Key Trends in Globalisation

The sustainable speed of China's economic growth - a comment on Gavyn Davies analysis

Gavyn Davies has a long analysis of the sustainable speed of China's economic growth on his Financial Times blog. Below is the comment I wrote on it - the comment is rather self-contained so can be read as a stand alone. Normally, of course, I would like to reproduce both sides of the argument but I cannot do so without infringing the Financial Times copyright. Readers are therefore, of course, encouraged also to read Gavyn Davies own analysis which can be found here.

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Rather than taking 3rd party projections, which do not control China's economic policy, the starting point needs to be China's own stated goal. As set out in the latest 5 year economic programme this is to double GDP between 2010 and 2020 - average growth  7.2%.

So far since 2010 each year growth has exceeded this target. On the official target, total GDP growth 2010-2014 should be 32.1%. If a probably excessively conservative 7.3% growth in 2014 is assumed then actual growth 2010-2014 will be 36.1% - significantly above target. This means 6.7% average annual growth would have to be maintained until the end of the decade. If I were in the habit of making bets I would place a very significant sum of money on the fact China's target will be met, rather than the deceleration to 3.9% endorsed by Larry Summers, the Conference Board or 'bought' by George Magnus, to use his own phrase on a recent Twitter discussion (or the 3-4% projected by Michael Pettis).

One of the good things about this discussion, however, is that numbers are now used by serious participants instead of vague talk of 'slowdown' - if China's growth is 0.5% or 7.0% this is 'slowdown' but evidently the real meaning of the two numbers would be totally different.

I have set out at the fundamental factors which permit China to maintain such high growth rates in 'China's Economic Growth in the Light of the Findings of Modern Western Economic Research' which can be found here. 

My own view is that China at present is making some policy mistakes which are knocking a bit, probably 0.5% - 1.0%, off the actual growth rate it could achieve. This would not be the first time such mistakes have been made, and in other periods its targets have been exceeded - naturally the targets are averages. But the present situation merely means China is coming down closer to its official growth rate rather than substantially exceeding it.

There is no indication China will not make its own target and every indication Larry Summers, the Conference Board and George Magnus will be wrong - although I much respect the fact they are engaging in serious projections which can be empirically tested, as opposed to meaningless rhetoric sometimes used in discussion on China.

The changing pattern of foreign investment in China

Inbound investment into China continues to be the highest for any developing economy - US$101 billion in 2013 on UN data. But the pattern of investment in China is changing significantly as the country develops, and this trend will inevitably become more pronounced. China refusing to acknowledge and internalise that only 30% of the world’s population now lives in countries with a higher per capita GDP than China leads to confusion on the key issues in foreign investment.

In the first decades after the start of China's economic reforms in 1978, inward foreign direct investment (FDI) was primarily undertaken by overseas companies to create a base for exports. Although this was helpful in China's early stage of "reform and opening up," the investment was frequently very low value added. For example, a 2009 study found China received only 2 percent of worldwide wages paid for iPod production despite the fact that every iPod, at that time the world's most successful consumer product, was manufactured in China.

As recently as 2010, the majority of China's exports came from foreign-owned companies. Among large exporters, the role of foreign investment was even greater - of the top 200 exporting companies in 2009, 153 were foreign-funded. Only among small and medium size exporters were Chinese companies dominant and Alibaba's original success was creating the Internet systems that connect these Chinese companies to their foreign markets.

But as China's economy has developed, the reason for its attractiveness to foreign companies has radically changed. In comparative international terms, China is no longer a low-wage economy. On World Bank data, only 30 percent of the world's population now lives in countries with a higher per capita GDP than China, and wages will be approximately proportional to this. In Southeast Asia and South Asia, every developing country except Malaysia now has a lower per capita GDP than China.

