After 600-Year Slumber,
China's Wide Awake

The Western world has had a 600-year breathing space, but that is over.
The other engine of the world economy
is here to stay.

Editor’s note: Following is an edited transcript of comments on China and its surprising role in the world economy from Joseph A. Massey, director, Center for International Business, Tuck School of Business, Dartmouth University. Massey addressed executives at the Metals Service Center Institute Aluminum Division conference in November.

During the time of the Ming Dynasty, 1405 to 1433, China was in the midst of an enormous thrust into the world. They mounted some 60 maritime expeditions all around the world with ships 400 feet long—ships much larger than the Pinta, Nina and Santa Maria—that were navigated by magnetic compasses with upwards of 25,000 men on each expedition. They got as far as Mecca. China at the time was the most dominant power in the world. They felt an inward threat from the Mongols, who began to invade, so they stopped the expeditions and looked inward.

The Western world has had a 600-year breathing space, but that is over. The other engine of the world economy is here to stay.

Let’s look at the Chinese dragon. China has the largest population in the world, but India will overtake China by 2035. China had an economy valued at $1.4 trillion in 2003, compared to the U.S. economy of $10.4 trillion. They are growing, not at 3 or 4 percent like the U.S., but on the order of 9 percent. They have GDP per capita of nearly $1,100, up to five times more in cities like Shanghai.

From 1980 to 2003, China grew at almost 9 percent per year. In terms of the composition of the economy, 51 percent of China’s economy derives from industry and construction activities, compared to about one-seventh of the U.S. economy.

It took China only 10 years to double its national income—faster than any other country in modern history, even faster than Korea. China has grown over eightfold since it re-emerged on the world scene in 1978, two years after the death of Mao Tse-Tung. With the emergence of Deng Xiaoping, they started opening their markets to the world.

So what’s been driving the Chinese dragon? First, China moved away from Marxism and Leninism and the proletariat means of production and moved toward privatization and the profit motive. China had 300,000 state-owned enterprises, most of which were losing money and were nonproductive. They worked more as a social welfare network than an economic engine.

Deng Xiaoping and his successors recognized that in order to get rich and be glorious, they’d have to bring in market forces. So a decline in state-owned enterprises began, from 300,000 down to about 101,000 mostly larger and more strategic companies in areas such as steel, autos and electronics.

On trade, China has gone from virtually no trade in 1978 to No. 4 worldwide. The Chinese had a secret weapon, which has manifested itself in the form of foreign direct investment. China has gone from virtually no foreign direct investment to No. 2 worldwide, and at one point last year was No. 1, surpassing even the United States. It was led by the overseas Chinese—55 million people living outside the borders of China in Hong Kong, Taiwan and Singapore—who know how to make money, who know how to manage companies and who understand Chinese culture.

These expatriates represent about 60 percent of the foreign direct investment flow. Every week, more than $1 billion worth of foreign direct investment flows into China—$53 billion total last year. In the first 10 months of this year, China has experienced a 23 percent increase over last year’s foreign investing.

Another important factor is the Chinese people’s sense of nationalism. Ninety-five percent of the people who live in China are from a single ethnic group. They are very much like Americans in one respect; at almost any gathering of Chinese, someone will stand up and say, “We are the greatest country on earth.” The Chinese believe they belong at No. 1 and they intend to get there.

One factor that sets the Chinese apart is their consumerism. They are extremely materialistic. They are both investors and consumers who were long denied the benefits of modern society by the Cultural Revolution, especially housing. In the past few years, there has been a liberalization of real estate in both housing and commercial properties. The tremendous boom has been part of what’s driving the economy. They want houses, they want cars, they want the latest technology—cell phones, laptops—everything we have.

China is also becoming a larger outward investor. China is Brazil’s largest foreign investor, including its investment in Comphania Vale do Rio Doce, a large iron ore mining company, and one of the largest companies in Brazil. Most of the investment has been going to ASEAN countries, but some is coming to the United States.

The hotel mini-bar was likely made in China, by Haier, which has a 50 percent share of the world market for small refrigerators. Haier makes a wide variety of appliances. The Chinese understand the market. Whirlpool, Maytag and others who were selling washing machines in China experienced a lot of consumer returns because the machines failed. They and Haier both discovered that people were using the machines to wash sweet potatoes, in addition to clothes. Haier adapted the machine with a different cycle to clean sweet potatoes. Haier is going to be a world brand.

