The Rising Chinese Consumer

China’s policies on currency and trade, seen by the United States and other Western countries as protectionist, are coming under increasing criticism. China’s yuan policy is a potential flashpoint at the G20 meeting next month in South Korea, but Princeton University’s JC de Swaan says a faster revaluation of China’s currency is less likely to impact U.S. job growth than it is job growth in countries with more labor-intensive, low-value-added industries, such as India, Vietnam, and Bangladesh. U.S. companies are more concerned about China’s preferential treatment of Chinese companies and lack of protections for intellectual property rights, he says. De Swaan also notes that the Chinese consumer is not as weak as some data suggests and will be a formidable force in the next five years. He stresses the benefits to foreign firms of improved infrastructure, more funding availability, and expanding financial services. "Ultimately China is an enormous opportunity for U.S. businesses and is becoming increasingly attractive over time."

What are the implications for U.S. companies operating in China of the recent uptick in riots by Chinese workers?

One is that the Chinese government has seemed more reluctant to intervene in worker demonstrations that happen at factories owned by foreign companies. Taiwanese technology firm Foxconn and Japan’s Honda are two prominent examples, so foreign companies seem more at risk of protracted labor unrest. But  more importantly, the episodes of labor unrest earlier this year were a reflection of the fact that we’ve come to the end of surplus labor in China, at least in the coastal areas, where most of China’s manufacturing has traditionally been concentrated. That also means that wages will go up structurally going forward, which over time is part of a broad trend that will turn China into a formidable consumer market. As wages rise in conjunction with China’s climb up the value chain, Chinese households will have more purchasing power, which will likely also be boosted by continued revaluation of the currency. This will make China the most exciting market in the world to sell into for U.S. companies.

Are U.S. companies more likely to focus on the Chinese consumer or on moving operations to other Asian countries with lower labor costs?

For companies looking to China to either manufacture in China or source from China, there are several options. Now that we don’t have labor surplus in the coastal areas and wages are increasing pretty significantly, it makes sense to move some of the production facilities or set up some new facilities in the western and central parts of China, an area the government has been keen to develop for years, and has done so through various tax subsidies. Not all industries can migrate there, and for some industries it makes sense to consider moving production facilities or setting up new ones in countries that are lower cost like Bangladesh, India, and Vietnam. But a lot of U.S. companies are looking at China as this enormous, burgeoning consumer market. A perfect example of this is Li & Fung, the largest trading company in Asia, which is reorienting itself. The company has become an iconic Chinese success by acting as the outsourcing arm of U.S. and European retailers over the years. The president of Li & Fung recently said, "This is the end of the cheap outsourcing cycle," which is stunning, since this is starkly what their model has been based on.  He said costs are structurally rising, and yet also said that their new focus is to sell into China because of the huge opportunity it represents.

How weak is the Chinese consumer compared to U.S. perceptions?

Retail shops, malls, and department stores have proliferated and always appear enormously busy. Leading retail companies such as Daphne, Parkson, Golden Eagle, Li Ning, and Anta are now very established and have been expanding very aggressively and recording very strong same-store sales [a comparison of sales over time for stores that have been open a year or longer].

Consumption is weak in relation to overall GDP growth. That’s because the proportion of GDP growth driven by private consumption is extremely low and has been declining. An important reason for that is the implicit of subsidy of manufacturers by households, which has caused real labor wages to rise more slowly than real GDP growth.  The government has historically focused on favoring the corporate sector, particularly on its exporters. A good example is the government controls on deposit yields and lending rates. Historically, China has had low deposit yields, which have predominantly hurt households because they’re the savers. And they’ve had low lending rates, which have predominantly helped the corporate sector, and particularly many factories and exporters.

Is that subsidy changing?

It’s pretty clear the government is keen to boost consumption and is doing so through various structural reforms. They have an ambitious reform program for the healthcare system, a primary reason for why Chinese have historically saved so much of their earnings. The government also plans to develop consumer financial services. The Chinese government is well aware that structurally, it’s not going to be able to rely as much on the export growth and fixed asset investments as has over the past thirty years.

How quickly will the Chinese consumer become a formidable force in the global economy?

It’s a five-year story, not a six-month story. The recent wage hikes and the minimum-wage hikes were headline grabbing because they were big numbers. Wages in certain provinces, on average, increased by 10 to 20 percent, and for specific companies, increases were even higher. But those cases don’t represent a hockey stick trend; we’re not seeing a huge inflection point in 2010. It’s more of a catch-up phase, because there were no wage increases in 2009. But overall, we’ve seen significant wage increases for the last six or seven years, and I would expect those to accelerate.

What about U.S. calls for China to more rapidly revalue its currency?  To what extent would quicker revaluation help China’s rebalancing, and U.S. job growth?

I wouldn’t expect it to have significant impact on U.S. jobs. It would most benefit countries that are also competitive in labor-intensive, low-value-added industries. That’s more likely to be places like India, Vietnam, and Bangladesh.  And history suggests we shouldn’t expect too much from [revaluation]. When the yuan revalued by 18 percent between July 2005 and July 2008, the U.S. trade deficit with China actually increased pretty significantly.

What Chinese economic policies should be of greater concern, then, to the United States?

Some of the issues are perennial: the lack of protection of intellectual property rights remains an enormously challenging problem, and we’re seeing a significant increase in China’s own patent filings. That could give hope that China will feel more compelled to address this issue, but we’ve been waiting on that for a long time. Challenges that have become worse include discriminating in favor of indigenous technology for government procurement, which was a priority issue in the latest round of U.S.-China strategic and economic dialogue. Even putting aside the highly publicized cases like Google or Rio Tinto, there has been increasing noise in recent months from U.S. companies saying they are experiencing a less than level playing field.

What about China’s dominance in producing rare earth elements needed to produce things like wind turbines and hard drives?

That’s a real concern, because of China’s quasi-monopoly on the possession of rare earths and legitimate concerns that they could use that monopoly for strategic reasons. And Japanese companies suggest China might be doing so. The reason China had a monopoly in the first place was market-driven, because it was no longer profitable for U.S. firms to operate mines, whereas it made more sense for China because of its low labor costs and lower environmental standards. There’s no question longer term we need to find a way to produce rare metals outside of China, or find substitutes. You would actually expect mine operations outside China to become more profitable now that prices have risen so much, because of the export constraints that China is putting on its own production.  As I understand, a couple of mines are being reopened in the United States. China also would likely lump that industry into the high polluting/low value-added industries it’s trying to consolidate. Official statements suggest China is encouraging other countries to develop their own mines.

On the whole, is China’s changing business environment working for or against U.S. multinationals?

We’ve mostly talked about the challenges, but it’s worth pointing out that from U.S. companies’ perspective, the opportunities are greater, richer, and more diverse now than they’ve ever been, and at a high level.  Foreign companies are not looking to only manufacture in China or source from China, but also to sell into China, and that’s a huge new opportunity. And there are aspects that have improved over the years.  Infrastructure has dramatically improved. It’s easier for U.S. companies to get funding now than it was twenty years ago to operate in China or do business with China, and the country’s financial services are expanding and rapidly becoming more sophisticated. So, ultimately China is an enormous opportunity for U.S. businesses and is becoming increasingly attractive over time, even if there are all these obstacles at the ground level.