a fiction. This is a strange claim to make, since if China's growth was pretty much an invention of the Chinese Communist Party I can't for the life of me understand why those at the opposite ideological pole (in the US Republican Party) would be taking it so seriously. It is a strange claim to make, but nonetheless it is being made. Clearly, there is, as we have all seen with SARS, a serious problem with using official statistics. But there are other measures. One of these is power consumption. Another is the level of exports, which are a lot easier to measure. A separate question is whether this growth is sustainable. Clearly China's institutional infrastructure has, to say the least, enormous shortcomings. However it is important to note that China's growth is export driven, it is not simply an internal speculative boom. In addition, the rapid shedding of labour from the more-or-less moribund state enterprises means that inflation does not seem to be a present danger. Bottom line: Andy Xie may well be right, and we may even be underestimating the scale of China's growth explosion.

China's economy may be growing much faster than official economic statistics suggest and is in danger of overheating, according to an emerging consensus among foreign and local economists. The economists say a surge in investment, bank lending, construction and car manufacturing has put the Chinese economy on course to grow at about 11 per cent this year, well above official forecasts of just over 8 per cent. "Right now, it is as high as it has ever been," said Jonathan Anderson, of UBS, in Hong Kong.

Using the bank's own system for measuring Chinese gross domestic product, Mr Anderson said third quarter growth was running at 14.2 per cent and would be close to 11 per cent for the year, once the slower rural economy and other factors were taken into account. Few of the economists believe that the present growth rate is either sustainable or desirable for the central government, which is now tightening credit in an attempt to rein in credit growth.

UBS's view is broadly backed by some of China's best-known economists, including Wu Jinglian, of the State Council's Development Research Centre, and Zhang Jun, of Fudan University, in Shanghai. Mr Wu said at a recent seminar that China's growth for the first six months of 2003 was more than 10 per cent, compared with the official figure of 8.2 per cent, and was likely to beat the government's whole-year forecast. Prof Zhang agreed that the official figures were understating growth, saying the figure for GDP could be "bigger than people have expected".

China's official GDP statistics have long been criticised as inaccurate because they do not measure significant parts of the economy, use outdated methods and rely on questionable provincial data. Local officials, used to meeting targets set in a command economy, have consistently reported growth rates that outstrip the national average. The inconsistencies were most glaring during the late 1990s, when official statistics recorded high-speed expansion at a time of falling energy consumption, weak jobs growth and declining prices. This year, however, most leading economic indicators are pointing steeply upwards.

Exports, property and cars accounted for about one third of the economy in terms of their value-added contribution to GDP, said Andy Xie of Morgan Stanley in Hong Kong, and all three were growing by more than 30 per cent. "One third of the economy is growing by about 30 per cent - that's about 10 per cent already," he said. Power consumption, one of the most important independent indicators of Chinese GDP growth, was up by 15 per cent so far this year compared with 2002, Mr Xie added. China's growth rate this year is especially fast in the light of the crisis over severe acute respiratory syndrome, which brought travel and much retail activity to a standstill.
Source: Financial Times
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China Reins-in on Institutional Reform

This is not good news for those who look towards a future of serious and substantial institutional reform in China. It is also further evidence that the current attempts to 'browbeat' China into currency flexibility are likely to prove counterproductive:

China is set to postpone indefinitely a landmark scheme that would have opened the Hong Kong stock market to legal investments by mainland institutions. The setback might also delay progress toward satisfying US demands for a more flexible renminbi exchange regime, officials and financial industry executives said.


Official opposition has been building towards any early approval of the Qualified Domestic Institutional Investor (QDII) plan, under which a crack was to be opened in China's closed capital account to allow some mainland funds to change their renminbi into hard currency and invest in Hong Kong's capital markets. "There is really a lot of opposition to QDII at the moment," said one official. "There is no way it will be approved by the end of this year and probably not early next year either." The postponement will come as a blow to investors and the government of Hong Kong, which first proposed the scheme as one of several means to integrate the territory's lacklustre economy with a booming China.

