Business

Monday October 12, 2009

China – from containment to engagement

Hock's Viewpoint - By Choong Khuat Hock


SIXTY years ago when the Chinese Communist Party (CCP) swept into power in China, the Western world was more concerned about containing China, especially when communism was sweeping through South-East Asia.

An isolated China then had little economic impact on a world embroiled in a cold war.

As China celebrates its 60th anniversary under the CCP rule with dazzling displays designed to awe the world and convince its population of the CCP’s success and legitimacy, it should not be forgotten that the first 30 years of CCP rule, mainly under chairman Mao, was beset by many failures, notably the Great Leap Forward (1958-60) and the Cultural Revolution (1966-76).

Perhaps the leaders in China should not forget that the Nationalist government in China post-World War II was defeated due to the large income disparity in China and rampant corruption, a condition that exists to varying degrees in China today.

Furthermore, China’s insistence on maintaining an 8% growth target, no matter what, is reminiscent of unsustainable steel targets set during the Great Leap Forward which resulted in agricultural utensils being melted leading to starvation as agriculture output stalled.

Currently, investments account for over 40% of the Chinese economy.

With falling exports and foreign direct investments due to overcapacity and shrinking world trade, China is sustaining its growth through domestic investments, supported by state-owned banks which have doled out 8.1 trillion renminbi in the first eight months of 2009 (See table).

In the longer term, China will have to depend on internal domestic consumption and rely less on exports and investments. It will have to boost its private consumption which only accounts for 36% of its economy, significantly lower than 70% in the United States.

China will have to improve its safety net like providing healthcare, social security and retirement benefits so that its population can reduce the need for high savings.

Reducing domestic investments will also boost the percentage of private consumption as a percentage of gross domestic product.

The economic returns arising from China’s massive infrastructure expenditure will initially be good as China needs to modernise.

Indeed, China now has more highways in kilometers and faster average train speeds compared with the United States. However, the law of diminishing returns means that over-investment, like building bridges to nowhere in Japan, will only boost government debt and burden future generations.

China has overtaken Germany to become the largest global exporter while it has become the third-largest global importer, sucking in raw materials to produce manufactured goods for domestic consumption and exports.

The economies of scale enjoyed by Chinese manufacturers and their improving technology and quality make it difficult for manufacturers in other countries to compete with them.

Companies in Malaysia will have to find niches where they can produce specialised goods in smaller quantities but at higher margins.

This is a strategy adopted by many Malaysian furniture companies that cannot compete with Chinese manufacturers who can mass produce at very low prices.

A recent trip to South Korea also indicated that Korean companies are facing pricing pressure from Chinese companies with larger capacity and fast improving quality.

Only in certain areas like rubber gloves have Malaysia maintained its global dominance, a feat made possible due to the proximity to latex sources and the entrepreneurial spirit of often egoistic rubber glove magnates.

At the rate Indonesian plantation companies are expanding, it is likely that they will soon overtake their Malaysian counterparts.

Another policy adopted by multinationals and companies facing Chinese competitors is to set up a manufacturing presence in China so as to benefit from lower production costs and China’s large domestic market.

This is the policy adopted by electronics companies like Malaysia Pacific Industries Bhd (MPI) and Unisem (M) Bhd. The Chinese operations of these companies are growing faster than their Malaysian operations.

Such a policy helps the companies maintain their competitiveness but it results in money flowing out from Malaysia into China.

Taiwan, for example, has experienced a hollowing out as Taiwanese companies scale back their more expensive manufacturing operations in Taiwan while shifting their investments and production to China.

The fact that Malaysian companies are being forced to invest in China due to lower operating costs, ample skilled labour with better education and a large domestic market does not augur well for Malaysia’s manufacturing sector.

Nevertheless, Malaysia is benefiting from China’s hunger for raw materials. China is now the largest importer of Malaysian palm oil.

China’s reduced confidence in the US dollar and its global rising trade may also lead to a global financial architecture which is less US-centric and less dependent on the US dollar.

As China’s status improves, it will have to play a larger role in multilateral organisations like the United Nation, International Monetary Fund and World Bank.

The world should welcome this, as political and economic engagement will ensure a more moderate China.

Economic liberalisation and better Internet and mobile connectivity will eventually lead to greater transparency that will put a check on corruption in China.

The CCP is unlikely to allow political liberalisation soon but hopefully the consultative process at the higher echelons of power will ensure that policies will eschew the fanatical and extremist policies seen during the Mao era.

In the meantime, world leaders are making a beeline to Beijing in efforts to engage China on a mutually-beneficial basis.

By being the first few South-East Asian leaders to visit the Ming emperor in Beijing around 600 years ago, Parameswara (1314-1414) sowed the seeds for the creation of the Malacca empire through Chinese trade and protection.

Every country needs a policy to engage China, especially if they are close to China and trade with it.

If there are any lessons to be learnt from history, it is to recognise China’s need for respect and to be the first to engage it on a government-to-government level, especially as China with its new-found wealth and depreciating US dollar reserves will have ample investment choices.

It would be a boost to Malaysia if the country can sign a free trade agreement with China (just like New Zealand) and ensure that Chinese companies use Malaysia as a manufacturing and services base for South-East Asia by taking advantage of Malaysia’s location, good infrastructure, multilingual capabilities and government incentives.

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