For many foreign companies aiming at exporting, China's unrivalled skill in major manufacturing fields has become the country's main attraction. A U.S. study, with the self-explanatory title "Why Apple builds iPhones (and everything else) in China," spells this out clearly. The New York Times posed the question, "What does China have that America lacks?" The conclusion was:

"Quite a lot. China has more mid-level engineers, a more flexible workforce, and gigantic factories that can ramp up production at the drop of a hat. China also offers tech firms a one-stop solution. 'The entire supply chain is in China now,' a former high-ranking Apple executive tells The Times. 'You need a thousand rubber gaskets? That's the factory next door. You need a million screws? That factory is a block away. You need that screw made a little bit different? It will take three hours.'"

Indeed, the example of the iPhone, now the world's most successful consumer product, graphically shows how China's manufacturing capability saved what is now a triumph from a potential PR disaster. As the New York Times noted:

"A little over a month before the iPhone was scheduled to appear in stores, Mr. Jobs beckoned a handful of lieutenants into an office. For weeks, he had been carrying a prototype of the device in his pocket. Mr. Jobs angrily held up his iPhone, angling it so everyone could see the dozens of tiny scratches marring its plastic screen… People will carry this phone in their pocket, he said. … 'I won't sell a product that gets scratched,' he said tensely. The only solution was using unscratchable glass instead. 'I want a glass screen, and I want it perfect in six weeks.' After one executive left that meeting, he booked a flight to Shenzhen, China. If Mr. Jobs wanted perfect, there was nowhere else to go."

The result was that when the screens arrived: "the workers were assembling 10,000 iPhones a day within 96 hours. Another example: Apple had originally estimated that it would take nine months to hire the 8,700 qualified industrial engineers needed to oversee production of the iPhone; in China, it took 15 days."

Low wages are therefore no longer China's key attraction for foreign investors.

"Wages actually aren't that big a part of the cost of making consumer electronics… Paying American wages to build iPhones would add only about US$65 to the retail price of each handset, according to analysts' estimates. That's an amount Apple could likely afford. And in fact, China no longer offers rock-bottom wages. But when it did, it used that window 'to innovate the entire way supply chains work,' says Sarah Lacy at Pando Daily. China is now 'a place other countries can beat on sheer cost, but not on speed, flexibility, and know-how.'"

The second fundamental feature of the new situation for inward FDI is that since 2007, China has not only been an export base, but it has also been the world's most rapidly growing market in dollar terms as well as in percentage terms. This will only continue. This is a result of the fact that although the U.S. remains the world's largest economy, at market exchange rates, China's growth rate is almost three times that of the U.S. Consequently, as shown in the chart, in 2013 China's increase in GDP was US$1,038 billion compared to US$555 billion for the U.S., i.e. China's dollar GDP increased by almost twice as much as it did in the United States.

China's unparalleled market expansion presents decisive advantages for potential company growth. In stagnant or more slowly growing markets, such as the U.S. and Europe, to achieve rapid growth most companies have to increase market share. In China, in contrast, rapid growth can be achieved without gaining market share but simply through ongoing market expansion - an easier prospect. FDI is therefore increasingly taking advantage of China's domestic market, not for exports. A further result, consequently, is that FDI increasingly flows into the service sector, which primarily serves China's domestic market and not exports. In 2013, 52 percent of inward FDI went into China's service sector.

But if China's market expansion is the world's fastest, there is no doubt competition for companies engaged in FDI is becoming tougher in certain respects. In its earlier stages of development, China so badly needed FDI that it offered formal tax concessions and regulatory enforcement was sometimes lax. Tax concessions are already largely abolished, and lax enforcement is being tightened.

The latter includes dealing with criminality - in 2010 RTZ employees in China admitted taking kickbacks and recently GlaxoSmithKline was fined US$490 million after it was found to have bribed doctors to sell its drugs. Anti-competitive behavior is also being clamped down on. This year six infant milk powder companies were convicted of price fixing, and fined US$110 million, while 12 Japanese auto-parts makers were also fined US$200 million for the same offence.

