At an impasse

China’s economic challenge at the moment is probably the greatest it has faced since Deng Xiaoping embraced market reform in the early 1980s. Thirty years on, “Socialism with Chinese Characteristics” has passed through several stages before arriving at its current plateau in the 2010s. Without a major evolution in the national growth model, the pressures facing the Chinese economy could destabilize the achievements of the past decades.

Until now, China relied upon low-value exports and major investments to grow its economy. This model has resulted in diminishing returns in recent years. Low wages, the key ingredient to its global competitiveness in low-cost manufacturing, are no longer part of the economic equation (on average, wages rose 12% in 2012). Countries like Bangladesh and Cambodia, with rock-bottom pay and a rapidly expanding industrial base, will continue to reap the benefit of this increase as foreign companies shift production from China to maximize profits.

This trend exacerbates the problem of China’s already-excessive industrial capacity. Private companies and state-owned enterprises (SOEs) have long had easy access to credit from China’s state-owned banks. China’s population is notoriously thrifty, a characteristic that has stymied the kind of domestic consumption growth the nation sorely needs. Instead, the banks have played the essential distributive role in the economy, using the population’s saving accounts to provide cheap credit to Chinese companies, in particular the SOEs, who have been under little pressure to use this capital effectively.

Financial reform in the works

            Fortunately, the news from the Third Party Plenum in mid-November was mostly positive. Plenums in China happen on an annual basis as part of the five-year Party Congress, and the third one is often policy-focused – indeed, the market-based economic shift initiated in 1978 was similarly announced at a Third Party Plenum.

            Contemporary China may indeed be at a decision point that is in some ways as important as the one 35 years ago. Good, then, that the result of November’s plenum was a strong affirmation of market-led development. The single most talked-about sentence in the summit’s main document is that the market should play a “decisive function in resource allocation,” a deliberate rhetorical upgrade from the status quo, which declared that the market had a “basic” role in directing resources. From The Economist to Avery Goldstein, a professor at the Center for the Study of Contemporary China at the University of Pennsylvania, those whose job it is to read the semantic tea-leaves in Chinese government communiqués insist that this is a significant symbol of policy evolution. Pieter Bottelier, a professor of China Studies at Johns Hopkins, even characterized the plan as “the most ambitious reform [...] I’ve ever seen.”

            Aside from finance, other aspects of the reform include the dismantling of the labour-camp penal system, the end of the one-child policy, reform of the hukou system that defines the population’s right to live in the city, and the establishment of an elite council to execute these reforms.  

            Such a dramatic announcement of reform required Xi to amass significant political capital. To that extent, at least in the short term, “political reform” is off the table. On the contrary, Xi has increased surveillance and repression–the surveillance apparatus now costs nearly as much as the entire military budget ($111 billion USD versus $114 billion). But, notes Goldstein, further market reform may lead to political opening down the road – just not right away.

            That may be for the best. It would no doubt be practically impossible for Xi to unleash economic reform on this scale while simultaneously throwing the hegemony of the Party into jeopardy. As for the SOEs, the administration is almost certainly attempting to address the problems created by cheap credit and its economic effects (excess industrial capacity and a bloated real-estate market) by insisting on the market distribution of resources. Here Xi is admirably taking on state-owned companies that are controlled by family members of the highest-ranking government officials. With the publishing of the post-plenum document, he seems to be announcing his dominance over this gilded class to both China and the world.

Charting the way forward

Replacing China’s investment-powered growth engine with a vibrant domestic consumer market will require a cultural change if Chinese people are to part with their wages, of which they currently save about one-third. In contrast, profligate Americans manage to save only between two and three percent of their annual income.

Various government policies, including  its anti-corruption measures, which has reduced conspicuous consumption among China’s 60 million party members, and the spread of automobile limits to more cities, a measure intended to reduce China’s choking urban pollution, will also continue to exert downward pressure in various sectors.

These issues demand a strident government response. For one thing, China’s deposit savings rates, usually between three and four percent, are much higher than in most developing East Asian countries. Lowering this would encourage Chinese people to leave less money sitting in the bank. Continued de-incentivizing of real estate investment is a must: property prices have increased nearly 10% year-over-year. Thankfully, the administration’s plethora of mechanisms designed to cool the housing market, seem to be taking effect, as November 2013 showed a slowdown in property inflation compared to the rest of the year.

