Getting China Wrong?

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Debates about China have often been focused on those who say its growth can go on for decades and those who predict imminent doom. Here Mike Haynes argues that neither approach is correct, but so far the Chinese leadership has been more adept at understanding its growth than outside commentators

If you have a mobile phone or a computer then there is a good chance that it has been made in China. This is where top Apple products come from - the iPod, the iPhone and the iPad. These embody some of the cleverest ideas of modern technology and judged this way a lot of people think that China's growth is something completely unusual. Whereas a generation ago China was one of the world's poorest economies, today it is jumping stages to become one of the richest. This idea is causing consternation both among those who support global capitalism and those who oppose it.

But what is going on is widely misunderstood. China's growth is spectacular but there is also a strong element of illusion in those accounts which suggests that it is leapfrogging up the international division of labour.

China's rulers have been very clever. They rejected the advice from the West - known as the Washington consensus - to open up their whole economy. Instead they followed what has been called the Beijing consensus. This involves a policy of protecting priority sectors while opening up part of the economy as a giant export processing zone based on cheap labour. Goods produced in this export sector arrive in some 5,000 containers a day in European ports. They are filled with everything from low level consumer goods to be sold in Tesco or Poundland, to top-end consumer electronics. It has been fantastically successful but all is not quite what it seems.

The success part can be seen in the way that the economy has grown year after year at around 10 percent and exports have grown at a rate of 16 percent. Today China's is the world's largest exporter by value and it will soon overtake the US as the world's biggest economy. Within China millions of people have moved from the countryside to the towns as the urban population has risen from 19 percent in 1980 to 51 percent in 2011. China has a hundred cities with populations of more than 5 million and Shanghai and Beijing each have 20 million. The labour of workers in these cities has allowed China to develop a dollar millionaire elite which was said in 2011 to have topped a million in number. This elite within the ruling class makes up less than one in 1,000 of the population but it is often seen as the face of the new China.

On any account this is remarkable but readers will immediately spot one obvious qualification that needs to be made. China's population is huge - standing at one sixth of the world's - so when it becomes the world's biggest economy this will be because its sheer numbers will overcome its low output per head. Nobody is quite sure where China is in output per head terms because the figures can be calculated in different ways, but at best it is only 20 percent of the US level and perhaps as low as 10 percent.

But if we dig deeper there are still more interesting things going on. Economies grow by piling in more workers and more machines but also by improving the productivity of these workers and their machines. China still has a long way to go on both dimensions. The amount of capital per worker in China, for example, is only around 15 percent of the Korean level and 6 percent of the American one. China's total capital stock is estimated to be only 30 percent of the American level. Productivity per worker is also low - the figures are again fuzzy but they suggest it is perhaps a fifth of the level in Western Europe and 15 percent of the US level.

Poor countries grow by copying what others do. They can import, even steal, knowledge but they also import it in the form of machines and equipment. Some of the machinery used in China is "made in China"; some of it is imported new but a lot of it is imported second hand. "The used equipment market in China is huge," says the US government's Commercial Service organisation. This equipment can go straight into use or be refurbished, reconditioned or, to use the current phrase, "re-manufactured" before being sold on.

Trade in second hand
This use of second hand equipment is one of the least understood and least investigated aspects of the world economy. Machines are like cars except that they are often better made. Just as cars usually have several owners, passing through several hands before they are finally scrapped, so do machines. There is a trade in second hand textile equipment, plastic manufacturing machines and IT equipment. The trade in second hand construction equipment is enormous. You can buy second hand military equipment to kill people - China has a second hand Russian aircraft carrier. You can also buy second hand hospital equipment to help heal them. One estimate suggests that China's second hand IT market will be worth $25 billion by 2014. IBM wants a big share of this as it offloads its old servers and big corporate systems. It has even opened its own reconditioning plant in Shenzhen.

China itself then sells on equipment that it has bought and used, now third and fourth hand, to countries like India and Vietnam. If you combine a relatively unskilled or semi-skilled worker with this type of machinery you can get a real boost in output and productivity. But this does not mean that you can just set up a factory anywhere and start the lines rolling. Look at a map of 19th century Britain and you see industrial specialisation - cutlery in Sheffield, shoes in Northampton, cotton in Lancashire and wool in Yorkshire. The same is happening in China. It has its specialised industrial districts or clusters. There is a "bra city" where several billion pieces of underwear are made (the centre of this trade is Shantou). Jeans mostly come from the factories of the "jean city" of Xintang. Many electronics come from Dongguan, while Wenzhou produces cigarette lighters and sex toys.

The speed with which this is happening is the astonishing thing - not the process. Britain did it and so did the countries that followed including Japan and South Korea. Now China is trying it. And you don't just have to ring up or email a supplier in China. There is a website to help - Alibaba.com. But there are also big players who link suppliers to retailers.

