Why We’re at the End of Cheap China: Q&A with Author Shaun Rein

Shaun Rein

The emergence of China’s economy on the world stage has been perhaps the pivotal event of the 21st century, particularly for global commodity markets. China is now not just the world’s second largest economy but also a country undergoing tremendous change.  It is this China at a crossroads from factory workshop to consumer society that Shaun Rein explores in his timely new book  “The End of Cheap China”.

As founder and managing director of China Market Research Group with over two decades spent living in China, Rein has had a ringside view of the changes and challenges shaping China.  His firm works with both international multinationals as well as leading Chinese firms and entrepreneurs.  We sat down with him to discuss some of the key changes facing China and its economy.

 

As your books title states China is no longer a cheap manufacturing location as wages and costs rise.  Does this now mean it is set to lose its place as the world’s  manufacturing  hub?

There is no doubt Chinese laborer wage costs have been rising rapidly and this is forcing some light industries to relocate. Nike now produces more of its products in Vietnam than in China for instance.  But China manufacturing is not going to lose its dominance.  We have seen instances of firms moving to other locations such as Indonesia and it didn’t work out.  China’s skilled workers are more numerous and better than in other countries.  Relocating all manufacturing out of China is not really an alternative for many companies.

There is more of a focus on worker productivity within China.  You have entire manufacturing eco-systems here – everyone has consolidated operations to China.   What you will see more of is factory relocation within China to take advantage of lower land and wage costs.  One example is how Nestle has moved production facilities from Shanghai to Chengdu.  Another is how Foxconn – the manufacturer of Apple’s iPhone – has relocated 350,000 of its factory workers from Shenzhen in Southern China to a new facility in Henan Province, in the central part of the country.

While China is unlikely to see its overall share of global manufacturing fall, it is no longer the only game in town. The US is now becoming more cost competitive.  There has been a recent trend for more companies to set up factories in the US. But this is for Greenfield projects selling locally, rather than exports.  Apple, GE and even Chinese brands like Haier have all recently announced new US manufacturing investments.

 

What does the end of cheap China mean for the rest of the world?

China is no longer just a place to manufacture, it is now a place to sell goods into.

And it is not really as price sensitive as people think, despite lower income levels than the west.

Take the example of the performance of Starbucks in China.  It is now the company’s second largest market outside the US. It is also the most profitable with margins of 30 percent versus 22 percent in the United States and 5 percent in the Middle East.  The consumer demand is not driven by coffee per se, but more for the lifestyle experience that displays a social status;  Starbucks coffee is a mini-luxury in a cup.  This is a great example of how even low-end Chinese consumers will impact commodity demand.

One downside is that consumers globally will have to keep getting used to higher prices for goods coming out of China. In 2011 for example, U.S. import prices from China increased 2.6 percent. China’s economic transformation will likely mean the end of cheap consumption for Americans and much of the world.

 

China’s growth has had a huge impact on commodity prices. But with signs China’s economy is slowing will this supportive demand continue?

Chinese consumers are now becoming inflationary and this consumption will continue to build pressure on global commodities markets. I am very bullish on food demand in China and food commodities. China will continue to gobble the world.

Over 20 years ago China’s consumption of meat was 20 percent per capita of the United States. It is still just 50 percent now, meaning it has a long way to go. Chinese are really looking to eat imported food, particularly meats and high-end fruits.

China’s demand will also continue to support other key commodities such as oil.  Although China is already the world’s largest auto market, there is still a huge pent-up demand for car ownership.  Auto sales are actually being suppressed by authorities who are limiting the number of cars on the roads.  This growth is already being felt across the world. China now imports more from Germany than it exports.

 

You explain in your book how the rise of cheap China is creating an optimistic consumer class. Yet China still appears a minefield for foreign brands. Some are huge success stories, while others flounder.

To be successful you have to adapt your brand and product for Chinese tastes. Brands like Gap have not really done very well. One reason for this is the middle class does not really exist [as a consumer demographic] in China.  A brand has to be either really cheap or one with high status. Pricing and advertising has to connect with the Chinese standpoint.

Foreign food brands have done particularly well in China, where an important selling point is being trusted. Our research found food and product safety are by far Chinese consumers’ biggest concerns.  The huge success of Kentucky Fried Chicken in China is because it has the right product and brand, and is also very trusted.  However, this has also meant recent troubles that KFC has had with suspect chicken supplies have been very serious. People had such high trust in Yums (KFC’s owner) it had much further to fall, such was the level of outrage.   Still, if a brand gets it right, China will likely become their largest market.

 

Expectation are building of major reform in China this year with the arrival of a new government led by Xi Jinping.  What do you expect to see?

Overall I expect the pace of reform to be slow. There is clearly a need for reform of state-owned enterprises as there is a massive amount of inefficiency in various industries.  As regards financial reform, although we are seeing increasing internationalization of the yuan, full convertibility will be tough and could be another ten years away.  The financial system is still extremely weak and government fears money will be converted and moved overseas.

 

Various analysts warn China’s addiction to fixed- asset investment has left its economy seriously unbalanced and on course for a hard- landing. Are such fears unfounded?

One misconception is that China’s economy has very low levels of  consumption versus investment. Incomes and spending is far higher than official figures suggest.  Personal income tax rates in China are relatively high with a top rate at 45 percent.  What you often see is consumption spending through company expenses.  And if you are an entrepreneur in China, consumption is often allowed through the business -  house, cars, vacation and health clubs are a 100 percent tax right-off.  The low private consumption figure in China partly reflects existing accounting and tax laws.

While China has high levels of fixed-asset investment, this is for railroads, tunnels and bridges, which are increasing economic efficiency for the most part. Unlike Japan, infrastructure spending in China is not wasteful.

 

There are so many reports about widespread corruption in China’s government. Is there a risk this could trigger a collapse of the one party state?

Corruption is at all different levels of government. But you need to make a distinction as Chinese people view local government very differently from the Central government.  Some of the risks can be overstated. Whereas, there is a lot of conflict with local government, Chinese people are more likely to support the direction of the Central government.

China has been ruled by one Party for a very long time. There is clearly a need for better checks and balance.  One solution is for the government to pay its officials better and also allow the private sector a bigger role in the economy.

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