The hackneyed adage about “crisis” and “opportunity” being the same character in Chinese, a mainstay in Western motivational speeches, has an undeniable relevance at this historical juncture. China seems more confident and powerful than ever, while the world’s financial markets fret about grave structural problems and images of smog-choked cities shock the rest of the world. The concerns won’t cease until China sees itself past the current challenge into an economy that is driven chiefly by consumers rather than cheap government credit and ever-increasing industrial output. In this process, there is the potential to forge a nation that is more sustainable economically, socially, and environmentally. To fail to capitalize on this opportunity would be grave for an administration that has set out its stall to achieve a historical transformation.

Whilst Africa as a continent continues to grow at a modest pace, 6.6% GDP growth in 2012 (4.8% and 5.3% are forecast for 2013/14), the fact remains that this growth is not high enough to alleviate poverty and move countries up the Human Development Index (HDI). Growth alone has proved to have little impact on poverty reduction. Whilst resource rich African countries continue to benefit from relatively high commodity prices, this represents a short-term positive. It`s infrastructure, power production and intra-African trade (via locally manufactured goods) that will push countries up the HDI on a durable and sustainable growth path and this is where China could prove to be the making of the continent.

Whilst China-African relations have been shaped in the past by China securing the supply of resources and financing the infrastructure to obtain them, the future will be a far more expansive relationship, involving both the state sectors and private entrepreneurs selling to Africa’s consumers, and not just outsourcing production there. To facilitate this, China currently deploys some 150 commercial attaches throughout the continent..

Africa represents about half of the 25 fastest growing economies of the world, meaning rapidly accelerating consumption of made in China products: everything from low cost textiles to up-stream advanced technologies are suitable for African markets and the rapidly growing middle classes. Private investment is simultaneously taking advantage of the wage cost differential and adding value to products on African soil, if not carrying out the full manufacturing process there. On a recent visit to Ethiopia, the landscape I encountered transported me back to Guangdong with its neat lines of machining factories.

Surprisingly China currently lies in 6^th place behind the UK, India, USA, UAE and France in terms of greenfield investment, however the ambition is there to increase this dramatically. Chinese FDI is currently re-focusing on the manufacturing and infrastructure sectors, and current Chinese governmental subsidies are now aimed at developing industrial parks, to both enhance manufacturing capacity as well as facilitate technology and skill transfer. In return African Nations will increasingly be expected to support China`s policies in international forums. China increased its share of total African exports from 3.2% in 2000 to 13% in 2011, whilst investment has gone from US$100 million to more than US$12 billion in the same period.

Potential stumbling blocks that must be addressed now by the new Government are: environmental concerns, worker safety, compliance with local labor law and corporate social responsibility. Currently Chinese businesses on the continent often rely on imported Chinese labor, offer limited job training or opportunities for Africans to rise beyond unskilled work and continue to have image problems among the local populace.  China is not unaware of such issues and is actively addressing its image problem in Africa with vigorous soft power initiatives: 5,000 fully paid scholarships to Chinese Universities, technical training for over 30,000 Africans, the launch of the very slick CCTV Africa as well as numerous local grants for infrastructure projects. China is fast addressing its image in order to reverse hostility towards deeper economic engagement.

China, not only has the supply chain in place, the FDI, the political will, but also a multitude of both smaller and state run companies well placed to provide the skills, technology and materials needed to realize Africa’s structural transformation: the reallocation of economic resources from activities with low productivity – such as small farming and informal trading – to more productive ones – such as manufacturing, will ultimately define the rate of development of the African Continent as China’s demand for African raw materials  grows at a slower pace each year.

Human development in Africa

Very high and high human development

Algeria, Libyan Arab Jamahiriya, Seychelles, Tunisia.

Medium human development

Botswana, Cape Verde, Egypt, Equatorial Guinea, Gabon,

Ghana, Morocco, Namibia, South Africa, Swaziland.

