China's Too-hot Economy is Prompting Firms to Look Elsewhere to Invest
Steel is the measure of an industrial economy. Or so thought Chairman Mao
when, to achieve his utopian Great Leap Forward in 1958, he ordered the masses
to quit their communal fields and instead melt woks and teakettles to forge pig
iron in farmyard blast furnaces. The man-made famine that followed killed
millions.
Today a sequel of sorts is unfolding！but it's a crisis of plenty, not want.
China has built so many steel foundries in recent years that it is poised to
flood global markets. Its current output, a world-leading 350 million tons,
already satisfies domestic demand. Yet with new mills capable of churning out an
additional 100 million tons coming on line, China recently became a net steel
exporter！astonishing for a country in the midst of the biggest building boom in
human history: "They have grown their capacity much faster than anyone
anticipated," laments Daniel DiMicco, head of U.S. steelmaker Nucor, speaking
for a jittery global industry. "And they just keep building."
And as goes steel, so goes the rest of China's industries. Its factories,
builders and foundries arguably produce too much aluminum, cement and cotton; as
well as too many T shirts, cell phones and cars. Runaway fixed-asset
investment！the construction of unneeded factories, office towers and
resorts！combined with sluggish consumer demand, has knocked the Middle Kingdom's
macroeconomy severely out of whack. China's GDP is still expected to grow by 9.4
percent this year！but some economists believe serious problems are lurking
behind that robust number. They argue that exports and excessive investment
cannot continue to drive growth, because both have already reached unsustainable
levels.
If that's true, then a slowdown in China may be imminent. How painful is
anybody's guess, but Jim Walker, chief economist for investment bank CLSA, says
the figure could dip as low as 5 percent next year and 3 percent in 2007. His
evidence: higher manufacturing costs, thinning margins and intensifying price
competition across a range of industries. Indeed, the World Economic Forum
ranked China 47th in business competitiveness this year in a survey of 116
nations. "The bloom is starting to come off the rose in terms of China being
this mecca for business," concludes co-author and Harvard Business School
competitiveness guru Michael Porter.
Many global investors, especially multinationals, are now coming to the same
conclusion. Manufacturers of low-value toys, sporting goods and garments along
China's eastern seaboard, for example, no longer turn big profits. Meanwhile,
high-value-added technology companies are increasingly frustrated with
intellectual-property theft and China's weak legal system. As a result, many
foreign enterprises！American, Korean, Taiwanese and Japanese！are starting to
hedge their China bets. After flocking into the Middle Kingdom from Taiwan, Hong
Kong or South Korea, many companies are setting up factories in cheaper Asian
locations. South Korea's chaebol now pursue a hybrid "Chindia strategy" of
seeking opportunities in both of Asia's continental economies. Within Japan
Inc., the mantra nowadays is "China-plus-one"！meaning the Middle Kingdom and a
manufacturing beachhead somewhere else in Asia. For investors fleeing China's
pricey coastal cities, Vietnam is the preferred lower-cost manufacturing base.
China still attracts far more foreign direct investment than India or any other
developing country！$5 billion a month in recent years！but that number is
expected to trend down in coming years, while FDI in other emerging markets
should rise rapidly. Even the Taiwanese, who poured investment dollars into the
mainland after the 1989 Tiananmen massacre, are having second thoughts.
Cutthroat competition plus anti-dumping measures imposed on China by the United
States and Europe have hit their mainland enclaves hard, in industries ranging
from electronics to sporting goods. In the mid-1990s, Seoul-based Kookmin Bank
helped hundreds of South Korean factories relocate to Shenzhen！the model special
economic zone approved by the late reformist patriarch Deng Xiaoping. "But due
to financial troubles, they are now packing and moving to Vietnam and India,"
says Kim Woo Sung, a manager at the bank, adding: "Their heyday in China is
over."
To be precise, companies aren't pulling out so much as halting expansion plans.
The Taiwanese motorcycle firm Kymco, for example, owns assembly lines in China
and Indonesia but is looking to build next in Vietnam; its rival, San Yang, is
eying Indonesia. A study from the government-funded Chung Hua Institution for
Economic Research in Taipei found that between January and August 2005,
Taiwanese investment in China shrank 18 percent from the previous year to $3.59
billion. Said the institute's president, Chen Tain-jy, after a recent visit to
Shanghai: "People are starting to think of diversifying."
Like many, the Taiwanese have found China's fabled consumer market elusive. The
country's 2001 WTO accession pried open many closed sectors, but some firms who
jumped into those businesses quickly sank. Tsann Kuen, Taiwan's top
home-appliance and electronics maker, entered China in 2003 but within two years
lost $30 million; in July the company said it would sell its China business to a
local retailer. In another cautionary tale, cell-phone maker Dbtel！once a huge
contractor manufacturer for Motorola！tried to go it alone in China, declaring
its intention to become the next Nokia. It lost $60 million and saw its share
price tumble to pennies a share in Taipei after insider trading allegations
emerged. Dbtel blames its reversal of fortunes on expanding too fast in China,
where cutthroat competition and slack demand have driven down handset profits.
Garment makers are in a particular bind. The Taipei-based Makalot Industrial Co.
and its partners saw their China orders double after textile quotas expired last
January. But then the United States and Europe pressured China to adopt
voluntary quotas on items like bras, knit shirts and cotton pants under threat
of antidumping countermeasures！effectively putting a much-anticipated textile
boom on hold. This year, Makalot's China-based factories will fill 27 percent of
its global orders, but that percentage is forecast to drop to 20 percent in
2006, leaving its Indonesia plant to take up the slack. While China remains the
company's second cheapest base of operation behind Vietnam, the firm is wary of
depending too heavily on the mainland. "We're not going to let our production
capacity in China reach more than 30 percent," says company spokesman Anthony
Ma. "It's too risky."