Last month, another Hong Kong proposal to turn the territory into an offshore centre for trade in the renminbi was also relegated to the backburner by Beijing. The main official reason for opposition to the QDII scheme has been that it would divert funds away from Shanghai's languishing stock market, possibly causing further erosion in stock prices.

Shang Fulin, chairman of the China Securities Regulatory Commission (CSRC), the market watchdog, was one of the main opponents of early approval for QDII, officials said. The People's Bank of China, the central bank, which has pledged to ease capital controls selectively to create a more convertible currency, was broadly supportive of the QDII plan but sympathised with the objections of the CSRC at the moment, officials added.

The mothballing of QDII highlights a dilemma for China. On the one hand, it has promised John Snow, US Treasury secretary, that it will move toward a more flexible exchange regime to allay Washington's concerns over a record $103bn (?88bn, £62bn) Chinese trade surplus last year. But on the other hand, the weakness of domestic markets and financial institutions is frustrating progress in this direction.
Source: The Financial Times
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The Price of a Loan

A month back I posted over a piece from Frans Tuinstra about the difficult problem of enforcing a car loan in China. Now it seems some 'Gweilos' are about to try their hand. Obviously this kind of infrastructural evolution is central to the development of the internal consumer market in China.

Beijing has published its long-awaited rules for car finance companies, removing one of the last barriers for foreign groups to establish institutions in China to lend money to buyers. The regulations, which China had agreed to issue under its accession to the World Trade Organisation, will add further momentum to the saloon market. Sales had grown by about 80 per cent year-on-year in the seven months to July.

General Motors, Volkswagen and Ford have made preparations to start car finance businesses in China and will now be able to apply for licences. Although foreign multinationals have complained about the time taken to release the rules, their publication at the weekend, by the Central Banking Regulatory Commission (CBRC), comes earlier than many had expected. Michael Dunne, of Automotive Resources Asia, a car consultancy, said the release may have been accelerated by government concern about the ability of Chinese banks to manage the rapid growth in credit for cars. Car finance is monopolised by Chinese banks.

"It may be that they want the more professional approach of foreigners in the market," said Mr Dunne. The volume of car loans increased by 286 times between 1998 and 2002, according to the CBRC, but they still account for only 20 per cent of auto sales, compared with 70 per cent in mature markets. This year, loans have accounted for up to 40 per cent of purchases, according to Mr Dunne, as Chinese banks have sought to increase their exposure to the booming car sector. The tide of new loans has been matched by a large rise in defaults, prompting some Chinese insurers to stop underwriting the banks' car loans.

In a country that has only recently begun gathering information for a national system of credit checks, the banks still know little about the people they are lending money to. Foreign institutions, with this in mind, are likely to be cautious about lending, which could limit the immediate impact on car sales. China's strict controls on interest rates also make it difficult to develop the business rapidly. The regulations issued by the CBRC will allow only large local and foreign businesses to enter auto financing, as they include a requirement for any new entrant to have at least Rmb4bn (?417m) in assets. The finance company itself will have to have paid-in capital of Rmb500m.
Source: Financial Times
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The Friends We Used to Have


While I was over at The China Trade , I came across this piece (thanks Fons for the link) whose sentiments I thoroughly endorse. As he says, China's currency future passes through institutional reform:

In the lobby of the Beijing Hotel, there was always a wonderful portrait of Chairman Mao surrounded by a diverse set of smiling people. Entitled: "We have friends all over the world," it is a legacy of the days when China was the political inspiration for the developing world. Today, there are few places around the world where China is not considered a direct economic threat.

The Managing Director of a well-known European firm says he will spend "the remainder of [his] career closing factories in Europe, and opening new ones in China." The North American customers of a well-respected European engineering firm now require them to manufacture 30% of their output in China, and to benchmark the remainder against Chinese prices. Mexico is reported losing jobs to China, and in the U.S. entire industries are at risk of vanishing, leaving only the unemployable behind. The stark reality of China's becoming "the factory of the world" is that factories elsewhere are closing.