The Fung Group (Li and Fung) is one of the world's most important companies but few have heard of it. Set up in 1906 in Hong Kong, today it has links to big Western companies and to 15,000 different suppliers. Its turnover is $20 billion with 58 percent of what it sources coming from China and 34 percent from the rest of Asia. It will find the supplier, even help with the design and arrange for the transport until the goods turn up in the retailer's depot on a motorway near you.

So what about those Apple products? The trick here is that China is not only the world's biggest exporter, but also a leading importer. It sucks in raw materials and equipment but it also imports huge numbers of parts which are then assembled in Chinese factories. China is not yet the world's workshop or factory - it is the world's leading assembly plant. The sophisticated bits in an Apple product come from more advanced countries such as Korea and even very advanced ones such as Japan, Europe and the US. China's exports are only sophisticated when they embody these sophisticated imports.

This has an important consequence. China captures little of the value embodied in the products supposedly produced there. It literally gets a few dollars for each Apple product which sells for hundreds of dollars in London, Paris or New York. And even this element is formally run by the favourite sub-contractor of Western electronics multinationals - Foxconn (officially Hon Hai Precision Industry Co) whose giant factories in China are controlled from Taiwan (Longhua is the biggest of nine Foxconn cities in China). It also means that the data on Chinese exports exaggerate their sophistication because they attribute all the value to China when only a part really belongs there. Foreign content has been estimated to be over 40 percent of China's exports and over 50 percent of its exports to a country like the US. And the more sophisticated the product the higher the level of foreign content.

The reason that this is profitable is that China's private and state bosses, and its foreign ones, use high volume production based on cheap labour, although China's labour costs are rising sharply. But it is not just labour. The Chinese state also keeps down other costs to help exports and has subsidised transport systems to help get the goods out in containers to the nearest ports.

There is an additional element that is also important. China is at the heart of the world's knock-off economy. Nobody knows how big the world's counterfeit trade is. Estimates vary from 2 percent of world trade to 7 or 8 percent. China is said to be responsible for two thirds of it - three quarters if Hong Kong is added in. This means that as much as a fifth of China's trade might involve counterfeit production - you can see it at a local market near you. Few will have any sympathy with the Western multinationals that lose out. But this is not the point - the important thing is that this knock-off element again warns us not to exaggerate how far up the division of labour China has come.

If this sounds a bit like the earlier dismissal of Japan in the 1950s and 1960s as an economy which grew by making plastics and putting transistors together this is because the similarity is real. Japan eventually made it and China might too but it will take a long time. China talk has too often been a debate between those who say its growth can go on for decades and those who predict imminent doom. Neither group has looked too closely at how China is growing.

But one group does. China's leaders seem to understand the process of China's growth better than some outside commentators. So far they have played their cards right although problems are clearly building up. To succeed in the long run they have to overcome the problems of a Chinese boom and bust and the discontent of the millions of workers who produce the wealth of China's ruling class. But they also have to find a way of shifting the economy upwards. That is why China's leaders maintain a heavy industrial priority sector protected from the global economy even though it is much less efficient. But they must also try to combine this with new priority sectors that can help the economy move up. According to a recent article in Quishi, "the organ of the Central Committee" of the Communist Party, "our capacity for independent innovation is insufficient. Our large-scale industrial enterprises spend only 0.69 percent of their income from major business on research and development, and we are still heavily reliant on imports for key and core technologies and equipment."

Emerging industry
Recently China's leaders have identified seven strategic emerging industries - energy saving and environmental protection, new-generation information technology, biotechnology, high-end equipment manufacturing, new energy, new materials and new-energy vehicles. At the moment these provide only 4 percent of output but the hope is that they can increase their share to 8 percent in 2015 and 15 percent in 2020. The aim is obviously to create a modern internal manufacturing sector within China and under the control of Chinese companies rather than the Western multinationals which at the moment control two thirds of high technology assembly and 90 percent of high technology exports.

The Chinese state has a greater power to control the direction of development than states in the West. But this is relative and even here all is not what it seems. Chinese central government expenditure is only around 25 percent of output - much less than in advanced western economies. State purchases are also a smaller share of consumption than in advanced countries. Where the Chinese state has greater reach is in its control of infrastructure investment. Here it does play a bigger role than in many countries. But pulling a lever in Beijing does not necessarily mean that there will be an automatic response at the other end. This is another China myth. "Who actually knows what's happening in the remote Chinese provinces? Beijing doesn't even know what is happening in remote Chinese provinces," said one Western business expert a few years ago. His frustration may also be shared at the highest levels of the Chinese government.