McKinsey and Company present their annual China predictions. A good read.
I recently wrote something called "is China too big to fail" - it touches on a number of these issues.
I agree with a number of the issues raised here. From an environmental perspective water and energy costs will impact productivity. To compete with a resurgent Mexico, rising wages and rising energy costs China needs in increase productivity. That will be difficult.
The job creation issue is also important. China has to create jobs as part of the social contract. As wages rise and firms replace workers with capital jbo creation will be harder and the slack cannot be taken up by services just yet.
What is very interesting is the decaying infrastructure argument based on the premise of poor quality materials - this is something to follow up but difficult to prove.
I agree entirely with the bankrupt mall scenario. The solar industry rebound is less clear but there have to be some survivors in this sector and given the state support for those in China this could be a good bet.
Finally, the football prediction is unlikely. Corruption is a problem in business - I suspect European clubs would be playing with fire if they go anywhere near the Chinese football league.
A good article.
1. Two phrases will be important for 2014: ‘productivity growth’ and ‘technological disruption’
China’s labor costs continue to rise by more than 10 percent a year,
land costs are pricing offices out of city centers, the cost of energy
and water is growing so much that they may be rationed in some
geographies, and the cost of capital is higher, especially for
state-owned enterprises. Basically, all major input costs are growing,
while intense competition and, often, overcapacity make it incredibly
hard to pass price increases onto customers. China’s solution? Higher
productivity. Companies will adopt global best practices from wherever
they can be found, which explains why recent international field trips
of Chinese executives have taken on a much more serious, substantive
tone.
2. CIOs become a hot commodity
There is a paradox when it comes to technology in China. On the one
hand, the country excels in consumer-oriented tech services and
products, and it boasts the world’s largest e-commerce market and a very
vibrant Internet and social-media ecosystem. On the other hand, it has
been a laggard in applying business technology in an effective way. As
one of our surveys
recently showed, Chinese companies widely regard the IT function as
strong at helping to run the business, not at helping it to grow.
Indeed, simply trying to find the CIO in many Chinese state-owned
enterprises is akin to hunting for a needle in a haystack. Yet the CIOs’ day is coming. The productivity imperative is making
technology a top-team priority for the first time in many enterprises.
Everything is on the table: digitizing existing processes and
eliminating labor, reaching consumers directly through the Internet,
transforming the supply chain, reinventing the business model. The
problem is that China sorely lacks the business-savvy,
technology-capable talent to lead this effort. Strong CIOs should expect
large compensation increases—they are the key executives in everything
from aligning IT and business strategies to building stronger internal
IT teams and adopting new technologies, such as cloud computing or big
data.
3. The government focuses on jobs, not growth
Expect the Chinese government’s rhetoric and focus to shift from
economic growth to job creation. The paradox of rising input costs
(including wages), the productivity push, and technological disruption
is that they collectively undermine job growth, at the very time China
needs more jobs. Millions and millions of them. While few companies are
shifting manufacturing operations out of the country, they are putting
incremental production capacity elsewhere and investing heavily in
automation.
For example, Foxconn usually hires the bulk of its workers for a given
12-month span just after the Chinese New Year. Yet at the beginning of
last year, the company announced that it wouldn’t hire any entry-level
workers, as automation and better employee retention had reduced its
needs. Although upswings in the company’s hiring still occur (as with
last year’s iPhone 5S and 5C release), the gradual rollout of robots
will probably reduce demand for factory workers going forward. In short,
many manufacturers—both multinational and Chinese—are producing more
with less.
So as technology enables massive disruptions in service industries and
sales forces, what happens to millions of retail jobs when sales move
online? To millions of insurance sales agents? Millions of bank clerks?
Even business-to-business sales folks may find themselves partially
disintermediated by technology, and rising numbers of graduates will
have fewer and fewer jobs that meet their expectations. They will not be
happy about this and may not be passive. Finally, while state-owned
enterprises will feel pressure to improve their performance, to use
capital more efficiently, and to deal with market forces, they are
likely, at the same time, to face pressure to hire and retain staff they
may not really need. The government and the leaders of these
enterprises have long argued that such jobs are among the most secure.
They will find it very hard to declare them expendable.
4. There will be more M&A in logistics
As everyone pushes for greater productivity, logistics is a rich source
of potential gains. State-owned enterprises dominate in capital
expenditure–intensive logistics, such as shipping, ports, toll roads,
rail, and airports; small mom-and-pop entrepreneurs are the norm in
segments such as road transportation. This sector costs businesses in
China way more than it should. With upward of $500 billion in annual
revenues, logistics is an industry ripe for massive infusions of
capital, operational best practices, and consolidation. Driven by the
pressure to increase productivity, that’s already happening at a rapid
pace in areas such as express delivery, warehousing, and cold chain.
Private and foreign participation is increasingly encouraged in many
parts of the sector, and its competitive intensity is likely to rise.
5. Crumbling buildings get much-needed attention
While China’s flagship buildings are architectural wonders built to the
highest global standards of quality and energy efficiency, they are
unfortunately the exception, not the rule. Much of the residential and
office construction in China over the past 30 years used low-quality
methods, as well as materials that are aging badly. Some cities are
reaching a tipping point: clusters of buildings barely 20 years old are
visibly decaying. Many will need to be renovated thoroughly, others to
be knocked down and rebuilt. Who will pay for this? What will happen if
residential buildings filled with private owners who sank their life
savings into an apartment now find it declining in value and, perhaps,
unsellable? Alongside a wave of reconstruction, prepare for a wave of
local protests against developers and, in some cases, local governments
too.
