Don’t bet it all on China

- Updated November 9, 2014
What’s next for China? Best case, worse case and status quo scenarios are almost equally plausible. Here are eight questions about China’s future.

1. Is China’s growth sustainable? When China embarked on its economic liberalization, it was, effectively, a Third World country and a recipient of aid from the World Food Program. Starting from such humble beginnings, it’s easy to make great strides in economic growth. But as the country becomes richer, those numbers are harder and harder to achieve. Is China’s growth likely to level off? Probably. Will it hurt business? Probably not. Will China crash hard, as Russia did in 1998, when its banking system collapsed and it had to default on its obligations? Definitely not. The difference between China now and Russia then is that China is economically strong. It doesn’t owe money. In fact, the strength of its currency reserves is causing some problems for other countries. Its currency is so strong that it is only keeping down the exchange rate through keeping a firm hand on the amounts of money that can be exchanged. Russia, by comparison, was victim to spiraling inflation and a faltering economy. Bad debt problem Yes, China’s banks do have a problem with bad debt, but every year, the Chinese government is getting more and more of those debts off the books. Chinese banks are beneficiaries of one of the highest savings rates in the world, at 40 percent of GDP. In addition, China’s banks have been raising stratospheric amounts of money in the stock markets. Last fall, China’s largest bank, the Industrial and Commercial Bank of China, raised a world-record $21 billion in an initial public offering. In December 2006, China opened up its banking sector to foreign competition. This move is likely to strengthen China’s banking sector even more, as the Chinese banks step up their game to compete with the big international players. A bigger threat is the exuberance of the Chinese stock market, which is not completely warranted. Chinese companies still have problems with transparency and few have long track records to rely on. If the stock bubble bursts, then things can go very sour very quickly and, if handled badly, a big stock market crash could lead to a wave of bankruptcies and social unrest. In addition, during China’s last stock market downturn, some investors gambled with money that wasn’t strictly theirs, and a few companies, such as brokerages that misused clients’ funds for this purpose, went under. In addition, if a company is counting on going public in order to raise needed cash, it may have to make alternate plans if the stock market collapses. Ted Revis, president of the Norelli Group, a Charlotte, N.C., strategy development and management firm, has been helping companies come to China for almost 14 years. For the most part, he said, China has been doing a good job in managing change, keeping inflation low and minimizing the degree to which outsiders can impact the economy. “The Chinese regulators can’t necessarily control individual companies or the prices people charge for things, but they certainly have many ways to influence the economy,” he says. As the country opens up, however, this is starting to change. “I think the biggest risk factor is the U.S. devaluation of the dollar,” Revis says. “That is going to increase people’s costs more than anything.” If the exchange rate goes to 5.5 yuan to the dollar, for example, that would increase the cost of Chinese goods by 50 percent. 2. Is China running out of employable people? In a country with a population of more than 1.3 billion, this may sound like a stupid question. But for some manufacturers doing business in China, there is, in fact, a shortage of workers. The problems, however, are mostly limited to the coastal regions, and specifically to the fast-growing cities of Shanghai and Guangzhou. As the economy improves across the country, more and more people who live in the inner provinces are able to find jobs closer to home. In addition, there are simply too many manufacturers in Guangzhou, experts say. “They try to stack too many factories in one place,” Revis says. He suggested that the United States look beyond the coast for partners. Most cities now have decent airports and highways, he says. Moving inland also lowers labor costs. “I’ve had manufacturing locations in 16 provinces and have flown to just about every province,” he says. “I’m sure that there are some places that are still difficult to get to, but those are not the places where they have the factories.” 3. Are prices going to rise? In the big coastal cities, prices are, in fact, going up. Workers demand, and get, big salary increases every year, and can sometimes double their wages by job hopping. Retention is the number one topic of discussion for international managers in Shanghai. The growing shortages of migrant workers in the coastal cities are also forcing companies to improve working conditions, which also serves to increase total compensation costs for employers. And the government, ever vigilant for signs of social unrest, is paying increasing attention to workers’ rights. This isn’t all necessarily bad. Even with the eight or 10 percent salary increase that he’s seeing in the coastal cities, Norelli’s Revis says, some of the cost can be offset by working more efficiently. “And I don’t see anywhere near that percentage increase in the interior provinces.” But many companies are avoiding wage inflation problems by moving further inland, where wages are still low.