Foreign companies investing in China continue to enjoy clear advantages in key sectors. These include in advanced technology industries, apart from defence - for example high end computer services and civil aircraft production; highly concentrated global industries dominated by global producers such as automobiles, and non-financial services in general - for example supermarkets and fast food chains. But in medium technology, or many rapidly growing industries, Chinese companies are increasingly tough competitors - Lenovo not only dominates China's domestic computer market but has become the number 1 PC producer globally, while China's smartphone manufacturers, such as Xiaomi, Lenovo and Huawei, are increasingly effective in domestic competition with Apple and Samsung.

Given the size and growth of China's market, inward FDI will remain at very high levels. But the days of China as a cheap labor export base are ended – because the majority of the world’s population is now at a lower level of economic development than China. Only by accurately analysing its real stage of development, and therefore its real position in the world economy, can China realistically assess its strengths and weaknesses in attracting foreign investment.

In a person modesty is admirable. But in serious economic matters neither boasting nor excessive modesty is a virtue – only realism. To navigate a ship must have an accurate chart – if it does not there is a danger it will hit a reef. The same applies not only to foreign investment but to China’s economic policy in general.

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This article originally appeared in Chinese in ‘Opinion Leaders’ at Sina Finance. An earlier version appeared in English at China.org.cn.

China lacks innovation? Take another look

Until recently, the big myth about China's companies was their lack of innovation. That view is now being reassessed in a series of Western studies analyzing rapid innovation by China's firms.

Ming Zeng's and Peter Williamson's Dragons at Your Door, Dan Breznitz's and Michael Murphree's Run of the Red Queen, Vijay Govendarajan's and Chris Trimble's Reverse Innovation, and Amitava Chattopadhyay's and Rajeev Batra's The New Emerging Market Multinationals are just a few of the studies showing that China's companies are no longer competing just on low wages, but also on strong innovation.

One reason Western analysts are just now waking up to this fact is that they that have been looking in the wrong place and relying on a wrong definition of innovation. As Breznitz and Murphree correctly put it: "They look for the fabled creature of "true" innovation - a novel-product, innovation-based industry resembling the Silicon Valley. If they see it, they declare innovation policies a success; if they don't, they warn that China's growth is not sustainable."

But in reality, the pair said: "For China, excelling in other kinds of innovation has been the key to economic growth. China has become the global center for many different stages of production. It has also developed a formidable competitive capacity to innovate in different segments of research, development and production that are as critical for economic growth as many novel-product innovations."

Stage of innovation
China is certainly not strong yet at the type of innovation illustrated by Apple's iPhone or iPad. But there is no reason to think China should be strong at this stage of its economic development.

China's per capita GDP today is equivalent to Japan's in 1964 or South Korea's in 1986. At those times, the two countries, as China is today, were no longer dominated by agricultural populations but had evolved into middle-income economies. At those times, Japan and South Korea led the world in steelmaking, shipbuilding, construction equipment and similar mid-technology industries - exactly the industries where China is becoming dominant today.

The introduction of new products is far from being the only criterion for innovation. Take a US car, as an example. The World Trade Organization found that only 37 percent of the value of that car is added in the US, 30 percent is created in South Korea, 17.5 percent comes from Japan and so it goes. Non-US companies contribute 63 percent of the value chain, and in many parts of it, significant innovation can be introduced by independent companies.

The old integrated production that characterized Ford-style mass production in the 20th century - iron going in one end of the factory and cars coming out of the other - is increasingly disappearing. In its place, numerous global specialist companies contribute to the final product in what might aptly be termed the "dispersed innovation network."

An excellent study of how this creates opportunities for innovation at many different parts of the productive chain can be found in the book The New Industrial Revolution, by Financial Times reporter Peter Marsh.

As Breznitz and Murphree put it: "While American companies formerly had the organizational and innovative capabilities to run such large-scale operations, even in its heyday the American production system was focused on mass production and could not flexibly produce an array of products in the same place on the same production lines. Currently, capabilities of ultra mass-flexible production are unique to China."

A classic case is China's Wanxiang Group, which became the world's leading supplier of universal joints for automobile drive shafts before expanding into a wider range of automobile components.