6. The country doubles down on high-speed rail
When China inaugurated its high-speed rail lines, seven years ago, many
observers declared them another infrastructure boondoggle that would
never be used at capacity. How wrong they were: daily ridership soared
from 250,000 in 2007 to 1.3 million last year, fuelled partly by
aggressive ticket prices. Demand was simply underestimated. Now that
trains run as often as every 15 minutes on the Shanghai–Nanjing line,
business and retail clusters are merging and people are making weekly
day-trips rather than monthly two-day visits. The turnaround of ideas is
faster; market visibility is better; and many people come to Shanghai
for the day to browse and shop. There are already more than 9,000
kilometers (5,592 miles) of operational lines—and that’s set to double
by 2015. If the “market decides” framing of China’s Third Plenum applies
here, much of the investment should switch from building brand-new
lines to increasing capacity on routes that are already proven
successes.
7. Solar industry survivors flourish
Many solar stocks, while nowhere near their all-time highs, more than
tripled in value in 2013. For the entire industry, and specifically for
Chinese players, it was a year of much-needed relief. By November, ten
of the Chinese solar-panel manufacturers that lost money in 2012
reported third-quarter profits, driven by demand from Japan in the wake
of the Fukushima disaster. (Japan’s installed capacity quadrupled, from
1.7 gigawatts in 2012 to more than 6 gigawatts by the end of 2013.)
Domestic demand also picked up as the State Grid Corporation of China
allowed some small-scale distributed solar-power plants to be connected
to the grid, while a State Council subsidy program even prompted panel
manufacturers to invest in building and operating solar farms—an
initiative that will ramp up further.
This year is likely to see even stronger demand. Aided by international
organizations, including the World Bank, an increasing number of
developing countries (such as India) regard scaling up distributed power
as a way of improving access to electricity. In addition, solar-energy
prices continue to fall rapidly, driven down by technological
innovations and a focus on operational efficiency. While I’m on green
topics, I’ll point out that the coming months are also likely to see
another effort to create a real Chinese electric-vehicle market. The
push will be centered on the launch of the first vehicle from Shenzhen
BYD Daimler New Technology.
8. Mall developers go bankrupt—especially state-owned ones
Shopping malls are losing ground to the online marketplace. While
overall retail sales are growing, e-retail sales jumped by 50 percent in
2013. Although the rate of growth may slow in 2014, it will be
significant. Yet developers have already announced plans to increase
China’s shopping-mall capacity by 50 percent during the next three
years. For an industry that generates a significant portion of its
returns from a percentage of the sales of retailers in its malls, this
looks rash indeed. If clothing and electronics stores are pulling back
on the number of outlets, what will fill these malls? Certainly, more
restaurants, cinemas, health clinics, and dental and optical providers.
But banks and financial-service advisers are moving online, as are
tutorial and other education services.
I expect malls in weaker locations to suffer disproportionately. These
are often owned by smaller developers that can’t afford better locations
or by city-sponsored state-owned developers that are expanding into new
cities. The weak will get weaker, and while they may be able to
consolidate, it’s more likely they will go out of business.
9. The Shanghai Free Trade Zone will be fairly quiet
In early October, there was much speculation about the size of the
opportunity after the State Council issued the Overall Plan for the
China (Shanghai) Pilot Free Trade Zone (FTZ), and the Shanghai
municipality issued its “negative list” of restricted and prohibited
projects just a few days later at the end of September. For the FTZ, the
only change so far appears to be that companies allowed to invest in it
will not have to go through an approval process. As for the negative
list, while there’s a possibility that Shanghai will ease the
limitations, for the moment the list very much matches the categories
for restricted and prohibited projects in the government’s fifth Catalog
of Industries for Guiding Foreign Investment. This ambiguous situation
gives the authorities, as usual, full freedom to maintain the status quo
or to pursue bolder liberalization in the FTZ in 2014 if they see a
need for a stimulus of some kind. On balance, I’d say this is relatively
unlikely to happen.
10. European soccer teams invest in the Chinese Super League
I know, I know—I’m making exactly the same prediction I did a year ago.
True, Chinese football has battled both corruption and a lack of
long-term vision. It’s also true that the Chinese Super League still
trails Spain’s La Liga and the English Premier League in television
ratings. That’s in spite of roping in stars such as Nicolas Anelka and
Didier Drogba (who both returned to Europe this year) and even David
Beckham (as an “ambassador”).
At least this year some things started to improve. After all, Guangzhou
Evergrande just won Asia’s premier club competition—the AFC Champions
League—a year after hiring Italy’s seasoned coach Marcelo Lippi. This
international success could be temporary, but there is a shared sense in
China that something has to change because there is so much
underleveraged potential. Maybe Rupert Murdoch’s decision to invest in
the Indian football league will precipitate more openness among Chinese
football administrators? Perhaps the catalyst will be the news that the
Qatari investors in Manchester City also invested in a New York City
soccer franchise? An era of cross-border synergies from the development
and branding of sister soccer teams is coming closer.
Finally, something that’s less a prediction than a request. Can we
declare the end of the “BRICs”? When the acronym came into common use, a
decade ago, the BRIC countries—Brazil, Russia, India, and
China—contributed roughly 20 percent of global economic growth. Although
China was already the heavyweight, it did not yet dominate: in 2004,
the country contributed 13 percent of global growth in gross domestic
product, while Brazil, Russia, and India combined contributed 9 percent,
with similar growth rates. Compare that with the experience of the past
two years. China accounted for 26 percent of global economic growth in
2012 and for 29 percent in 2013. The collective share of Brazil, Russia,
and India has shrunk to just 7 percent. It’s time to let BRIC sink.
About the author
Gordon Orr is a director in McKinsey’s Shanghai office. For more from him on issues of relevance to business leaders in Asia, visit his blog, Gordon’s View, at McKinsey’s Greater China office website.