Workers are also increasingly taking on employers, especially when their employers are foreign-owned companies. For example, workers recently unionized Wal-Mart facilities in China, and McDonalds and KFC were attacked in the Chinese press for not paying their student employees enough. Foreign firms make easy targets for activists, as opposed to state-owned factories. This could potentially create problems for Western companies sourcing in China. Before signing agreements, the U.S. company should check to see that the manufacturer complies with all health, safety, labor and environmental regulations, Revis says. 4. Will domestic demand use up all manufacturing capacity? Yes, domestic demand is growing, not only for locally produced goods, but also foreign-made products. If demand rises too high, this could put upward pressure on prices and stress the manufacturing capacity of China’s factories. 5. Will environmental problems curtail growth? China is paying increasing attention to pollution and environmental destruction, especially given the wave of high-profile ecological disasters and sandstorms in Beijing. Complying with environmental laws could potentially be costly for manufacturers, and could cause some projects to be cancelled altogether. According to Revis, China has gone through a stage of assessing the impact of environmental damage to its economy, and now local jurisdictions are held accountable for environmental costs as well as for economic progress. The biggest targets of these laws are big, state-owned heavy industries, he says. Smaller manufacturers, such as furniture makers, still need to comply with pollution laws and properly dispose of wastes, but these are more procedural improvements. 6. Will China run out of energy? “If there’s any limitation in China, it’s energy,” Revis says. “China surpassed Japan last year to become the second-largest consumer of oil in the world.” Some cities in China have been running out of energy already. China is investing heavily in new generating capacity and working to secure overseas oil and gas resources. But, experts warn, a background check of power grid reliability should be on the to-do list for every sourcing manager seeking a potential new supplier. A couple of years ago in southeast China, the government was rationing electricity so that some factories could only operate one or two days a week, Revis says. For the most part, the worst of these problems have been addressed. “That’s not happening this year,” he says. “But it’s still part of the due diligence that we do. If they’re having electricity problems, we don’t use them.” 7. Will there be a war with Taiwan? It pays to keep an eye on geopolitics, and on moves toward independence in Taiwan. Of equal importance is the U.S. position. Will the United States back Taiwan if there’s a confrontation with China? If so, that could seriously disrupt trade. 8. Will there be another Tiananmen Square? Probably not. China has become increasingly sensitive to the power of public opinion and more adept at managing people’s expectations. Potential flashpoints include unemployed college graduates, who are often finding that their degrees don’t prepare them for the real world. The graduates feel they are overqualified for blue-collar jobs. In addition, college curricula still haven’t fully adjusted to the modern realities of capitalist life. According to Labor Minister Tian Chengping, Chinese universities graduated 4.13 million people last year, of whom 30 percent were not able to find jobs. Tian was speaking at the National People’s Congress in March, a sign of the importance the government now attaches to the issue. If their numbers continue to increase, they could create pools of discontent. In addition, small farmers forced off their land are another unhappy social group, and there were thousands of protests about illegal land seizures last year. In summary, China is working to manage its explosive growth. There are challenges ahead, but they may only slow the growth rate, not halt it. These days, all the news out of China is good, better and just fantastic. For a decade now, the economy has been chugging along at an unbelievable 10 percent growth a year. Last year, it hit 10.7 percent. Stock markets in the country are hitting record highs day after day. By all accounts, the people of China are more optimistic and more upwardly mobile than ever before in history. Does this mean that we should all be placing massive bets on China as the world’s next big superpower? Maybe. But before we move all our factories to Guangzhou and invest our retirement money in China Inc., there are a few factors to consider. “China is really difficult in corporate planning because it’s one of the few countries whose future could go in so many different directions,” says Mark Frazier, chair of the Dept. of Government at Wisconsin’s Lawrence University. “Best case, worst case and status quo scenarios are almost equally plausible.”

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