This is a big issue! Unemployment is a tragedy wherever it occurs. In the past few weeks, nearly every manager I have met with has had China on their minds - and it's not good. There are no easy answers here, but as this debate grows, it is key to remember several key points:

Revaluation will not be the solution: Despite political pressure for yuan revaluation, this will not happen, or matter, in the short-run. China will not put its own growth at risk; it is as afraid of unemployment as we are. Furthermore, the magnitude of China's manufacturing cost advantages in many industries are well-beyond what any realistic revaluation could correct.

Floating the yuan is even more unlikely as long as China fears significant capital flight once currency constraints are relaxed. Correcting this is about institutional infrastructure.

Chinese factories are now key players in the global supply chains of "our" multinationals: Their success becomes "our" success. "Our" corporations are the beneficiaries of China's cost-advantages, and so are Western consumers! It is not so much that China is taking our jobs away, as it is that "we" are making different sourcing choices in the value-chains that serve us.

Moving-up the value-chain is no longer assured protection: China is becoming a major source of intellectual property - in science, R&D, design, & entertainment. The reality of 1.3 billion people is that China can and will compete on the basis of low-wage labor and high-impact brains, at the same time.

Much of what we have long-wished for in China has occurred: a market economy is growing and Chinese people are better-off than they have ever been. China is presently the best bet for an Asian growth-engine, and a force for political stability. As China integrates into the global economy, some job relocation is to be expected.

Gradually, the Chinese will certainly import more as growth continues. In the meanwhile, look for a lot of political bluster on all sides, but little effective immediate resolution of the dilemma.
Source: Bill Fischer, ChinaBiz Sunday Column
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China's Real Munfacturing Revolution


Here's a nice piece for a change from the WSJ, and as they say, it's 'fair and balanced'. The message seems to be that there are scale and 'learning by doing' components to working in China, which is what theory would lead you to expect. Supply chain reliability and local management expertise are things which will only develop with time. This is really the strongest, and the only really uncontroversial globalisation argument. The third world isn't going to 'bootstrap up' if it doesn't have the opportunity to learn. Of course, once they start, then they become potential competitors, and we get to hear another set of arguments.

The argument about plant design is interesting, since having a high labour component is only a temporary option for China: with time wages and living standards will rise. Of course if they also manufacture capital goods there, then this will keep capital cheaper, and if a large part of capital costs are in IT hardware and software, and these come from China and India, then where we are going is anybody's guess. (BTW, thanks to Walter for drawing this article to my attention).

The Real Contest Between America and China
By THOMAS HOUT and JEAN LEBRETON


Shopping at Wal-Mart will give you the wrong idea about where China's threat to U.S. manufacturing lies. Most made-in-China consumer goods on those shelves represent industries which left the U.S. for Mexico and Southeast Asia years ago. Instead the real contest between American and Chinese factories is taking shape over industrial goods, a $2 trillion market of everything from small motors to oscilloscopes to locomotives, where fast-moving U.S. productivity and technology have kept production at home.

The problem is that China's rapidly-growing capability and huge scale are turning these U.S. defenses on their head, creating astonishing cost advantages in moving to China. These can amount to savings of 20-35% with no loss of quality -- opening the doors to moving even high-performance, highly-automated product lines there.

Unlike Japan a generation ago, which reinvented manufacturing through quality and continuous improvement, China is deinventing it by removing capital and reintroducing manual skill and handling on the plant floor. China's far lower cost of not only production workers but plant technicians, accountants and managers allows U.S. companies to rethink everything from how the product and its parts are designed to how they are made and tested.

The result is more craft, less complexity in plant processes, and often a shorter time from design to production -- all at a far lower total cost. Together with the improving quality of materials and reliability of supply chains inside China, this means some American companies are moving whole core product lines there.

But many are not. China is still small fry in the U.S. industrial-goods market. Domestic production accounts for 70% of industrial goods sold, and imports from Japan and Western Europe account for another 20%. Only 10% comes from low-wage economies, and China has less than one-third of this -- or 3% total penetration of the U.S. market, shipping fewer goods than Mexico.