Low human development

Angola, Benin, Burkina Faso, Burundi, Cameroon, Central African Republic, Chad, Comoros, Congo, Congo, Demireps. Côte d’Ivoire, Djibouti, Eritrea, Ethiopia, Gambia, Guinea, Guinea-Bissau, Kenya, Lesotho, Liberia, Madagascar, Malawi, Mali, Mauritania, Mozambique, Niger, Nigeria, Rwanda, São Tomé and Príncipe,

Senegal, Sierra Leone, Sudan, Tanzania, Togo, Uganda, Zambia, Zimbabwe.

Source UNDP 2013

Sandwiched between articles on the smog in Beijing and the political machinations of the Chinese government, a BBC article a few weeks ago featured Chinese painting, calling it “one of the world’s oldest continuous artistic traditions – and so innovative that it was centuries ahead of the European art movement”.It neatly exemplifies the main thrust of this article – China currently has something of a media-led image crisis outside its borders that threatens its ascendancy in the world order. Who can be sure of what China stands for when the CCP is quite so opaque?

So how do people all over the world view China? Perceptions appear to be almost as diverse as the country itself but key themes of surging economic growth, the prevalence of ‘Made-in-China’ products,  and rapid urbanization on an unprecedented scale all make a strong showing. According to a recent poll, 23 out of 39 nations believe China either has or will soon supplant the US as the world’s next big superpower. Whilst close neighbours view China negatively (just one in twenty Japanese think of the Chinese in a positive light), what makes 79% of El Salvadorians choose the US over China? After all, the US had a tendency to favour dictators in Latin America while China has a booming economic relationship with the region. The Chinese, for their part, think this is quite unfair – the majority, in a survey by the Pew Research Centre, felt their country deserved more respect globally than it gets now.

The cultural and linguistic gulf between the West and China is undeniable, but is underscored by the Chinese immigrant story in the West, that still taints perceptions. As with other immigrant groups, first generation Chinese made their niche in classic immigrant sector jobs characterised by manual labour, often catering to the needs of the local communities where they settled in businesses such as restaurants and laundries.This led to historical stereotypes associating the Chinese with laundries and restaurants.

In recent years this has changed as university towns are inundated with an influx of wealthy Chinese students who represent a wholly different category of educated, ambitious Chinese expats. Chinese business people are welcomed globally as the carriers of much needed investment and Chinese tourists are even spoken to in their native tongue in the most fashionable shopping districts such as 5^th Avenue in New York and Knightsbridge in London .

The Western media’s portrayal of China, also contributes significantly to China’s global image crisis. International politics is obviously a major factor in the media’s decisions, but so is the Chinese government’s press censorship policies –in a vicious cycle, the censorship tends to antagonise the press further, causing more ‘bad press’. But as China’s grip on the world economy tightens, Western media may choose to impose self-censorship to protect their business interests in the country: the recent New York Times article on Bloomberg editors halting publication of an article that questioned the uncomfortable relationship between the Chinese leadership and business being one such example.

The most obvious vehicle of Beijing’s soft power efforts has been the Confucius Institutes – there are ten in France, nine in Germany and seventeen in the UK alone. But even this soft power is soft power, Chinese style. The Chinese government’s heavy-handed dealings with its neighbours – such as the recent unilateral extension of air-defence identification zone over the disputed East China Sea islands – belies the promise of panda diplomacy. No amount of Mandarin lessons will decrease the anxiety nations around the globe feel upon seeing China’s border disputes with almost all its neighbours. The obvious question they ask is, ‘If that’s what the next superpower does to its neighbours, what happens if we ever land in their bad books?’

Nevertheless, there are many nations where China is making steady inroads in gaining prominence – for them Chinese business is key to survival and China is a ‘partner’. Asian countries, such as Pakistan and Malaysia, and African nations, such as Senegal and Kenya, lead the pack when it comes to pro-Chinese views. For 4 of the 5 former Soviet Republics, China is their largest trading partner.  In some regions it is a case of strategic alliance – Pakistan, for example, receives military support from China, which shares its antipathy towards rival India. In other nations, it is the business angle that triumphs –China is Ghana and Kenya’s second largest trading partner, Nigeria’s fourth, and Senegal’s fifth. This scenario is similar to Latin America as well. (China Brain has covered China’s trade relationship with Latin America in detail, particularly Brazil and Mexico.)

