Recession has different impact in China

A BizTimes Milwaukee reader recently contacted me by e-mail with a fairly simple question: “By the way, have you seen China coming back to life? I was in Shanghai-Suzhou-Wuxi in November, and things were already slowing.”

The answer is tied into the different perceptions we have of China vs. the reality of China.

China has an inverted misery situation in comparison with the United States. Large Chinese companies are doing better than small and medium ones, whereas our small and medium companies are doing better than our larger ones. This is a gross simplification which depends on whether the companies are centered on domestic or export markets and a host of other issues, but it is a significant distinction that underlines the differences in our economies.

In China, many of the larger companies tend to be focused on domestic markets, whereas many of their small and medium enterprises (SMEs), many of which are based in Shanghai (Long River region) and Guangzhou (Pearl River Area) tended to be associated with the export market. These areas have suffered the most and as a result often give visitors a slightly skewed vision of the economic impact on the current financial crisis on China, mainly because those are the areas we see.

Only 10 percent of Chinese exports are under Chinese brands. The rest are just manufactured for others. When the economic tidal wave hit, the first casualties were the export manufacturers, especially those original equipment manufacturers (OEMs), who saw their orders dry up overnight.

There are many stories of how unscrupulous business people ran out their credit lines, shorted their employees, shipped everything of value to neutral ports and then disappeared. Many of these companies were owned by foreigners who have departed without a trace. In all, 10,000 businesses and 2 million people were displaced in Shenzhen alone during 2008. Although the Chinese government has compensated the workers and will be keeping an eye out for those who left, the majority of their efforts seem to be focused on enforcement of their corporate registration and operation policies.

Inverted economy

In 2008, exports represented 40 percent of China’s GDP and growth was just under 10 percent. In 2009, it is estimated that growth will slow to between 6 and 7 percent. This is a marked contrast to most Western economies, where the GDP will go negative. It underlines that the strength of the Chinese economy has shifted from its export manufacturing capabilities to its domestic market growth.

Keep in mind China’s export market is far from dead. You only need to visit a local department store in America to see the number of labels which still read, “Made in China.” In addition, there are many Chinese companies that had developed niche markets or had their own branding and distribution systems, which are using the current situation to expand. The overall impact on the Chinese economy has been severe, especially in the areas that had large export-based economies, but it has been offset by its robust domestic market, which the Chinese government is vigorously supporting.

China’s robust domestic growth has its dark spots, such as the real estate market. The difference is that the Chinese banks going into the crisis had twice the reserves of our banks, and people in China, even when they are speculating, tended to pay cash when they bought property. In terms of their developers, they face losing their equity, but the banks are not in the double-whammy position of having to cover the developers and the mortgages of those who bought the property, as prices decline.

In terms of China’s domestic market, the main structural difference is that China’s largest set of companies, the State Owned Enterprises (SOEs), tend to concentrate on its domestic markets so they are not feeling the same pressures to lay off workers and restrict expansion plans as ours are. In the United States, our large multinational companies, which were inextricably linked to the global markets for their production and sales, have suffered, resulting in massive layoffs and economic displacement. In the United States, the larger companies have traditionally controlled markets through economies of scale, marketing and sometimes political clout. The dependence on foreign sources for manufacturing kept many industries insulated from capital equipment risk for some parts of their operations, but their sheer size and inflexibility have made them vulnerable to rapid shifts in economic demand.

In terms of small and medium enterprises (SMEs), U.S. SMEs are actually doing better than their larger businesses counterparts, they tend to be more balanced and/or in niche markets and many of them are looking to use the downturn to expand. The major exceptions were those businesses that were captive suppliers to large industry groups such as the automotive brands.

China’s SMEs are diverse and tend to run on cash rather than credit, so while they have suffered setbacks they are not in the same position as many U.S. companies, which assume that business ventures will use borrowing to leverage their returns as part of their business plans. Chinese OEMs, which depended on the international markets, have suffered.

Stimulus impact

The other area to watch is China’s recent $600 billion stimulus package. It is aimed at boosting domestic demand during the global financial turmoil, but it will also create opportunities for the fleet of foot. It is a 10-point massive spending program emphasizing innovation and structural adjustment. In part, it translates into buying and developing better technology, and it will allow Chinese companies to deduct the cost of VAT on equipment purchases which they could not do before.

On the U.S. side, the only bright spot I could find was a recent report on small business confidence by the Small Business Research Board (SBRB), which indicated that they were significantly more bullish than they were back in the fourth quarter of last year.

So, to answer the question; China is very much alive. The financial crisis is affecting it, but not the way it is affecting us. It is clear that China as a market rather than just a source is the major trend which we need to pay attention to and that what we see when in Shanghai, Guangzhou and Beijing is only part of an economic story which is rapidly spreading to the rest of China.

 

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