Many American companies find China's cost advantage elusive. Sending buying teams to China from their headquarters in the U.S., armed with drawings and specs in search of lower-cost sources, often doesn't work -- as American auto companies have recently learned. Small engine and low-end farm equipment producers, among others, have looked at taking production lines to China and found uneven quality and unreliable supply lines back to their U.S. customers outweigh the advantage of lower production costs. The higher technical- and inventory-support costs plus all the risks just aren't worth it.

Sourcing in China works best for companies which invest know-how and painfully nurture their China operations over sustained periods, and only a limited number of foreigner manufacturers have done this so far. Our research shows that companies committed to large-scale manufacturing in China think differently in several important ways from competitors without such commitments.

First, committed companies accurately cost the labor and capital costs of their products. Accounting statements may tell a finished-equipment manufacturer that factory payroll is only 10% of its costs, but when the full payroll cost of the purchased components and company overheads are added in, the total labor costs are typically 40% to 60% of the final product cost. And those labor costs are lower across the board in China. Production workers typically cost 5% of their U.S. counterparts, while good engineers and plant managers may cost 35%.

But what about higher U.S. labor productivity? True, American workers in capital-intensive factories can be several times more productive than their Chinese counterparts. That's because U.S. plants have replaced many factory workers with complex flexible-automation and material-handling systems. This has reduced labor costs but raised capital and support systems' costs.

Chinese factories reverse this process by taking capital out of the production process and reintroducing a greater role for labor. Parts are designed to be made, handled and assembled manually. This reduces the total capital required by as much as one-third. So output per worker is lower in Chinese factories, but the combination of lower wages and less capital typically raises the return on capital above U.S. factory levels.

American companies like Kodak or Copeland that develop several factories in China will see more cost savings than a competitor taking its first steps. Several factors working together explain this. These companies develop and improve their local suppliers. Their Chinese engineers learn the quality disciplines. And they become smarter in hiring people and designing incentives. The costs and benefits of manufacturing in China increase with scale and experience there, meaning that the more you grow the easier it is to continue to grow.

Second and counterintuitively, it usually makes more sense to send a distinctive new product line to China than an old, price-pressured one. The payoff from sending the latter to China is low. The many one-time expenses -- product and process redesign, new local suppliers to sort out, and the need to requalify the finished product with U.S. customers -- could wipe out any profit margin. But designing a new product for China makes sense for a company well down its experience curve there.

For instance, Tektronix's new oscilloscope was designed by U.S.-based engineers working virtually with their China-based tooling counterparts. Although some materials and components were imported, the product will have only one set of start-up costs and a lower capital investment to amortize.


Third, companies committed to production in China take a more realistic view of the risks involved. Supply-chain risks are often exaggerated by outsiders. As for country risk, again China's resilience and production security tend to look better to insiders. That was recently demonstrated when the outbreak of severe acute respiratory syndrome earlier this year caused few supply disruptions from China. And Chinese authorities regard foreign-owned plants as valuable assets not to be disturbed.

But some risks are not exaggerated, such as the need to protect intellectual-property rights, which deters many companies from bringing highly proprietary processes to China. Armstrong, the world's leading floor- and ceiling-tile manufacturer, keeps some material formulas and processes in the U.S. AMP, the world's leading connector producer, had no choice but to move to China because of the cost savings involved. So its proprietary inline plating process in China is done in a special secure enclosure with specially licensed employees. U.S. auto companies know their technology is leaking to Chinese joint-venture partners, but in return they get a head start in China's exploding market.

There are limits to what can move to China. Products where customer-driven innovation is frequent and critical will not go. Nor will those where customization and intimate user contact with the factory are required. Some American customers, especially publicly funded organizations, will insist on goods being produced in the U.S. The most persuasive barriers to movement will be customer-related, not technology-related. Production technology is often surprisingly mobile and divisible between locations. Large portions of leading-edge medical diagnostic equipment are being made in China, and jet aircraft engines will follow.

While China today has only 3% of the U.S. industrial goods business, its shipments are growing at 21% annually in a basically flat market. This penetration rate will be governed by the rise of capability of foreign-owned and operated plants in China, not by wage increases or exchange-rate revaluations. The cost differences are too great. In addition, China is becoming the world's largest market for some industrial goods, for example machine tools and power equipment. There are many reasons to make more things in China. As more companies discover this, the impact on American jobs will grow, making it an increasingly potent political issue.