The Chinese government’s approach in Africa has been an intelligent one: “Soft power, Hard cash”, along with the launch of CCTV Africa and its numerous partnerships with African media bodies.Its positive coverage of African affairs, focusing on the self-reliance of Africans in developing Africa, also sets itself apart from the Western media’s mostly doom-and-gloom coverage of the continent. This has helped it gain significant popularity as an alternative source of credible news in the region. The charm offensive is also helped by heavy investment in building infrastructure, which are very visible sources of cooperation between the nations and plays a role in garnering much needed  public support.

To understand to what degree this approach has been successful one should look at some of the voices coming out of Africa that quite worryingly question the very basis of liberal democracy in favour of China-style state capitalism: ‘Why wait for lacklustre democracy tomorrow if you can get a job or a new roof over your head today?’

Some of the criticisms levelled against China – lack of freedom of expression, workers safety, etc. – certainly also merit some serious internal reflection. The way forward for China therefore lies in a combination of rethinking its media policies, along with strengthening its soft power initiatives. Defining a brand, that fits with the country, of who it is now and who it hopes to become in the future, can be the first step in this process. The country contains so much young talent and ability that is simply under represented to the world. In doing so it can draw significantly on its glorious history of arts and culture to establish ‘Brand China’, but it also needs to promote the intellectual and commercial innovations from a fresh emerging China, least its image remain in a quandary.

China’s phenomenal economic growth has made it the second largest economy in the world in a relatively short time. In the process, its impact on Brazil has been significant. The two countries have long been allies; China recognised Brazil as a ‘strategic partner’ in 1993, the first country in the Latin American region to be accorded this status. The commodity related interdependency between the two countries is so high that it has even lent itself to the official name for a classification of ship type – Brazil developed massive ships called “Chinamax” to ply mineral ore from Brazil to Chinese ports. Over time “Chinamax” has become the standard name for ‘very large ore carriers’. In this article, China Brain explores how the relationship between the two countries is evolving and why tension has been rising in recent years.

Bilateral trade

The rhetoric from the two nations is still overwhelmingly positive. As the Brazilian foreign minister put it in 2004, “We are talking about the relationship between the largest developing country in the Western hemisphere and the largest developing country in the Eastern hemisphere”. Brazilian exports to China rose massively from $1.1bn to over $21bn in the first decade of the twenty first century. At present China is Brazil’s largest trading partner, although, crucially, Brazil is not even among China’s top ten trading partners. In the following sections we explore the nature of this asymmetry and what it means for the countries involved.

‘Primarization’ of the Brazilian market

 90% of Brazilian exports to China are primary products such as iron ore and soybeans that satisfy the Middle Kingdom’s need to build its new skyscrapers and feed its giant population. Brazilian commodity businesses have long been riding high off the back of China’s growth. Contrast this to Chinese imports into Brazil – in 2009, only 1.6% of total Chinese imports were primary goods. The majority were relatively low cost consumer appliances, which have put price pressure on local manufacturers. Many Brazilians now see Chinese companies as direct competitors and a threat to their own employment. The combination of these two forces is threatening to move Brazil further down the technology ladder and regress into a less industrialised market.

 A possible explanation for this ‘primarization’ is that as a resource-abundant country, Brazil’s comparative advantage over China is only in primary goods. But studies indicate this is not always the case. Machado and Ferraz (2006) identified 58 products that Brazil was not exporting to China despite having a comparative advantage in their production. In these cases it was the Chinese government’s import substitution-protectionist policies that were barriers because China imposes escalating tariffs on processed products.

 Unfortunately, any attempt to even the playing field between the two countries is fraught with danger. In 2010, when Argentina tried to restrict import on Chinese manufactured products, China retaliated by stopping soybean oil imports from Argentina. Trade relations did not normalise till Argentina ultimately relented six months later. Brazil cannot afford to make the same mistakes. If China closed its doors to Brazilian goods, however temporarily, the impact on Brazils’ economy would be disastrous.

