China Research

More and more economists deal with China. This a good thing since China nowadays is the second largest economy in the world (in PPP terms). This position urges for increased knowledge about the Chinese economy.

And there is much more to learn – particularly with regards to the way economic policy and the economy works. One of the biggest mistakes that Western analysts usually makes is the transition of analysis and its interpretation from the Western model to Chinese applications. China works differently – and will continue to do so.

One of these moments came recently when I got really surprised by Western songs of joy after the official announcement that China had enlarged the quota for qualified foreign institutional stock investors from $30 billion to 80 billion.

First, this increased amount is not that large. But it was also interpreted as symbolically important. Really? Not necessarily.

Second, Western analysts also interpreted the above-mentioned step as an indication that a more sizeable and visible opening of the capital account balance is on its way. In my opinion, this is a premature interpretation. According to all experience from Chinese deregulation policy, steps are taken cautiously and very gradually. In a forthcoming paper, I am going to show that there are many reasons for the Chinese to conduct a cautious course on deregulations of financial cross-border movements.

Third. It seems to be the case that also domestic Chinese financial markets are increasingly hit by contagion from immature Western conclusions and/or by overreactions on their own in Shanghai and Shenzen. Anyway, Chinese stock markets are starting to be a topic for behavioral economists, too.

Another example of not understanding the Chinese economy quite well was recently given by U.S. secretary Timothy Geithner when he praised China for having widened the band for currency fluctuations. Sure, faster appreciation periods of the RMB may become possible (what the U.S. administration wants). But this is only one side of the coin. It could also happen that China in the nearer future could use the option of a weaker RMB – either just on a daily basis or a little bit more as a kind of support to Chinese exports if the global economy was to face even more growth troubles.

It cannot be ruled out that China’s slight changes in the exchange rate policy may even have negative consequences for the U.S. in the longer rum. This would happen if China really was heading for a more market-driven exchange rate by steadily enlarging the fluctuation bands, as frequently stated in the past years by Chinese officials. At the end of the day, this could also mean that the Chinese currency – at least temporarily – can become a case for depreciations vis-à-vis the dollar, and other currencies as well. Free(er) cross-capital movements open the door for speculation much wider than deeply regulated capital inflows and outflows. (The advantages of liberalized international capital flows have been discussed in previous articles and blogs of mine).

In other words: Chinese appreciations of the RMB (renminbi) do not need to be an ever-lasting story. The more market in the Chinese economy and on Chinese financial markets, the higher the sensitivity for ups and downs of the RMB, at least when looking a little bit longer into the future.

Hubert Fromlet
Professor of International Economics
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The emerging market of China is not only the second largest recipient of inward foreign direct investment (FDI) following the US. A rapidly increasing level of outward FDI is also seen, being driven by an overheated domestic market and governmental policies such as the ‘Go abroad’-policy stated by the Chinese government in 2001. Despite smaller decreases during the recent global recession, FDI from China is all time high and increased with 20 percent from 2009 to 2010. China then surpassed Japan and became the fifth largest country in the world on outward FDI. Still there is a surplus of investments since the inward investments are 1,5 times higher than the outward FDI. A majority of the outward direct investments are undertaken by larger, government-supported multinational corporations. Such firms and their investments were marginally affected by the recent global recession, while the growing exports of smaller privately owned Chinese firms within low-tech industries were more severely hit by the crisis. As a result, these firms restructured and now focus on the domestic market. But what challenges are met for such firms to manage international expansion in the future?

Many private-owned Chinese small and medium-sized enterprises (SMEs) are located within industrial clusters for production of consumer goods such as toothbrushes, textile or electrical components. Here they become sub-suppliers to a few larger companies, often referred to as captain companies, which conduct the foreign sales. Thus, the SMEs are indirect exporters selling via domestic intermediaries, thus having limited contact with foreign markets. This is seen as a major obstacle for their further internationalization. Key to handle future international expansion is knowledge and experience of branding and how to sell their products directly to foreign markets. Through the co-location and co-operation in the clusters the firms have the possibility to learn from more experienced firms; through this they could collect general internationalization knowledge to spur their own take off. However, mere co-location does not seem to be enough when there are no formal intentions within the cluster to facilitate international take off by the firms. Instead of making use of joint resources, firms have to operate individually and then they need to find a way to get pass the pitfall of indirect export.

