China of Robots and Old People

China has rapidly become the second-largest economy in the world. It will likely contribute two-fifths to global growth this year, twice as much as the United States. Resource-hungry China has an outsized influence on most commodities markets.

A visitor to the port city of Ningbo soon after Chinese New Year was struck by how little traffic this large port city had. Employers were anxious to see if migrant workers would return from visiting their families in the interior. The city’s mayor had called an emergency meeting with local business leaders because exports had plunged in January. This illustrated the plight of China’s coastal region.

Wage growth is currently outpacing productivity. This is good for consumption, but hurts China’s competitiveness in labour intensive industries. Many of the latter, including garment makers, have already moved to cheaper countries such as Vietnam and Cambodia.

This is a good thing for China. The country wants to move up the value chain, and this is one way to achieve it. It is starting to work, evidenced by the share of processed exports slowly diminishing. These are exports of basic products using mostly (imported) raw materials or simple assemblage where China adds little value.

Of Robots and Old People

The easy productivity gains have been harvested, but there is room for more. The work of Tsinghua University professor Gavriel Salvendy, for example, shows it is easy to rack up double-digit productivity increases by introducing basic management techniques to minimise waste and stop staff churn.

New highways and rail tracks have opened up the country’s interior. Companies have moved inland to take advantage of lower wage and property costs. Apple supplier Foxconn, which employs more than one million in China, has already made a big push into Chengdu from its “Foxconn City” base in Shenzhen. It is going one step further: Chairman Terry Gou plans to put to work one million robots in the next three years, up from 10,000 in 2011.

Vietnam, Indonesia and Bangladesh are just not in the same league. These are smaller economies without the enterprise, scale and infrastructure of China. With productivity growth running at a much higher clip than that of the developed world, China is not about to lose world trade share.

Also remember there is no average in China: Income levels and minimum wages vary greatly by city and province. This means relocating to the interior can lead to easy productivity gains.

Productivity will need to keep growing to make up for the effects of a greying population: The number of people older than 65 will surpass the group of people younger than 19 by 2030. Bottom line: China’s demographic dividend – a huge working population supporting a relatively small number of dependents – is disappearing fast.

The property boom has arguably thwarted innovation because the government, businesses and consumers alike focused on making quick profits. On the other hand, China surpassed Japan and the United States in patent filings in 2011, according to Thomson Reuters research.

In all, chances are China will overcome competitive pressures. It may even emerge stronger. Competitiveness is very much part of the China story – and likely more sustained than doubters opine.

Bull, Bear and Bottom Line

Bull Case: China’s value-added exports are increasing and industries are investing in automation to stay competitive and improve quality. China is filing more patents and is now dominating industries of the future such as solar power. The country has a first-class infrastructure. The migration of labour-intensive industries to Vietnam, Cambodia and elsewhere is a good thing.

Bear Case: Heavy subsidies have thwarted competitiveness and innovation. Violations of intellectual property rights still occur. The easy productivity gains have been harvested, and wage growth is a problem. China has yet to develop real brands.

Bottom Line: Loss of competitiveness is the lowest risk to the economy this year and beyond. China already is moving up the value chain.
Signposts (What to Look for)

Productivity and real wage growth
High-end machinery orders
R&D spending and patent applications
Trends in returns of Chinese who have studied abroad
Emergence of domestic and global Chinese brands
Protectionist actions by China’s trade partners

The above information is reproduced from “Braking China without Breaking the World” (April 2012) issued by BlackRock Investment Institute.
 
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