No threat
When Wanxiang first entered the market, US auto-parts company Visteon dismissed it as no threat. "Visteon doesn't treat Wanxiang as a competitor," said Visteon's director of Asian-Pacific purchasing. "We are treating them as supplier of components for auto parts."

The magnitude of this underestimation was illustrated by Wanxiang's development. The company initially focused its strategy on the relentless improvement, both technically and in cost, of universal joints. In time, it became the world's largest world supplier of these parts.

Wanxiang got its first foreign order from the Schiller Group, then a leading US auto-parts supplier. When Wanxiang refused to operate only as Schiller's original equipment manufacturer, Schiller took away its business. By 1998, Wanxiang had so outmaneuvered Schiller internationally that the latter offered itself for sale to Wanxiang for only US$19 million. After selling the factories but retaining the intellectual property, Wanxiang acquired the key remaining technical assets of Schiller for only US$420,000.

By 2005, Wanxiang operated 38 companies in eight countries. It expanded from universal joints to other parts of the automotive drive systems - to brakes and finally to the whole chassis. Meanwhile, Visteon went bankrupt. Another example of radical innovation in China is the high-performance computer manufacturer Dawning.

Cost advantages
Dawning started with imported processors but rapidly developed its own motherboards, coding and modified operating systems. Because interactions between processors account for 50 percent of a computer's performance improvements and superior chips for only 20 percent, Dawning concentrated its research on the former.

It didn't even have to use the latest and most expensive processors to achieve world-class performance. That gave it enormous cost advantages over foreign competitors. By 2010 Dawning had produced the world's second-fastest supercomputer and was introducing its own chip line Loongson. Another classic case is China International Marine Containers Group (CIMC), the world's No. 1 producer of containers.

The company, which was dominant in China's domestic market, expanded internationally by focusing on reducing costs – not by cutting wages but by radical innovations in raw materials procurement, transport and international financing.

As a result, CIMC reduced materials costs by 33 percent, and manufacturing and overhead costs by 46 percent. Consequently, even when competitors moved production to China, they couldn't produce as cheaply as CIMC.

CIMC then showed innovative ability when expanding into specialized containers. To start producing refrigerated containers, it purchased a production line from Germany's Graaff. In China, CIMC re-engineered the production line four times until it was ahead of competitors, both technologically and in terms of cost. By 2005 Graaf, was bankrupt.

A further recent example is China's Broad Group, which has developed a modular building system allowing construction of a 30-story building in 15 days. No Western company can match that. To make the point, Broad recorded the construction cycle for YouTube - where it has been watched by five million people.

Far from being "no good at innovation," China's companies are among the world's best at it. China is succeeding at just the type of innovation that is most important at its stage of economic development. As the recent outpourings of books shows, it wasn't the case that China's companies weren't innovating; it was a case of analysts not understanding what was going on.

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This article originally appeared in Shanghai Daily on 10 September 2012.

China's is the world's greatest contribution to the real development of human rights

The following article was originally published on 2 June 2014 and dealt with a resolution passed by the US House of Representatives. However its arguments clearly deal with the issue of human rights in general. For the reason's given in it, China's is easily the greatest contribution made to human rights by any country in the world.

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On May 28, the U.S. House of Representatives chose to debate a resolution expressing its concern over the issue of "human rights" in China. This makes it appropriate to make a comparison of the real records of the U.S. and China on human rights.

This is a vital issue as human well-being is certainly the sole goal of any correct policy -- including in that the right of each nation to pursue its national sovereignty and national culture, which is why China's "national revival" and overall human progress are inseparably linked.

Real human beings have an immense number of needs and desires ranging from basic ones, to have good health and enough to eat, through to the most complex -- the most advanced fields of human culture or science. Objectively only extremely developed societies, with enormous economic and social resources, can approximately meet all these needs.

Consequently the attempt to reduce "human rights" to a Western style political structure, as though having a "parliamentary" system were the most important question facing human beings, is ridiculous. The real issue was very well put by the BBC's correspondent in China, Humphrey Hawksley:

"I hear from an Iraqi wedding photographer who had lost so many friends and family members that he would gladly have exchanged his right to vote for running water, electricity and safety; from an Argentine shoe maker who bartered trainers for food because his economy had collapsed; and from the African cocoa farmer whose belief in the Western free market left him three times poorer now than he was thirty years ago."

