Retailers Need a Fresh Start

Retailers need a fresh start
Andy Xie
Caixin Online
Aug. 30, 2010

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BEIJING: China’s gross domestic product surpassed Japan in the second quarter of 2010. The international media gave this milestone considerable attention. The domestic media hasn’t paid as much attention.

As natural disasters, environmental degradation and property bubbles take the center of attention, the domestic media isn’t likely to focus on this number. Besides, China has 10.5 times as many people as Japan does. The same GDP still puts China’s per capita income at less than 1/10th of Japan’s, which is hardly a moment to celebrate. Nevertheless, it would be useful to look back on how far China has come, study the risks in China’s future, and, if the country can overcome the existing challenges, how much further the country can go in the next 10 years.

China’s economy took off in 2002: nominal GDP has grown at 18.5%, exports in dollars at 21.7%, and electricity consumption at 12.8% in the following eight years. (I extrapolated the economic performance for the remaining months of 2010.)

In terms of levels, the nominal GDP has increased by 2.9 times, exports by 3.8 times in dollars and 2.9 times in yuan, and electricity consumption by 1.6 times in eight years. Japan had a similar performance in 1960s, Korea and Taiwan in 1980s. But, they were much smaller. What China has done is unprecedented in terms of scale.

When growth lasts many years, it makes a huge difference over time. It is the miracle of compounding. China and India had about the same value in GDP 20 years go. In 2010 China’s GDP is roughly four times India’s. There is little doubt that China has done many things better than India or most other emerging economies. Otherwise its economy couldn’t be so much bigger in relative terms.

The “Reform and Opening Up” policies have been the center of China’s economic policy in the past three decades. This has undoubtedly been the most important factor. China’s exports have become the largest in the world from virtually nothing three decades ago, and almost nothing two decades ago. In the last decade alone, the exports have risen 5.2 times. Being the workshop of the world has been the most important part of China’s economy so far. Without China’s export success China’s economy wouldn’t be near where it is today.

Joining the World Trade Organization made the critical difference for the country’s export success. It has given multinational companies the confidence to base so much production in China. As China’s domestic market becomes big, it gives MNC’s another powerful reason to keep production in China. No other country could offer the economies of scale from selling locally and exporting abroad, plus low production cost.

China’s production cost is no longer the lowest. Bangladesh’s labor cost is merely one fourth of China’s. Indonesia’s labor cost was twice as high as China’s before 1997. It is now comparable to China’s and is rising slower. Some industries that don’t require the supply chain nearby are likely to leave China. Shoe and garment industries, for example, may move to other countries. But, most other industries will stay in China.

Infrastructure development has been China’s second important competitive advantage. China has continually delivered strong infrastructure development due to the government’s ability to mobilize resources. The state ownership of land and banks are the critical factors. Land and credit are usually the constraints to infrastructure development in most other countries. Without such constraints, China could go for size to achieve economies of scale.

The development of the national expressway system, for example, is a good example. Only an interconnected system of size could deliver economic benefits. A few isolated expressways couldn’t deliver much benefit. This is due to the so-called network effect. In a dozen years, China has completed over 60,000 kilometers of expressways, with another 30,000 under construction. The expressway system has made the national population mobile, integrated villages and small cities into the national economy, and sharply decreased logistics costs.

The development of ports and industrial parks has made it possible for OEM industries to locate in China. Together with the highway system, they have made it possible for China to become the largest export country in the world. Inability to build infrastructure quickly is perhaps the bottleneck in most developing countries. Money is a constraint in that regard but is not the most important. Land acquisition and government implementation capability are the most important barriers.

In addition to traditional infrastructure, China embraced the Internet early, the latest necessary infrastructure for a modern economy. When China decided to embrace Internet in the 1990s, it laid the foundation for China to benefit from and be part of the global economy. It is hard to imagine that China could be where it is without the Internet. If China hadn’t embraced the Internet, its economy today could be only half as big as it is.

Third, China’s large and productive labor force has contributed more than any other factor to China’s growth. Until five years ago, the nominal wage remained stagnant in nominal dollar terms for over a decade, even though labor productivity increased at nearly 10% per annum and total factor productivity at over 4%. Chinese labor’s increased productivity showed up in declining prices for Western consumers, rising profits for multinational companies, and rising tax revenues for the Chinese government. This is why more and more multinational companies have come to China to produce, and Chinese local governments have invested more in infrastructure to attract them.

China’s wages are rising from a low base. Many people are worried about China’s competitiveness. As I mentioned earlier, some shoe and garment manufacturers may move to other countries. Other industries may do so but not without difficulty. And some may stay, but pass the higher cost on to consumers. They need to regurgitate some of the past price reductions. Also, multinational companies may have to accept lower profit margins. The consumer products that China exports retail for 3-4 times the factory-gate prices. There is plenty of room to absorb China’s labor-cost rise.

China’s rapid growth has coincided with a weak dollar. The dollar index peaked in 2002 and has declined by one-third since. The Tiger economies and Southeast Asia had very high growth from the mid-1980s to mid-1990s, which also coincided with dollar weakness. The dollar plunged after the Plaza Accord in 1985. A banking crisis kept it weak into the first half of 1990s. The tech bubble bursting in 2000 was really the trigger for the dollar weakness this time. It slowed capital from flowing into the U.S. The current financial crisis is keeping the dollar weak.

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Andy Xie is a former Morgan Stanley analyst now living in China.