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Government policy and reforms in China

Chinas consumption story is driving MNCs strategy: The Chinese


governments drive to raise incomes and shift growth towards
domestic consumption is likely to have a profound impact on most
companies. Among survey respondents, 58% said that this policy is
the factor that will have the biggest impact on their China strategy,
while 56% said that growth prospects for their industry was the key
driver of their China strategy.

The Chinese government is eager to rebalance economic growth


drivers away from investment and exports towards consumption,
and it is especially keen to raise incomes of the less well-of. It
plans to raise minimum wages by at least 13% a year for the five years
covered by the governments 12th Five-Year Plan (FYP) for 2011-15.
Market forces are already driving up wages at an even quicker pace in
some areas: since 2010, 30 Chinese provinces have raised their
minimum wages, by an average of 23%.
In 2010 the minimum wage in Beijing went up by over 45%, thanks
largely to the galloping economy and tightening labour supply.
While companies are in the short term scrambling to find efficiencies
to offset rising wages, they are keenly aware of the opportunity the
creation of a new consumer class represents. This class will not be
limited to the first-tier cities of Beijing and Shanghai, but will emerge
all across China and deep into its poorer interior regions.
In addition to wage rises, Chinas galloping urbanisation will help
push up consumption and reduce the income gap. It will, in turn,
further spur economic growth and support consumption by existing
city dwellers and new migrants, as well as making it easier to reach
more consumers, creating huge potential opportunities for the worlds
industrial firms.
Forecast is that by 2025 around 70% of Chinas population will live in
cities. Between now and then 170 new mass transit systems and 40bn
square metres of floor space will be built. Chinas companies are not
likely to be able to manage all this on their own.
The housing sector is driving growth in China. At current rates of

construction China can build a city the size of Rome in only two
weeks. This means China is underpinning demand in global markets
for many key commodities. It also means that any downturn will
quickly register on Chinese GDP and global commodity markets.

In the decade leading up to 2010, China built the housing equivalent


of roughly two Spains or United Kingdoms, or one Japan. In per capita
terms, the average amount of floor space enjoyed by urban Chinese
has doubled over the same period.

So what does the future hold? Is Chinas current housing boom


sustainable or is it heading for a Dubai-style bust?

Healthcare reform, a key Chinese government initiative, will be vital


in unleashing the full potential of the countrys consumption power.
With no social safety net, many Chinese households continue to
save an inordinate amount of their incomes against medical
emergency, or to fund their retirement. Even relatively well-off city
dwellers report that they save more than 30% of their annual
household income, in part to cover medical emergencies. There is an
urgent need to overhaul Chinas patchy healthcare system to prepare
for the coming upsurge in the elderly population, and also to bring a
much-needed boost to the quality of life of many of its citizens.

Chinas rapid economic development has not translated automatically


into political development with many of its institutions still in
need of major reform. In the post MAO era despite the
decentralisation of local government with significant
administrative and fiscal authority, Chinas government and policy
making processes have retained much of the inefficiency and

corruption characteristics of the earlier period.


In OECD (Organisation of Economic Cooperation and Development)
countries, for instance it is believed that the authority of policy
making should be moved closer to the citizens so that the

decisions made are more suited to citizens needs.


The process of reform in China has been one of continuous
conflict between the agenda of political elites in central
government, and the priorities of local leaders, with local agents
often distorting, delaying or ignoring the policies emanating from the
central government.

Since the mid-1990s the central government has taken over several
important tax bases and substantially increased its tax revenue at the

expense of local governments.


The decentralisation since the early 1980s aimed at motivating local
leaders to develop the economy was a coping strategy to deal with the
problems caused by centralisation. Centralisation in China since the
mid 1990s, in turn was a response to the decentralisation problems
such as economy overheat, decline in central governments capacity

over taxation and thriving corruption.


A usual approach of researching China is to understand the theories
and concepts generated from the Western liberal democracies and
then apply these theories and concepts to the context of China.
Without modification, these theories and concepts are often

inapplicable to China.
The Chinese government has continually reformed its government
structure and policy making process to spur sustainable development
and enhance its legitimacy. The reform of government and policy
making in China follows two intertwining trajectories: the first is to
refine the technical arrangements of various stages of policy process:

the second is more political, entailing power redistribution.


