Filling the Hollow Middle

It is no secret that China no longer wants to be the factory to the world. The environmental degradation, depletion of natural resources, and continuation of such low wage levels is simply not sustainable if China wants to pursue the Chinese Dream of global influence and a developed standard of living.

The migration of foreign companies who helped make China the second largest economy in the world is well underway. Adidas left a couple of years ago. UNIQLO, Foxconn (the maker of many Apple products), Nike, Clarion, and Samsung have all invested in new factories in other parts of Southeast Asia in preparation for their continued downsizing in China.

Recently the CITIZEN watch company liquidated its Chinese manufacturing operation and laid off 1,000 employees. Microsoft, meanwhile, announced the closure of Nokia plants in Dongguan and Beijing which together employ 9,000 staff.

On the surface such corporate flight would seem to align with China’s desire to realign its economy and pivot from the export model that allowed it to lift 300 million people out of poverty in just one generation to a consumption-led economy similar in structure to the economies of the US and Europe. It does, however, complicate matters.

Over the last three decades China has created the greatest amount of real estate wealth the world has ever seen.  But is it sustainable?
Over the last three decades China has created the greatest amount of real estate wealth the world has ever seen. But is it sustainable?

China’s magnificent growth has relied largely on two engines: low value manufacturing and real estate development. Over the last three decades China has created the greatest accumulation of wealth through real estate development that the world has ever seen. It is, however, an unsustainable feat.

For starters, much of the wealth created by land development has come at the expense of local government debt that has been used to satisfy aggressive economic growth targets that drove the assessment of official performance. Many local governments, as a result, are so heavily leveraged that there is growing doubt that many localities can pay off their debts without Beijing-assisted restructuring.

Secondly, much of that wealth has essentially been taken out of the economy through private and official corruption that has essentially concentrated that wealth in relatively few hands and is not being reinvested in increasing economic productivity. Some of it, in fact, has left the country.

Perhaps most importantly, there is only a fixed amount of land to be developed and many smaller cities already have a glut of new housing and commercial real estate that remains unoccupied and probably will remain so for some time to come.

The growth of the service industry will help. As the experience of the US and other Western economies has so vividly demonstrated, however, you can’t just take assembly line workers and move them into high-paying service jobs overnight. And no economy can sustain itself on fast food and discount retail alone.

The fact is that manufacturing will continue to be an import sector of China’s economy for many years to come. BUT, and it’s a big but, it must move up the value chain. It can no longer rely on running shoes and low-end electronic assembly to drive its economic growth. It must fill in what one observer refers to as the hollowed out middle between unsustainably high real estate prices and the unsustainable production of low value-added manufactured products.

As any foreign manufacturer in China will attest, the local competition has gotten much better in recent years. Today they are much more competitive with the foreign companies manufacturing here than they were a decade ago.

The key nuance, however, is that they are much more competitive at producing low value-added manufactured products, which is exactly what the foreign companies who are leaving were producing here. They are, analysts note, still not competitive with the products that many of the fleeing global companies manufacture in their home countries.

As one writer noted, the departure of Japanese manufacturers, many of whom, like CITIZEN, are moving their production back to Japan, will only exacerbate the problem in the short term. While they may be forced to cede the low end of their markets to local Chinese manufacturers, they may actually get stronger in the high end where China ultimately needs to compete to fill in the hollow middle of its economy.

There are, of course, Chinese companies who have already moved successfully up the value chain. Companies like Lenovo are already demonstrating the kind of innovation and quality that it takes to compete at the top of the global value chain.

The Chinese government clearly has the money and the levers to pull in order to complete this transition. They must be flawless in their execution, however, and there will undoubtedly be a lot of volatility along the way.

The bigger question, perhaps, is whether or not the Chinese people have the patience for what is sure to be a slow, painful path to further development. Young professionals who have grown accustomed to changing jobs every two to three years for 30% – 50% salary increases each time will be forced to lower their expectations.

Families who have built huge amounts of wealth in real estate development may see much of that accumulated wealth disappear as the real estate market comes back to earth and the realization that there is a limit to how much wealth you can create through leverage settles in.

As in the past, I am not inclined to bet against them. I believe they will get there in the end.

Perhaps ironically, however, I believe it will take an iron will in Beijing to see the country through. The process will be a bit like surgery without anesthesia. The country can’t stop when the first scream is heard.

So for those who would be critical of the increasingly tight grip of the Party I would suggest you consider the alternative. It could well be that the hollow economy caves in on itself, the government collapses, and many people suffer. Truly compassionate people can’t want to see that happen.

There must be balance, of course. That goes without saying. But that is why I continue to be a supporter of the current administration. I believe it has the resolve to do what clearly needs to be done and the perspective to put their actions in the larger context of common good over the long haul.

 

China no longer wants to be the factory to the world.  And foreign companies are obliging.  But does China have the will to fill in the gap between an unprecedented accumulation of wealth in real estate and a manufacturing sector that can compete at the top of the value chain?
China no longer wants to be the factory to the world. And foreign companies are obliging. But does China have the will to fill in the gap between an unprecedented accumulation of wealth in real estate and a manufacturing sector that can compete at the top of the value chain?

The author’s newest literary novel is now available in paperback on Amazon worldwide.  Click on the link below to take a look.  It’s a very personal and thought-provoking tale.

The Bomb Shelter by Avam Hale

Copyright © 2015 Glassmaker in China

Notice:  The views expressed in this post are strictly those of the writer acting in a personal capacity.  They are not in any way endorsed or sanctioned by his employer or any other individual with which he may be personally or professionally affiliated.