There are limits to what can move to China. Products where customer-driven innovation is frequent and critical will not go. Nor will those where customization and intimate user contact with the factory are required. Some American customers, especially publicly funded organizations, will insist on goods being produced in the U.S. The most persuasive barriers to movement will be customer-related, not technology-related. Production technology is often surprisingly mobile and divisible between locations. Large portions of leading-edge medical diagnostic equipment are being made in China, and jet aircraft engines will follow.

While China today has only 3% of the U.S. industrial goods business, its shipments are growing at 21% annually in a basically flat market. This penetration rate will be governed by the rise of capability of foreign-owned and operated plants in China, not by wage increases or exchange-rate revaluations. The cost differences are too great. In addition, China is becoming the world's largest market for some industrial goods, for example machine tools and power equipment. There are many reasons to make more things in China. As more companies discover this, the impact on American jobs will grow, making it an increasingly potent political issue.
Source: Wall Street Journal
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Chinese Teddy Bears, Japanese Cars and Hope


It's Friday, and right on cue Shanghai based ChinaBiz journalist Fons Truinstra has pre-posted his weekly column. One of the week's little treasures.

Shanghai – This week I have purchased an American product made in the US. I thought I should mention this as even the Americans nowadays prefer to buy Chinese teddy bears and Japanese cars, because they are more competitive than American products. There is still hope!

What I bought is anti-spam software (Ihatespam – really good stuff). The number of spam messages I had to delete every morning passed the 100 threshold, so I decided that simply deleting them was not good enough. Maybe I’m more exposed to spam than the average internet user, because much of my work takes place online, but I’m sure that the nuisance of spam will force you too one day to act.

There are other trends in my purchasing habits that I find personally more worrying. This summer I have cancelled the last subscriptions on printed foreign media. I now get everything I need for free through the internet. Actually, I get much more than I need.

I pay 130 renminbi a month to Shanghai Telecom and no dime goes to any media company anymore.
Again, I might ahead of the crowd, because of my specific situation as a journalist in China. For foreign publications we traditionally had to pay a stiff surcharge in exchange for which we would get the publications two or three days after the rest of the world got them. Finding alternatives, mostly over the internet, has been more important here in China than elsewhere in the world. But again I’m quite sure that I’m not that far ahead of you all.

The worrying part of this is that Shanghai Telecom does not pay my bills. When we do not pay media companies for their information anymore, who is in the end going to pay my bills? That is a bit of an existential question for a light column like this, but still worth to consider. It is not only American manufacturers who have to face changing markets it is no different for journalists. I have been walking around with a shield saying “We are Doomed” at a meeting of the Shanghai Foreign Correspondents Club, but I do not think the message came across. We would rather write about other trades going down the drain than about ourselves.

It reminded me of my early lessons in history. Then we were taught the big theories about how cultures emerged and went down, emerged and went down. What was interesting was that the theories varied very much, only the end was similar. Every culture went down too. So when these great thinkers were asked how their theory would apply to their own, existing culture, they were all sure that their own culture was the only exception: their culture would not go down. It is a very human thing: we only like bad news when it is about others, not about ourselves.
Source: China Trade

Trying to Stay on Top

So Huawei and Cisco have reached an agreement. It's hard to see who will be the main beneficiary here. In the short term it's a victory for Cisco, but at the price of seeing Huawei coming out of China to offer competition. Presumeably later, as Huawei gets its own market share, a clearer identity and more experience it will develop its own legitimate products and then will really be able to comptete. This is another of the details about patents, they sometimes only offer limited protection when a rival has sufficent resources and determination to get round the problem.

won a victory in its battle over technology piracy claims on Wednesday when Huawei, the emerging giant of the Chinese communications equipment business, agreed to modify some of its products. The legal fight is the most prominent recent dispute over intellectual property rights involving the fast-growing Chinese technology industry.