The global financial crisis has undeniably raised Chinas stature in
the world. Thanks to its ability to maintain near double-digit annual
GDP growth through the tumult of 2008-09, China overtook Japan as
the worlds second-largest economy in 2010. Before the global
financial crisis erupted, Goldman Sachs had expected China to
surpass the US as the worlds biggest economy around 2041.

But now, the Wall Street bank projects that the Chinese economy will
overtake that of the US by as early as 2027. The Economist
Intelligence Unit (EIU) forecasts that on a purchasing power parity
(PPP) basis it will do so by 2017.

Chinas growth prospects look good in the short to medium term as


well. During 2012-15 the EIU forecasts Chinas GDP to expand by an
annual average of 8.4%. That would be only marginally lower than the
9% growth in 2011.

This dramatic reversal of fortunes between the West and the rest has
transformed the way many MNCs look at China (as well as other large
emerging markets, such as India and Brazil). Simply put, it is no

longer seen as a major market for the future but a place to make big
money now. While it may not be crucial to all companies, China
certainly ranks highly on the global agenda.

On a macro level, China faces some serious risks too. An inflation rate
that has been pushed to a three-year high by multiple factors (ample
liquidity, booming demand, high commodity prices and upward wage
pressures) has become the biggest headache for Chinese
policymakers. Rising prices disproportionately affect Chinas stillrelatively-poor masses, and in the past have triggered social unrest.
There is also the growing possibility that Chinas huge investment
driveespecially at the local government leveland its own exuberant
housing market could end in a bust, triggering a sharp economic
slowdown in the next few years. A timely policy response cannot be
taken for granted, since the government is increasingly preoccupied
with political manoeuvring ahead of the next leadership transition,
expected at the 18th Chinese Communist Party congress in late
2012.

MNC executives are not overtly concerned about a major crisis in the
Chinese economy, but they are not ruling it out. Just under 40% said
they were concerned (18% very concerned) about a crisis. More44%
were concerned about major social unrest. But many do expect a
slowdown in growth40% expect Chinas growth rate to slow to more
developed country levels, which was expected to be around 3-5%,
within the next five years.

A measure of optimism may be justified, because China has proven


sceptics wrong time and again during its three-decade-long pursuit of
national economic development. It is also important to distinguish
between inevitable cyclical downturns that affect all economies and
the inexorable structural upgrading of the Chinese economy. To
understand the full implications of the latter, one only has to look at
the immense collective purchasing power of Chinese consumers
today.

Some believe that foreign investment into China is set to slow over
the coming years. EIU special report argues that, in fact, the rapid
expansion of Chinese consumer demand will mean that the country
continues to attract FDI inflows, in particular into the services sector.
It explains that this investment will continue to move towards

booming inland metropolises such as Chongqing in search of cheaper


labour and faster growing markets.
With leading economies of the world in dire shape, China now has become a
crucial engine of global growthsooner than anyone had imagined.

One of the greatest challenges facing multinationals is achieving


China speed, while maintaining a low profile.
Multinational companies tend to want to build more slowly and solidly than
their local counterparts, but if they do so in China their competitors are
likely to fill the gaps. Overall, 59% of our survey respondents remain focused
on improving penetration in wealthier coastal cities/southern region, and
only 33% of them are currently moving into second- and third-tier cities.
At the same time, companies worry about getting too far ahead of the local
competition, lest they attract unwanted attention. This could explain the
seemingly low expectations in terms of using acquisitions as a route to
growth in China: only 20% chose acquisitions as the most important
strategy for growth in China, while 63% chose organic growth and 46% said
joint ventures.
There are signs that multinationals traditional competitive advantages
are beginning to erode in China.
It is often taken as fact that multinationals have superior technology and
better brand
management, and hold more appeal for talented workers. There are signs
that all of these advantages are beginning to erode in China. Even among
the large companies surveyed for this report (global revenues of more than
US$5bn), only one-quarter felt they have superior technology or a stronger
brand. Human-resources consultancies report that local talent is
increasingly gravitating towards mainland companies.
Chinas policies aimed at encouraging local innovation are causing a
great deal of ill will among multinationals.
Multinationals need to reorganise to match the importance being
placed on China. Among large companies responding to our survey, only
8% said that their China CEO sits on the company board (for 45%, the
China CEO reports into regional headquarters). However, 40% of large
companies said that they had posted very senior executives to greater China,

a move aimed at improving understanding of China and speeding decision


making at headquarters.
While planning how to win in China, multinationals are beginning to
think how they can leverage their relationships there to compete
elsewhere in the world.