In the 1950s, no one ever heard of Toyota. In the 1970s, no one ever heard of Samsung. We will be using Chinese brands very soon.

Back to trade, the Chinese are astonishing. China accounted for more than 60 percent of the growth in world trade in 2003. They have averaged 15 percent annual increases in foreign trade since 1978. The Chinese now make 75 percent of the world’s toys, 58 percent of its clothes, and 29 percent of the world’s cell phones.

They are the fourth largest exporter, behind the United States, Germany and Japan. They’ve become the sixth largest importer. They have surpassed the United States as the largest export market for Japanese goods.

The United States’ 2003 trade deficit with China totaled $135 billion. The intriguing thing is that as our deficit has grown, so have our exports [to China]. From 2000 to 2003, our export sales to China grew 76 percent. China has become our third-largest trading partner, surpassing Japan in 2003. It is the sixth largest market for our exports. Meanwhile, their own global surplus has been slowing dramatically as they have sucked in all those commodities.

That gets to the issue of the pegging of China’s currency to the dollar. Most economists do not believe that peg, despite its unfairness, has had a major role in the loss of manufacturing jobs in America. Industry has brought a number of proposals before Congress, including a 27.5 percent import surcharge, which would add a substantial cost to Chinese goods entering the United States.

In the 1970s, the Nixon administration put pressure on Japan to float its currency, as we experienced a $4 billion trade deficit with Japan. The currency went from 320 yen to the dollar to 79 yen per dollar. Japan’s surplus did not go away—it kept growing. I don’t think removal of the peg will bring about the desired effect—the elimination of China’s bilateral trade surplus.

To deal with international complaints about China’s currency, the central bank may widen its reserve of the foreign currencies it uses. Instead of 20 or 30 percent in one country’s monies, like the dollar, euro or yen, it may invest in 5 to 10 percent of a broader range of currencies.

China’s share of global output in the last decade has doubled to about 4 percent, but its consumption of commodities has been extraordinary. China consumes about 7 percent of the world’s oil supply, 25 percent of aluminum, 27 percent of steel products, 30 percent of iron ore, 31 percent of coal, and anywhere from 40 to 50 percent of the world’s cement supply.

China represented 40 percent of the world’s growth in oil demand, but energy is one area in which the Chinese are struggling, particularly with electric power. They are trying to combat blackouts and brownouts. Factories get unplugged when the power grid cannot supply the energy they need. But the Chinese have plans, by 2006, to add electrical generating capacity equal to the entire capacity of Great Britain.

In 1978, the likeliest threat to a visitor’s safety in China was a bicycle. Nowadays, there are huge traffic jams; it almost looks like the California freeway system. By 2020, China is expected to have 120 million cars. China is about to become the world’s third-largest market for automobiles, behind the United States and Japan, within the next four years. In a couple decades, China will surpass the United States as the largest auto market in the world.

Automotive is one of the strategic industries in China. If you want to invest, it has to be in a joint venture with a Chinese company. Shanghai Automotive Industries Corp., the largest and a partner with General Motors, VW and others, is already in the top 500 companies worldwide. We expect that in a decade, you will see automobiles manufactured by the Chinese component of this joint venture putting Chinese brands on the streets of American cities.

It’s not only autos that are thriving. China is the biggest and fastest-growing mobile phone market, with 300 million phones in use already and 60 million added each year. China is also the largest overseas market for Boeing and Airbus, with 2,300 to 2,400 new jets needed over the next 20 years.

China is forecast to overtake North America in 2005 as the world’s largest consumer of aluminum. China currently consumes about 25 percent of global output, which has grown 14 to 15 percent for the past few years. Supply will fall short of demand by an estimated 300,000 tons this year and perhaps as much as 450,000 tons next year.

China has had a massive expansion of domestic aluminum production and is now the world’s largest producer, at about 20 percent of global output this year, compared to only 8 percent a decade ago.

The aluminum industry in China does face some substantial problems. One of them is the very high cost of electricity, perhaps three times what it is in Russia and about 50 percent more than in the United States. At the same time they need aluminum, they also need a tremendous investment in brick and mortar, including primary smelters. The government is trying to throttle that back, and decrease exports to meet domestic need. They need to get a whole lot more efficient by building larger, more efficient smelters. China has more than 130 small, older smelters.

