Interesting times as investment fuels revival in China

Date: 07/10/04

TWO-THIRDS of the worldwide production of photocopiers, microwave ovens, DVD players and shoes, and almost half of the global output of personal computers, are now manufactured in China - the true workshop of the world.

According to the International Monetary Fund (IMF), since China began its economic take-off 25 years ago, it has been growing at annual rates of more than 9%. Although most of its 1.3 billion people are still living in poverty, China has become the world's second- largest economy measured in purchasing power parity terms and sixth largest measured at market exchange rates. It is now, the IMF says, the world's fourth- largest trading nation.

Its thirst for oil and voracious demand for commodities, ranging from iron and steel to copper, tin and lead, have helped to send world prices soaring.

Stephen Roach, chief economist for investment bankers Morgan Stanley in New York, says that as China's imports and exports have exploded it has become "Asia's low-cost producer with a production platform endowed with the latest in new technology, supported by spectacular infrastructure". It is, he says, "in the driving seat of an externally driven Asian economy".

Helping to fuel the transformation of the globe's most heavily populated country during the past decade has been an inflow of foreign direct investment (FDI) and the technology transfers that have gone with it. The figures are stupendous. In recent years, FDI has run at close to $50 billion (40.3bn euro) annually, equivalent each year to what India has absorbed in the whole post-Second World War period.

Today, even in booming markets, profit can be hard to come by for the companies that have been pouring funds into China, especially now that production costs are rising in response to shortages of raw materials and power supplies are proving unreliable or inadequate.

Worse, the tough competition is often seen as unfair. The European Union Chamber of Commerce in China says that a survey of its members found close to half of them worried that China is not prepared to live up to the spirit of its World Trade Organization (WTO) commitments.

UNICE, the voice of business in Brussels, is saying that the EU should not grant China the market-economy status that it is demanding. Intervention and subsidies, government discrimination against foreign firms and poor protection of intellectual property rights, it argues, "suggest that the Chinese economy needs further development" before it is a fully functioning market economy.

America, about one quarter of whose expected $600bn (483.6bn euro) trade deficit this year is with China, is showing signs of stirring itself up into a protectionist frenzy against its emerging rival. If so, it is ignoring the fact that it is now heavily dependent on official flows from China to help finance its economy.

The EU's trade deficit, although rising strongly, is not in the same league, running at around €70bn. Ben Broadbent, an economist at Goldman Sachs, has suggested that there is a downside to this. European consumers may not have benefited to the same extent as Americans from the lower prices which outsourcing production to low-cost China bring.

On the other hand, the evidence that European companies have been slower to invest and outsource to China may have helped to protect jobs at home. Thus, so far in Europe, there have been only stirrings of political conflict over 'de-localization' or outsourcing of production. This is perhaps fortunate given the EU's poor record at job creation.

There are today doubts about the pace of growth in China. The government has tried for more than a year to curb economic expansion as bottlenecks surfaced and inflation threatened.

There is a high risk, however, that its mainly administrative efforts to engineer an economic soft landing will ultimately result in a crash. Fine-tuning a transition economy is no easy job. So, much of corporate Europe is likely to continue to opt for a cautious build up in its investment in China.

But a cyclical Chinese slowdown, or even a slump, will not remove China from the role it is playing in reshaping global competition. Assuming the EU does not fall into the protectionist trap to try to keep Chinese competition at bay, member states and EU companies and workers will have to embrace structural reform to hold on to jobs and profits, especially if, as expected, the single currency starts strengthening again.

The new member states who have been counting on low labour costs and proximity to the EU's markets to underpin their growth are no exception. We are living in those interesting times that the old Chinese curse wishes for us.

• Stewart Fleming is a former US editor of Financial Times and is now a freelance journalist in Brussels.

Major analysis feature on the state of the Chinese economy and its trade and investment relations with the EU.