China’s sustained GDP and export growth contradicts Western conventional wisdom. Our previous analyses describe the critical role of expanding intra-Asian trade and China’s industrial transformation – two key dimensions of the tectonic shift now underway in the global economy. But much of the skepticism regarding the sustainability of China’s growth stems from fundamental misperceptions regarding the role that exports play and China’s ability to sustain its export competitiveness.
Four tightly intertwined beliefs enmesh many decision makers in a paradigm that comfortably supports the current conventional wisdom on China:
- Export Dependence: China’s overall growth is heavily reliant on growth in “global” demand – which in New York, London and Frankfurt is shorthand for US/EU demand – and China’s continued ability to be the lowest cost producer serving these markets.
- Wage Costs: China’s rising costs and appreciating currency mean labor-intensive industries will move to lower cost sites in Asia or Africa. The thinking is that if China cannot be a low-cost manufacturer, it cannot be a successful manufacturer/exporter at all.
- Globalization “Rebalancing: Advances in manufacturing technology (think 3D printing), “personalization” of consumer demand (design your own Nike sneakers) and renewed US cost competitiveness (driven by the drop in real wages and energy costs) mean globalization will go in reverse (hence much talk of “re-shoring”).
- Innovation and Quality Gap: China is far from ready to make the leap to producing high quality/innovative products in more sophisticated industries (assembling iPhones is infinitely easier than fermenting and purifying monoclonal antibodies).
From these tenets flow two flawed sets of conclusions:
Macro paradigm: Three decades of export-driven China growth has now ended, creating a negative multiplier effect through the entire economy as manufacturing slows, draining liquidity from the export surplus that fed property inflation, stock market investment and high-end consumer spending. Unlike 2008’s hiccup in export growth, this will be permanent and negative. So will the macro, financial and social consequences likely to accompany it.
Micro paradigm: Chinese revenue and earnings growth will slow or decline. Caught in the vice between slower growing export markets in the US/EU and rising domestic costs, Chinese manufacturers will see growth stagnate. Companies will not be able to add value through product upgrading and moving up the value added chain. Without inexpensive land and financing (via support from the government), their competitiveness and profits will tumble.
Origins of the Export Dependence Myth
The first stage of China’s industrial transformation profoundly changed the global economy. After decades of economic isolation, China seemed suddenly able to conquer one export sector after another, moving from garments to consumer electronics in much the same way that Korea and Taiwan emerged in the 1960s and 1970s.
But to extrapolate the industrial model of the so-called NICs (Newly Industrialized Countries), with their modest (or miniscule in the case of Singapore/Hong Kong) domestic populations onto the continental scale of the world’s most populous nation was always a flawed conception.
Thus understanding the next stage of China’s industrial growth starts with correctly framing the foundations for the economy’s industrial growth since reform began. China’s post-reform industrialization was characterized by two sequential – albeit overlapping – waves of development:
- Rapid growth of labor-intensive light industries. In the wake of initial economic reforms in the second half of the 1970s, China suddenly leapt onto the global stage of world trade, taking a dominant position in both global production and export of a wide range of consumer products. It moved from a zero market share in the US clothing market to capture 10% by the end of the 1990s. Foreigners (unsurprisingly) tended to see this as “export-driven” growth due to the dramatic change in China’s global market share and the catalytic role played by “foreign” (mainly Hong Kong/Taiwan Chinese) investment in export-oriented factories in the Pearl River Delta. But while export-focused factories helped drive rapid improvements in both production processes and product quality, the vast majority of output from China’s rapid growth in light industry was designed to meet the needs of domestic Chinese customers.
- Parallel development of modern capital-intensive industries. Domestic market reforms over the course of the 1980s meant prices of inputs and outputs as well as ownership of assets were gradually untethered from the command-and-control mechanisms of the centrally planned economy. This unleashed massive expansion in heavy process industries using imported equipment and technologies. These were designed to meet higher quality standards and capture economies of scale in contrast to the plants built during the Great Leap Forward or in the period of collaboration with the Soviet Union. While China’s role as an exporter of basic industrial products – ranging from cement to truck tires – rapidly expanded, the key driver was again rising domestic demand.
Since the mid-90s, China’s industrialization “story” has been simple: Move up the value curve, producing more technologically sophisticated and higher quality products at ever-lower cost. But is was not Foxconn producing iPhones for Western consumers with technology from Silicon Valley that led the transition from cassette recorders and transistor radios to mobile phones. Instead, the dramatic growth in Chinese domestic demand for mobile phones catapulted China from a non-producer of mobile handsets in 1998 to the world’s leading producer with half of the global supply in 2007 and 60% in 2010.
Similarly, it was China’s emergence as the world’s largest car market that drove the development of not only automotive output but also created a network of Chinese component suppliers as well as transforming the steel and chemical industries from producers of low grade commodity products to ones capable of delivering quality sheets and thermoplastics needed to make cars to the quality standards demanded by Chinese customers.
Thus the forward march of Chinese competitiveness has progressed steadily based primarily on the needs of China’s domestic market, with export markets providing a window on technology and customer needs that helped expand and deepen China’s manufacturing capabilities.