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CHINA
From Site Selection magazine, September 2010
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Grabbing a Tiger
by the Tail

Chinese Economic Growth Prospects for FDI

CHINA
Pudong Skyline, Shanghai, China
Image licensed from iStockphoto © ytwong

by JOHN J. EVANS
B

y most accounts, China in this the "Year of the Tiger" has eclipsed Japan to become the world's second largest economy. China's economy grew at a pace of 11.1 percent in the first half of the year and the International Monetary Fund expects the country to grow at a rate of 10.5 percent for the rest of 2010. A closer look at long-term economic indicators, societal changes and lofty forecasts point to one certainty: China is becoming a more expensive place to do business, especially for multinational corporations (MNCs).

China still possesses the key strengths that have transformed it into a manufacturing powerhouse: an abundance of relatively inexpensive labor and government led development in key sectors and geographic regions. Even so, China's heady days as the premier low-cost manufacturing destination are coming to an end as manufacturing competitiveness erodes due in large part to rising input costs, chiefly labor.

All in all, more than 20 provinces and municipalities have increased or plan to increase minimum wages this year: Shanghai raised monthly minimum wages 17 percent; Guangdong raised monthly minimum wages in five districts by an average of 21 percent; and in July, Beijing increased monthly minimum wages by 20 percent. Add to this fully loaded company costs for tax and social benefits that can amount to as much as an additional 45 percent of the base wages, and it is easy to see how quickly Chinese wages are escalating.

While China has ambitious plans to move low-end manufacturing inland and to quickly move up the manufacturing value chain, both of these goals will not happen overnight — and for most sectors of the Chinese economy there are large improvements in efficiencies that have yet to be realized. The supply of indigenous senior Chinese managers is increasingly tight causing overhead costs to rise. Additional concerns over debt in the Euro zone and a struggling US economy, China's chief export markets, and a rising tide of labor disputes and social unrest over wage levels and rising inflation are making one thing evidently clear: China must become a better consumer.

Promise Lies Within

Notwithstanding rising costs and eroding manufacturing competitiveness, the promise of healthy corporate profit growth is increasingly taking form as the state steers the economy onto the path of domestic consumption led-growth. China is currently the world's fifth largest consumer market and became the world's largest consumer of energy and automobiles in 2009. Decades of high savings rates, the government's goal of rising wages and increases in state social welfare spending — $125 billion yuan over three years to ensure at least 90 percent of Chinese have basic health insurance by 2011 — are beginning to release pent-up consumer demand for everything from cars to clothes, appliances and other consumer goods. The question then becomes how do MNCs strategically tap into China's increasing consumer demand led growth without being overwhelmed by a host of threats to the company's bottom line?

MNCs are increasingly relying on the "China plus one" strategy whereby they add a new manufacturing base outside of China to insulate them from materials price spikes, take advantage of increasingly competitive costs and Free Trade Agreements. As China charts a course to move up the manufacturing value chain, the ASEAN nations of Southeast Asia have benefited greatly from this strategy by offering a combination of established manufacturing bases with efficient technologies and/or increasingly competitive inputs, especially skilled human resources, and a large market and efficient trading block regulated by the ASEAN Free Trade Agreement.

For many MNCs looking to control and rationalize their existing operations costs in China, the "China plus one" is an attractive option, as many of these competing economies are not only increasing their competitiveness against China, but are able to offer attractive tax and other incentives to foreign direct investors — something the Chinese policymakers have nearly eliminated.

The opportunities for MNCs within a few key sectors such as aviation, automotive, medical devices and equipment, and clean technology [http://www.siteselection.com/theEnergyReport/2010/aug/solar-power.html] are especially promising. For 2010, automobile sales are expected to grow 20 percent to 15.6 million units. The most recent "Renewable Energy Country Attractiveness Indices" published by Ernst & Young put China in a tie with the U.S. as the most attractive place to invest in renewable energy projects — the first time that China has reached this position. Finally, China's focus on building the next major competitor to global giants Boeing and Airbus for passenger jet aircraft — the C919 — is receiving the full thrust of government support.

Also, there are many niche opportunities for best-in-class companies to fill holes in the value-chain or compete with Chinese companies that have not yet moved up the technology curve. China is also becoming more attractive for MNCs for services. These include engineering and technical support; software development, business processing outsourcing (BPO), healthcare and financial services due to continuing liberalization.

At this stage of China's continued economic development, MNCs that choose to "grab the Chinese Tiger by the tail" could have it lead to increasing market share and profits by capturing more of the growing domestic market, but it is fraught with risk. The fundamental premises of the economic landscape have changed and in many ways have made operating in China more complicated, expensive and time-consuming. But despite these increasing disadvantages and challenges to competitiveness, market access to China burgeoning domestic demand remains far too big for MNCs to exclude from their corporate profit growth strategies.


John J. Evans is the Shanghai based Managing Director of Tractus Asia Ltd. (www.tractus-asia.com) a corporate site selection and FDI advisory firm. He can be reached at jevans@tractus-asia.com.



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