What could get in the way of the Chinese dragon? Last March, the SARS scare worried people with a potential worldwide pandemic. They recovered pretty well from that. The impact on their growth was trivial. They formed an organization that is making plans to deal with public health scares. But it could happen again.

The Chinese are playing a more prominent and positive role in geopolitics, especially in North Korea, helping to establish China’s credibility on the diplomatic front. Taiwan is probably the biggest issue that could get in the way of China’s relationship with the United States and other powers. There is no doubt China will not let Taiwan be independent regardless of what we do. It would be like us letting Alabama secede.

Look at what China has done with Hong Kong since its reversion to Chinese sovereignty. The government has not really been a big bully. Newspaper editors have lost their jobs and the environment is not full of free political discourse, but the impact has been marginal. The government has been quite sophisticated about dealing with Hong Kong. Tibet will not become independent, either. Great powers make the rules—the Chinese have their own manifest destiny. The borders will not shrink.

Demographically, the Chinese population is getting older. They’ve had a one-child policy, without which the population would be 1.6 billion. Longevity is 72 years, and the population is not being replaced. The worker to non-worker ratio will decline. By mid-century there will be a precipitous decline.

Balancing that is the low-cost labor influx into the cities. They need roads, power, and rail service. They claim they’re building the largest high-speed network of roads. By mid-century, there will be more interstate highways in China and longer distances than in the United States. It will cut travel times down for commercial and passenger traffic between cities, providing a dramatic cost benefit to distribution.

They still have a long way to go. One of the issues for the steel industry in China is the rail problem; they haven’t been able to get coking coal to the mills because the freight lines are tied up so badly. They intend to move a substantial portion of goods by truck.

China also is feeling environmental pressures; they are polluting the air, water and earth. Some steps are being taken to address that. For example, they instituted the highest world standard for emissions for sport utility vehicles—not that there are that many SUVs in China yet.

The biggest issues impinging on growth would be overheating [inflation, gridlock], labor and pressure on the financial markets. Money-losing state-owned enterprises have stayed in business because the state banks are required to continue making loans. The government itself estimates that bad loans in China total about $290 billion. Independent analysts believe it’s at least $420 billion, and even as much as $600 billion. This means non-performing loans are 40 percent of GDP, which compares with the 2 percent of GDP that the savings and loan scandal in the United States represented, and 12 percent in Japan’s banking crisis.

The People’s Bank, between 1998 and 2005, spent about $200 billion recapitalizing and writing off bad loans. The problem is this is a relationship-based economy, not a transaction-based one. It’s a politically directed relationship, particularly in the provinces where the government will favor a specific project. In January, the government again poured $45 billion into the banks for foreign reserves, but had no real impact on reform.

The economy has been characterized by tremendous increases in growth and investment in fixed assets. The government has tried to take administrative action in the past to prevent overheating, such as denying loans to certain industries. They also raised interest rates for the first time in nine years, which is intriguing because it signals a shift toward using market-oriented measures to control the economy. The initial reaction was calm. There are very few fears about a slowing economy.

Most analysts believe that in the medium term, China is still on a growth path with a few bumps along the way. A soft landing is possible and probable, which will enable China to remain stable and fast growing, even if at a more moderate pace. If China continues to grow at 8 percent a year and keeps the relative distribution of income at the current level, by 2020 it will have about 100 million households with an income equivalent to that of Western Europe. That’s a substantial market and a substantial opportunity. A prosperous middle-class China will become less of a problem militarily or otherwise for the rest of the world.

Despite the myths that nobody makes money in China, U.S. firms are reporting to the Chamber of Commerce that this is not true. A Chamber survey of 254 firms in China asked them to compare their margins in China with their worldwide margins. Two-thirds of them reported in 2003 that margins were higher or comparable to other markets. Nearly 40 percent said they were making more money in China than they are worldwide. Eighty-one percent of them said their revenues were increasing.

The world is returning to normal. China is on the map as a world-class competitive powerhouse. They are attracting investment in ways that very few countries outside the United States are able to do. They are acquiring technology. They are leveraging the low-cost and increasingly skilled labor force. They are exporting manufactured goods across an increasingly wide breadth of product sectors. They are displacing long-established rivals such as Japan, Korea and Mexico in key markets and goods. They are ascending the technology and quality ladder.

China is back after 600 years.