China’s economic recovery: true or false?

In August, China announced that the country’s GDP grew by an astonishing 7.9% and claimed that a recovery was in full swing. But is it? And of great import for you—what will all this mean for molders around the globe?

China will reestablish itself quickly as the exporter with the lowest prices and will exert massive pressure on molders in key markets for molded products such as Europe and the United States. But for now we do not think that China will be able to quickly regain its former role as the supplier of choice.

Rather, the “new” China will have to compete much harder for market share. The recession-battered molders in North America and Europe have made major changes in their ability to deliver product at lower cost. The benefit of automation as well as part design changes reducing materials consumption will make it harder than before for Chinese exporters to compete for key components such as automotive, electrical, electronic, and appliance parts.

Bogus data?
China’s data are suspect, to say the least. For instance, the government there considered loans issued to companies by the government as part of the GDP. In other words, billions and billions of dollars worth of stimulus loans suddenly helped to bump up China’s GDP. This questionable way with statistics creates a false image of growth.

Another example of why we should question the extent of China’s “recovery” can be measured by power consumption. When the GDP growth for the first six months was announced, the Chinese also said that overall electricity consumption dropped sharply. How can you have a boom time in manufacturing without using electricity?
John H. Makin is a well-respected economist at the American Enterprise Institute who has testified before the United States Congress Ways & Means Committee. In August Makin wrote, “It is important to understand how China’s remarkable reported economic performance is possible in the midst of a global recession. True, China enacted a massive stimulus package last November worth about 14% of GDP and aimed at boosting domestic demand as exports fell sharply. And exports are indeed still falling. As of June, China’s exports were declining rapidly, at a year-over-year rate of 21.2%. Just two years ago, in 2007, its exports had grown 21.6%, but that was the last year of the global economic boom.”

Then, he adds, “Once China had announced its 8% growth target, it began to disburse funds directed at a sharp increase in public works spending. It is important to understand that the disbursal of funds is recorded as GDP growth. So the government can easily control the pace of growth by the pace at which it releases funds that have already been allocated in the stimulus package to the creation of higher production or growth numbers.”

In other words, a good percentage of the reported growth may be bogus.

Global change
The changes in the global economy and the real change toward growth in North America and Europe will create new pressure on China. Key economists such as the brains at the International Monetary Fund say that to sustain the recovery, the United States must refocus itself toward exports and Asia towards imports. If the United States is successful, China will only be able to maintain its growth pattern by being aggressive in both recovering some of its export markets and increasing domestic consumption.

The IMF chief economist in mid-August detailed this. Said Olivier Blanchard, “The turnaround will not be simple. The crisis has left deep scars, which will affect both supply and demand for many years to come.” He also said that—and this is bad news for Chinese exporters—that U.S. consumers are unlikely to resume massive spending in the near future. Rather, China must boost domestic consumption and imports in order to help with the global recovery.

“From the point of view of the United States, a decrease in China’s current account surplus would help increase demand and sustain the U.S. recovery,” he said. “That would result in more U.S. imports, which would help sustain world recovery.” He also wrote, “Both higher Chinese import demand and a higher [yuan] will increase U.S. net exports.”

What will China buy?
Regardless of the accuracy of economic data, China will boost purchase of components for its fast-growing automotive industry and also items such as small appliances to feed consumer demand. The latest set of (albeit somewhat suspect) Chinese data show that this is already happening. Urban investment increased by 34%, retail sales by 15%. It is hard to project just how much exports from NAFTA will grow in the next 12 months vis-à-vis China.

Economic numbers
The Shanghai Composite Index is an index of shares traded on the Shanghai Stock Exchange. It is a benchmark used to measure the health of Chinese stocks, much as the Dow Jones, NASDAQ, and S&P 500 are used to measure the health of U.S. stocks. The Shanghai Composite Index has gained almost 70% so far this year, having peaked at about 3478 points in the first week of August but later leveled off at about 3100 on worries that its rise was outpacing economic growth.

According to a statement by Shang Fulin, chairman of the China Securities Regulatory Commission, “There are some positive changes in the overall development of the market, as the global financial situation eases, the domestic economy gradually recovers, and reforms to capital market regulation show results. Market operations have reflected expectations about macro-economic stabilization and recovery. Positive factors are accumulating to promote a stable and healthy development of our country’s capital market.”

China’s economy is dependent on exports, and that country’s US$580 billion government stimulus spending on urban renewal has been taking up much of the slack. Li Xiaochao, spokesman for China’s National Bureau of Statistics, said at a Beijing briefing that “the grave international environment” affected Chinese exports. China’s exports for July 2009 were slightly more than $105 billion, 23% less than exports in July 2008. However, these exports were more than 10% higher than they were in June 2009, and the month-to-month growth is a solid indication of economic recovery.

China’s domestic consumption is up year over year. July 2009 figures of retail sales were up 15% and industrial output was up 10.8% compared with July 2008. GDP grew more than 7% in the first two quarters of 2009. While any mature economy would be thrilled with these numbers, analysts used to China’s formerly stratospheric growth were disappointed and these numbers fell short of government growth projections. As a result, the Chinese government recently announced they would invest an additional US$300 billion on railway construction over the next three years. The infrastructure expansion will create not only short-term construction jobs, but also development opportunities for production facilities by opening more areas to freight traffic.

On the oil front, according to a report by University of Calgary professor Philip Verleger, China has stockpiled more than 100 million barrels of oil this year while prices were low. It will soon build a second facility to hold another 170 million barrels, with a third expected in the future. Its goal is to build a 90-day reserve, similar to that of the United States.

The future
So where does this leave China in the coming year? If you listen to the China Plastics Processing Industry Assn. in Beijing, it will return to double-digit growth the second half of this year. The country’s largest producer of injection molding machines, Ningbo Haitian Plastic Machinery Group, is also saying that domestic machinery sales bounced back to pre-recession levels last April.

Our ears on the ground paint a different picture. They tell us that China has had thousands of factories geared toward mass production of simple parts components close down over the past year. We also understand that China has excess factory capacity—we have seen estimates ranging from 15%-50% overcapacity in Guangdong province, which has been a hotbed of plastics activity for more than a decade.

We anticipate that China will face stiff competition in contracts for mass-produced goods over the next year. While we will see global growth over the next several quarters, the return of the mega-volume orders that were so cost effectively “Made in China” are still far off. That means China will face competition from the usual low-cost-labor suspects as well as countries pressuring their businesses to produce domestically and stimulate local economies.

Expect this trend to trigger more attention toward niche production and customization, areas where China has not been able to compete well against the West in the past. China has the excess factory capacity in place to be able to switch gears and has the labor and raw materials to be able to compete globally on this level. The real problem is in marketing. The national reputation—and mindset of many businesses—is on massive quantities, fast and cheap. A paradigm shift to shorter-run, precision, high-quality items will need to take place on a local level. Then it needs to be sold both internationally and domestically before it will take off.

China, Europe, and North America will all be competing for the hearts and yuan of Chinese consumers. Even during the worst of their recession, China experienced double-digit growth in domestic spending. This caught the attention of producers around the globe who will now be pushing to increase their exports to China. China has spent a generation focusing on exports and being a major player in the international marketplace. Turning greater attention to its domestic needs and marketing products made in China targeted specifically for Chinese consumers will afford opportunities. China has not experienced the same levels of “branding” that most large economies have, in part due to the culture. Selling uniqueness can be a paradox in a culture promoting nationalism, but with more than 1.3 billion potential consumers, producers should be able to find a market for just about anything.

Agostino von Hassell (avonhassell@thereptongroup.com) is a senior advisor of The Repton Group LLC (New York, NY).