The example of women in China and India can readily be taken to illustrate the real issues involved in human rights. A Chinese woman's life expectancy is 77 years and literacy among Chinese women over the age of 15 is 93 percent, an Indian woman has a life expectancy of 68 and literacy rate over the age of 15 is 66 percent. India may be a "parliamentary republic" but the human rights of a Chinese woman are (unfortunately)far superior to the human rights of a woman in India. Anyone who does not understand or admit that there are better human rights if a person lives nine years less or more and whether they are literate or illiterate is either out of touch with reality or a liar.

If the real meaning of the term "human rights" is used, it is evident that China has the best human rights record in the world -- and those words are carefully chosen. China has lifted more than 630 million people out of poverty -- more than the entire population of the European Union or the continent of Latin America, and almost twice the population of the U.S. China has brought social security protection to 820 million people, and health care to over a billion. China is responsible for 100 percent of the reduction of the number of people living in poverty in the world. No other country in the world has achievements remotely matching these for the real well-being of humanity.

What is particularly striking is the factual contrast between what China has achieved and the laughable claim of the U.S. to a superior "human rights" record. In the world outside China the number of people living in poverty in an economic system dominated by the U.S. has, according to international criteria defined by the World Bank, increased in the last 30 years. The United States has waged a series of aggressive wars in Iraq and Afghanistan in which hundreds of thousands of people were killed -- not to speak of its earlier war in Vietnam in which it killed 3 million people. Even leaving aside the economic realities, in the purely political sphere, since World War II the U.S. has, as the U.S. commentator William Blum noted:

    • dropped bombs on the people of more than 30 countries;

    • attempted to overthrow more than 50 foreign governments, most of which were democratically elected;

    • attempted to assassinate more than 50 foreign leaders.

Furthermore, the facts establish clearly that the attacks on China's human rights record by the U.S.government, and those they support, are merely hypocrisy.

China openly states its foreign policy principle -- that each country has the right to choose its own form of government and whether it wants an absolute monarchy without political rights, a parliamentary republic, or socialism is not China's affair. The U.S., in contrast, in words claims the right to criticise other countries in the name of supposed "universal values" of Western forms of political rule.

But the reality is transparently different to this. A country such as Saudi Arabia, which is an absolute monarchy, in which political parties are banned, in which women are forbidden even to drive cars, is not subject to U.S. campaigns over "human rights." Nor is Bahrain, another absolute monarchy which serves as the base for the U.S. Fifth Fleet.

The U.S. involvement in events such as the military overthrow of Chile's president Allende is evident, and the U.S. has even formally admitted its role in the overthrow of the elected government of Mosaddegh in Iran.

In Russia in 1993 the U.S. government supported Yeltsin's attack with tanks on the Russian parliament, while they condemn as "anti-democratic" Putin, whom not only elections but every opinion poll shows to have the most popular support of any Russian leader in decades -- the difference between the two being that Yeltsin pursued a policy subordinate to the U.S. while Putin pursued a policy independent of it.

These facts establish beyond doubt that the problem for the U.S. government about China is not "human rights" -- if China were an authoritarian regime supporting the U.S. it would not be criticised. The real problem about China for U.S. neo-cons and their followers is that China's national revival makes it strong.

China's contribution to the real well being of humanity is not only greater than the United States but is unmatched by any other country in the world. Instead of complaining, the U.S. House of Representatives would be well advised to pass a resolution congratulating China for its unequalled contribution to human well-being in lifting over 600 million people out of poverty, establishing an enquiry to find out why U.S. supported economic policies in the rest of the world have made no such contribution to human rights, and publicly apologising for the hundreds of thousands of people it has killed in its wars -- including the thousands of ordinary U.S. soldiers who died in them.

Only when it does that will the U.S. House of Representatives begin to understand the real issues involved in human rights for real people of the real world.