Eye on China: New growth plan needed as costs rise in the South

Just as the rest of the world is getting more anxious about China's rise, the Chinese themselves are getting more worried about whether their model is sustainable.

Ever since "the reform and opening up" was launched in 1979, the engine of the Chinese economy has been the south-eastern coastal regions, based on trade, and joint ventures producing and exporting light industrial (that is, labour- rather than capital-intensive) goods.

The Chinese have dubbed this model "extensive" rather than "intensive," meaning that it has flourished on plentiful and cheap inputs of low-cost labour, subsidised capital and cheap land.

But results show that the coastal area performed surprisingly poorly in the first half of last year, to the extent it was outperformed in absolute and relative terms by other, traditionally poorer, provinces.

Aside from the obvious impact of the Government's macro-tightening measures, Chinese experts believe this raises two important questions. The first is whether China's rise as a heavy industry (capital-intensive industries such as coal, oil, cars, cement and semiconductors) and chemical-manufacturing (oil refining and petrochemicals) power will cause the centre of gravity to swing north and inland.

Some inland provinces have been experiencing a mini-boom off the raw materials, mainly coal but also metals and ore, they extract and process to supply China's factories. This wealth creation has been obscured by a flow of reports on coal-mining accidents.

The second question is what the slowdown in the southeast means in terms of changing China's traditional economic model.

First, here are some figures which are worrying the eastern seaboard dwellers, as quoted by 21st Century Business News, a Chinese biweekly:

* Guangdong province's industrial value came to around 98 billion yuan ($17.67 billion) in the first half of the year, an increase of 17 per cent year on year.

* But Shandong, a province on the northern coast of China, produced Y400 billion of industrial value added, an increase of 29 per cent year on year. Shandong also took top position nationally in terms of overall profitability, with Y91 billion. This is the first time any province has pushed Guangdong into second place since 1997.

* In terms of enterprise revenue growth, certain coal-rich inland provinces went up over 100 per cent year on year, while the main coastal provinces saw growth which barely cracked double figures. Shanghai grew at zero per cent, a huge shock to the city's self-confidence.

Growth has always been dynamic and uneven in China. Thus, after taking off first, the southeastern coastal provinces were rapidly followed by Shanghai and coastal provinces lying further north.

The question is now whether that growth will move even further north as well as eastwards and westwards.

The southeastern provinces and cities have been under pressure due to the rising cost of raw materials.

Chinese academic Zhao Xiao, of the Beijing University Guanghua School of Management, estimates that input prices rose four percentage points more than retail prices this year compared with the same period last year.

"The more manufacturers sell, the more money they lose under current conditions. Chinese companies in the export sector compete fiercely with Indian and southeast Asian companies in labour-intensive products.

"Local companies don't want to give up market share even in the face of raw material price rises, so they keep producing at cost or at a loss."

As a result of this pressure, coastal companies are looking to alter their business model, preferably by migrating upstream where the big profits are in the coal and oil industry.

But these are areas held by government giants running quasi monopolies, so they are stuck unless they move into more value-added services.

But they may be held back by their weakness in research and development, which is partly the result of a lack of protection for intellectual property rights.

What's interesting to foreign observers is the absence of debate in the local media about services. China economists abroad talk a lot about the importance of services, as does the country's central Government, but in practice such an upgrade seems more of an aspiration than a realistic short- or medium-term goal.

A China economist in Hong Kong believes the Chinese economic model is not on the cusp of any rapid transformation, although he does acknowledge some changes.

"If you look at foreign investment, the big German, Japanese and US firms are indeed putting a great deal of money into heavy industry - cars, semiconductors and other capital intensive industries," he says.

"In contrast, the early-wave investors from Hong Kong and Taiwan focused more on light manufacturing, such as textiles and toys. But what is occurring amounts to a broadening of the economic structure rather than anything close to a substitution."

He adds that although increasing the services component of GDP (about 38 per cent compared with a world average of 60 per cent) is more of a long-term goal, the Government is deadly serious about it.

"The big advantage of services - and of light industry - is that they employ lots of labour. So a vibrant services sector would help social stability and take advantage of China's cheap, plentiful labour."

China's light industrial, export-led model based on low inputs and an under-valued currency is experiencing strain from trade disputes and rising input costs.

Some elements of heavy industry - cars and steel spring to mind - have languished after initial vigorous growth. Extractive industries may be experiencing an unsustainable boom.

Quite where that leaves China will be the big question for the end of this year and next.

* The writer remains anonymous to protect his position in China.