Battling in third markets

Brazil and China are not only competing in their respective domestic markets; they are competitors in other nations too. Here the battle is fierce, and highly tilted in favour of China. Between 2003 and 2010, Brazil’s share of the US market fell by 0.15 points while China’s rose by 6.54 points. In Argentina, China has already displaced Brazil as the chief supplier of home appliances. This is why both Brazilian manufacturers and government officials have begun to voice their concerns, leading to China developing a serious ‘image problem’ in the Latin American business sector.

China can counter this image problem if it intelligently disseminates information on how its inelastic domestic demand for commodities has boosted prices globally. So when Brazil now sells commodities in third markets, they can piggyback on the global price hike led by rising demand in China. Studies show that if China’s impact on the global market prices on commodities was removed, Brazil would have lost between $9bn and $14bn in income since 2007. This is a significant figure in Brazil’s $2.5tn economy.

Direct investment evolves

Initially, China’s relationship with Brazil was one based on the import of Brazilian produced products. Prior to 2009, Chinese FDI in Brazil was nominal. But from 2009 to 2010, it rose sharply by $310m, making the current stock value of Chinese firms in Brazil $20bn. This may actually represent the lower end of the scale of the true value because a lot of the funds are transferred through off shore accounts in tax havens and the real value of Chinese FDI is notoriously difficult to estimate.

The main areas of Chinese investment into Brazil have been natural resources like mining, oil, gas, etc. Coupled with investment into Brazilian agribusiness, like Chinese state group BBCA sinking $320m to build a maize processing factory in Brazil, it shows a continuation of Chinese export strategy into FDI strategy. Rather than buying commodities from Brazilian producers, Chinese businesses are now buying Brazilian mines and companies so they can serve their own needs more directly.

 Chinese investment into the Brazilian manufacturing sector is also rising. Chinese automotive company, Chery Automobile Co, plans to build a factory for engines and gearboxes in Brazil. Technology company, Huawei, has already set up business in Brazil, relying on more than 90% Brazilian employees to run the company to good effect. In the beginning of 2011, Huawei’s local revenue reached $1bn, proving the future for Chinese technology companies in the Brazilian market is promising. Financial acquisitions are also increasing, albeit slowly – only last month, China Construction Bank Co. signed a deal to take control of a small Brazilian bank called Banco Industrial e Comercial.

 Brazilian FDI into China, on the other hand, has remained steady for the past decade at $500m, i.e. only 0.04% of the total stock of FDI into China. This comparatively lower FDI is explained by the difficulties foreign firms face when navigating the unfamiliar rules and nuances of the Chinese market.

 Unfortunately, the Chinese government still limits which sectors foreign firms can invest in. Sectors they consider strategic, such as energy and advanced communication technology, are strictly off limits. Firms working in other industries however have been lured in by the inexorable expansion of the Chinese market. One such example is Brazil’s sole business jet aircraft manufacturing firm, Embraer, which operates in China from the Harbin region. The firm projects that within the next two decades, Chinese airlines will require over 1000 new jet aircrafts (which is 15% of global delivery of jets). Embraer does plan to tap into this market. But despite the phenomenal projected growth in China, Embraer’s biggest FDI to date has been in the United States so progress in China has been limited.

Future

 Brazil and China’s trade relationship, even in its present form, is beneficial for both parties but inherently lop sided. Brazil’s narrow specialisation on commodities, plus its over-dependence on the Chinese market, may turn out to be dangerous. After decades of unbridled double-digit growth, the Chinese market is beginning to slow down – some analysts put this year’s projected growth at 7.5%. Not only will this lower the demand for Brazilian commodities in China, it will also have a negative impact on the price of commodities in the global market. Brazil will then have to deal with significant fallout from its over-dependence on China.

 Brazil can avoid this catastrophe by diversifying its exports and producing higher technology products, as well as commodities at different stages of processing. Though reports suggest Brazil has been making tentative efforts to diversify, their ultimate success will also depend considerably on the flexibility (or not) of the Chinese government in opening up more sectors for direct investment.

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