For Cisco, protecting its technology has become increasingly important as Huawei has moved beyond the domestic market to sell switches and router equipment in North America and Europe. The companies said that Huawei had "voluntarily made changes to certain of its router and switch products". The changes will be reviewed by an independent expert. If the changes are accepted by the independent expert, the two sides said they expected the legal action to end.

Cisco had accused the Chinese company of "systematic and wholesale infringement" of its intellectual property, including copying parts of the source code underlying the software that operates its routers. It also claimed that Huawei had gone as far as lifting some passages from its product manuals verbatim. Resolving the legal dispute could free Huawei to compete far more aggressively in overseas markets. It has agreed a partnership with 3Com, the US networking equipment company, to produce and sell equipment jointly.

A preliminary court injunction in the Cisco case has limited Huawei's international expansion. The injunction prohibited the Chinese company from selling products worldwide that included source code that infringed a protocol developed by Cisco. Huawei was also forbidden to let engineers who had seen the Cisco code work on developing a rival version and was ordered to stop distributing user man- uals and online help pages in the US. Wednesday's agreement with Cisco goes much further, blocking any global sales of Huawei products that infringe on Cisco's intellectual property. Huawei has agreed to sell only products that have been amended to deal with the Cisco complaint. The changes that will be submitted for independent review cover amendments to part of Huawei's source code, user manuals and online help screens.
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Chinese Banking Reform Moves Forward, Slowly

There is some evidence that the process of sorting out the Chinese non-performing loan problem is moving forward: slowly. Six billion out of a possible total of anywhere up to 750 billion dollars doesn't seem like a revolution. Still it is a start.

Chinese financial institutions plan to put up for sale about $6bn in non-performing assets over the next few months, marking the biggest push since 1999 to clean up the bad debts of the country's huge but insolvent big four state banks, Chinese officials and financial industry executives said. The new level of activism in China's most pressing economic reform signals an increased willingness from the government of Wen Jiabao, the premier, to experiment with new and different forms of asset disposal. It also suggests a potential bonanza for foreign and domestic investment banks. The big four banks, which between them have problem loans estimated at between $375bn and $750bn, are in a race to clean up their balance sheets and win official approval for a stock market listing.

The two front-runners to be listed are the China Construction Bank and the Bank of China, followed by the Industrial and Commercial Bank of China and, in a distant fourth place, the Agricultural Bank. The first move is expected to be an auction by Huarong, the biggest of four asset management companies set up in 1999 to dispose of about Rmb1,400bn in non-performing loans transferred from the big four banks. The auction, expected to take place this year, would be for NPLs with a face value of about $2.2bn, executives said. Yang Kaisheng, Huarong's president, started a roadshow to promote the NPLs to financial institutions in the US and Japan over the weekend. If it materialises, the auction would be only the second to be held since 1999, when a consortium led by Morgan Stanley bought NPLs with a face value of Rmb10.8bn and a Goldman Sachs consortium bought assets with a face value of Rmb1.97bn.

The increased size of Huarong's second auction indicates Mr Yang's confidence that foreign banks have been able to profitably dispose of the NPLs they bought. Mr Yang is also hoping for higher returns than in the first auction, when NPLs were sold for 8-9 per cent of their face value, Huarong executives said. Later, the Wuhan branch of Huarong plans to package about $500m in bad assets for sale, Chinese officials said. This represents a new method of disposal - previously only the head offices of the asset management companies were allowed to court foreign clients. Wuhan is an industrial city in central China.

Another new form of asset disposal is planned by the Bank of China in Hong Kong, which hopes to offer to the market assets with a face value of about $1.2bn, executives said. Because Chinese banks are not allowed to sell NPLs directly, the Bank of China assets are being packaged and held by a Cayman Islands entity, said the executives, who declined to be identified. It was not clear if the Bank of China (Hong Kong) plans have received approval from Beijing. A spokesman at the People's Bank of China, the central bank, said he had not heard of the scheme.China's largest bank, the Industrial and Commercial Bank of China, is also trying to package about $2bn to $2.5bn in non-performing assets for sale in the more distant future. The timetable for this sale was not clear.
Source: Financial Times
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