Even companies that played the China boom to perfection are now looking
elsewhere for growth. One example is the small-cap wunderkind Comba Telecom,
which made a killing as the mainland went from no phones to cell phones in less
than a decade and leveraged its achievements into a successful listing on the
Hong Kong stock exchange in 2003. Today it's the top seller of antennae, signal
boosters and other niche hardware for wireless communications networks in China.
Yet despite its commanding position, Comba's net profits plunged 67 percent in
the first half of 2005 due to slower growth in wireless usage, prompting top
executives to unveil a new expansion drive！into India. "We recently
restrategized," explains Simon Yeung, Comba's chief operating officer, mindful
that many competitors are just now landing in China. "While they're all coming
in, we're going out."
The auto sector best illustrates how overinvestment, massive competition and
falling prices are squeezing everybody. Chinese with the cash to procure
glimmering Ferraris, or even frumpy Daihatsu hatchbacks, have come to be seen as
saviors to the global auto industry. Trouble is, they're not buying as once
predicted. According to senior planner Chen Bin, deputy director of China's
National Development and Reform Commission, Chinese and foreign automakers have
the capacity to produce 8 million cars annually, but fewer than 5 million will
be driven off dealer lots this year. In Maoist fashion, about a hundred
automakers have sprung up from Manchuria to the Mekong, and without government
intervention, capacity could spike to 20 million vehicles a year by 2010. That
would intensify already crazy price wars that are great for consumers but
disastrous for manufacturers！economy cars already start below ！$5,000. "The
industry is facing a grave overproduction situation," Chen recently told China's
state-run media.
Volkswagen knows that only too well. After two decades of painstaking spadework,
VW grew China into its biggest foreign market. Buoyed by its popular Santana and
Audi sedans, VW once held a 50 percent market share. That's since dipped into
the teens. Worse, VW's main partner, the state-owned Shanghai Auto Industry
Corp., has unveiled plans to build its own plant and to launch a new line of
autos in 2007 using technology purchased from Britain's now-defunct Rover and
Korea's SsanYong Motor (in which SAIC took a controlling stake last year).
Jonathan Anderson, the chief Asian economist at UBS, says the sector "has gone
from boomtown to slaughterhouse." In August Volkswagen slashed the prices of its
models in China by up to 14 percent to boost sales.
Andy Xie, managing director for Morgan Stanley in Hong Kong, attributes the bulk
of China's overcapacity to cheap money that courses "hydraulically" through the
economy. Export earnings flow into China's state-owned banks, then out again
(often by official fiat) to fund more factories, malls or housing estates. New
industrial capacity then translates into oversupply at home and more exports,
which generate more inward remittances from abroad and start the cycle anew.
Some experts say the bulk of China's overinvestment is "driven by government
policy, not market forces," as Xie puts it. Others draw the opposite conclusion:
that spending patterns reflect a chaotic emerging-market economy in which
planners have lost control. Yet both camps agree that China's unchecked
expansion has come to resemble the pell-mell investment frenzy witnessed across
East Asia before the 1997-98 financial meltdown. "In South Korea [fixed-asset
investment] reached 40 percent of GDP, then the economy blew up," Xie says.
China's fixed-asset investments, he forecasts, could top 54 percent of GDP this
year.
Gluts in commodities, for which China's appetite was once deemed "insatiable,"
aren't the only sign of a dangerously overcooked economy. The country's vast
manufacturing sector is poised for painful consolidation. Despite bullish GDP
figures, "conditions facing Chinese manufacturers continue to deteriorate," says
CLSA economist Eric Fishwick, commenting on a new survey of more than 300
manufacturers released on Nov. 1. It reveals rising input and labor costs,
slower sales, profit margins shaved to near zero and an actual contraction in
the size of China's manufacturing work force. CLSA sums up the current situation
in one pithy PowerPoint slide. The title reads: china growth！profitless and
jobless.
In recent weeks, fears of lower profitability have begun to weigh on investors
in Hong Kong, dampening demand for the initial public offerings of dozens of
mainland firms listing in the city. IPO proceeds for 2005 are expected to exceed
$20 billion, with the $8 billion placement by China Construction Bank in
September taking the honors as the world's biggest listing this year. But
historically IPO fever is a warning signal！and in the past few months China's
largest banks, several automakers, and various retailers, textile mills,
chemical companies and other manufacturers have either floated shares in the
former British colony or begun exploring the option. Pundits say rising interest
rates and fears of bird flu！as well as jitters about China's economy！are now
keeping the Hang Seng index down, and several IPOs have been put on hold.
Of course, if China does fall into a slump, everybody will suffer. Latin
American and African exporters of oil, copper, soybeans and other commodities
would be hit hard. Weaker consumer spending in China would sting global giants
including Wal-Mart and General Motors. Already, says UBS's Anderson, China's
industrial neighbors are smarting from a downturn in demand for critical inputs.
"If you're [South Korean steel giant] POSCO, [Taiwan's] China Steel or Formosa
Plastics, your orders have flat-lined and China is now selling stuff back at
you." And it could get worse. During Japan's economic takeoff, its economy grew
by 8 percent a year on average from the end of World War II to the first oil
shock in 1972. But growth spiked to 14 percent some years, and fell to just 4
percent in others, moving parallel to its principal export market, the United
States.
Similarly, China's overreliance on U.S. consumers now endangers its boom
"[Today] 35 percent to 40 percent of Chinese exports go to America," Morgan
Stanley's chief economist, Stephen Roach, said in Singapore last week. "That's a
problem." For global businessmen, Chinese is still a key place to be！but perhaps
no longer the place to be.
Source: Newsweek, Inc.
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