As indirect export involves less risk and costs it is often utilized in the early stages of internationalization, which is the stage in which most Chinese SMEs are positioned since they only had the opportunity to internationalize since the opening up of the market in the 1980s-1990s. In comparison the utilization of domestic intermediaries, trading houses and fairs is less common in mature markets such as Sweden, since it was outdated for efficiency reasons based on the limited access to foreign market and customers. Using domestic firms for international sales does not provide the exporter with any international relationships or experiences. Thereby it is seen to represent a paradox of experiential knowledge, and it also hinders the establishment of international relationships. With no or scarce interaction with foreign customers, the firm will not accumulate any experiential knowledge which is gained from interactions with foreign actors. Instead, Chinese SMEs with indirect export become dependent on their domestic business network as a provider of knowledge and international contacts. In order to reach continued international growth and increased international competitiveness Chinese SMEs need to build up direct relationships with the foreign market. Either through (1) exporting via an intermediary in the foreign market (agent or distributor). Then the customer relationship is still indirect but the firm gets access to market-specific experiential knowledge by interacting with the foreign intermediary. Or through (2) establishing a sales office or production unit abroad (FDI), creating a direct relationship to the foreign customer in the host market.

While indirect export is less risky and costly, direct customer relationships in the foreign market is the most resource-demanding kind of foreign entry since it involves FDI. At the same time, it is advantageous in terms of giving the highest relationship commitment and knowledge accumulation. One way to achieve this for resource-poor Chinese SMEs is collective internationalization, being a new route to internationalization involving Chinese wholesale and retail market platforms abroad, localized for example in Warsaw, Budapest or Dubai. Through either buying or renting one of hundreds of small booths at the platform, a foreign sales office is established through which the firm can create a position in the foreign market business network. Thereby, the trap of indirect export is avoided. A note though; when internationally inexperienced Chinese SMEs go abroad they need to handle the institutional differences between home and host market since these affect the relationship building with the customers in the foreign market. Such distance is reduced through joint learning, economy of scale and scope, and shared risks and uncertainty offered by the market platform. Successful examples of market platforms in Europe were seen to be located in places populated by a Chinese Diaspora, since it offers an extant business network to connect into.

In summary; as a result of the global recession the ongoing expansion of exports by Chinese SMEs faced a rapid decline. But being established in the world’s largest emerging market with a continuous strong economic growth, the home market became an evident substitute. But with future up-swings, international markets should again be an attractive route to growth of Chinese SMEs. The challenge is then to get pass the pitfall of indirect export hindering the accumulation of essential international experience, here the SMEs need to learn how to be competitive in foreign markets and also to establish direct contacts with foreign actors. The importance of the collective character of the Chinese business life for the internationalizing SME is visible, both in a domestic and international perspective, through the dependence on clusters and networks as a way to create a somewhat stabile environment within the rapidly changing business world.

Susanne Sandberg
PhD International Marketing, Linnaeus University

The ideas brought forward above are based on my thesis: Internationalization processes of small and medium-sized enterprises: Entering and taking off from emerging markets (Sandberg, 2012). Here the international take off by Chinese SMEs is covered through in-depth studies of five Chinese SMEs in the Yangtze River Delta and four Chinese market platforms in China and Europe. Further research on challenges regarding future growth by Chinese firms will be undertaken within the China-Sweden Management Research Center, a collaboration between the Linnaeus University in Sweden and the Zhejiang University in China launched in March 2012.

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China wants to develop a new growth model that focuses more on private consumption as a growth-creating part in the economy – at the expense of the, until now, existing dominance of exports and investment. This relatively new objective has been announced officially, too.

This new orientation is logical. Heavy export dependence can under certain circumstances cause major problems, as is currently the case in China. The extreme high Chinese investment ratio in recent years – up to roughly 50 per cent of GDP – means an obvious risk for certain insufficient allocation of capital. And the opening of better consumption opportunities is not only a matter of creating new economic growth opportunities. It is also an important social issue.

In real life, however, the way to a more consumption-oriented society won’t be that easy – and certainly more complicated than many Western economists and commentators believe.

First, private consumption is already now growing quite considerably. Too little attention, however, is paid outside China to the issue of the increasingly uneven income distribution. Improvements in this respect are urgently needed to achieve fundamentally improved conditions for private consumption.

Second, acceptable social minimum standards have to be created for health care, pensions, education, etc., for achieving some fundamental downturn of the households’ high savings rate. Chinese political leaders know about these needs – but they also know that consumption-accelerating conditions cannot be created with short notice. It is much more of a medium and long-term project.

Third, as was said in the last edition of this blog, product quality improvements are needed as well – particularly in order to attract the younger urban generation to consumption goods that are “Made in China”. Imported consumption goods reduce economic growth – not the other way around.

Forth, Chinese exporters still have a strong lobby, which at the moment is reflected by a more cautious exchange rate policy. Exporters must be successful in the future, too. Otherwise the surpluses of the current account balance could be wiped out at some point – a development that would be counteracting China’s way to a more consumer-friendly trend.

Fifth, we do not know very much about the details of economic policy after the change of leadership at the end of this year. The Chinese people’s confidence in the future is needed for sustainable progress in private consumption to an increasing part of the Chinese people. Confidence, however, assumes continuous efforts and good/acceptable results.

Stronger growth inspirations to consumers do not come automatically.

Hubert Fromlet
Professor of International Economics
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