Times are changing. Companies in China now face a very different business environment. The future is looking much less certain.
What does the future hold for companies in China?
Companies in China have generally done well over the past decade: corporate income has grown very fast, and profitability has also been on the rise.
They have also benefited from world-beating productivity gains, an expanding labor force, and rising inflows of foreign direct investment.
Demand has been supported by domestic investment in industrial capacity and infrastructure, and, until the 2008-09 global financial crisis, steady growth in the world’s major markets.
Accommodating government policies have also kept the price of inputs low, thus raising investment returns.
But times are changing.
Companies in China now face a very different business environment.
The future is looking much less certain.
A gloomy global macroeconomic outlook, particularly for Europe and the United States. That has already had considerable impact on the Chinese economy as export growth to key markets in Asia, Europe, and North America has slowed significantly since 2010.
The worst is Europe, where exports have recently started falling, causing revenues flowing to China’s industrial sector to slow.
China’s productivity growth has also fallen. Growth in total factor productivity has dropped from an annual average of 4.7 percent in 2001-07 to 2.8 percent in 2008-10.
Earlier rounds of market liberalization and privatization have largely run their course, and the mass reallocation of labor from low productivity agriculture to higher productivity manufacturing is coming to an end.
The massive expansion of capital investment in recent years has caused capital efficiency to fall, effectively “crowding out” productivity growth.
Implications for the national economy
Raising productivity is critical for China’s economic future as the experience of other East Asian economies shows that capital-driven growth is not sustainable.
China still has a long way to go in this regard. While China’s labor productivity has improved a lot over the past decade, it is still behind that of developed countries. This, of course, presents both opportunities and risks.
China’s leaders recognize the importance of productivity to the country’s economic future.
A key objective of the 12th Five-Year Plan (2011-2015) is shifting the growth pattern toward consumption-led, efficiency-focused growth. Companies can, therefore, expect increasing pressure to raise productivity in the coming years.
Industrial policy will be designed to raise productivity, and increasingly to penalize unproductive and wasteful companies.
The government is expected to implement input-factor market reforms in line with the current Five-Year Plan’s binding targets to lift average incomes and increase resource efficiency.
This will have the effect of making cost-inflation a permanent feature in a slowing economy, something that most companies in China have yet to experience first-hand.
Taking a closer look at cost drivers, our analysis shows that both labor and commodity costs have increased substantially in the past five years. Labor costs have increased the fastest, with average wages more than doubling since the beginning of 2007.
In the same period, the average price of commodities consumed by China increased by 51 percent: soft commodities rose 60 percent; metals rose 19 percent; and energy prices rose 77 percent.
We expect these cost increases to continue. The upward pressure on labor costs will persist with the introduction of mandatory employer social-welfare contributions, government targets to increase the minimum wage, rising salary expectations from employees, and the increasing cost of living.
The price of commodities, generally lower in China than globally, will rise relative to international levels as the Chinese government removes administrative controls.
There are plans to link city-gate natural-gas prices with prices of imported fuel oil and liquefied petroleum gas in two provinces.
The only way to offset the impact of slowing revenue growth and rising costs is by lifting productivity.
Companies must, therefore, view productivity as a strategic imperative. For the economy as a whole, more productivity growth will come from improvements at the firm level.
By harnessing the following sources of productivity, we believe that companies can maximize efficiency and drive a new round of profitable growth across the economy:
- Take advantage of structural changes such as reforms to lower market barriers and the opening up of new industries to investment.
- Maximize the benefits of information technology by making better use of data, improving communication, and enhancing speed and flexibility.
- Exploit technological catch-up by combining different existing technologies and adapting them for China’s needs.
- Increase the pace of talent development, deploy talent to the highest-value opportunities, and improve the way workers engage with each other.
- Pursue mergers and acquisitions to drive scales of economy and add value through creative partnerships.
- Undertake overseas direct investment to gain experience and import advanced technologies.
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Rethinking productivity growth
Driving sustainable growth for China operations
