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 Article Published in The Economic Times  02 October, 2001

How sustainable is Chinese advantage?

While world economy is facing the slowest ever growth prospect in over two decades, China has acquired a magnetic attraction for investors for the size of its domestic market for all types of goods from cars to modern telecommunication products and computers. There seems to be a race among the Taiwanese, Japanese and western manufacturers to set up manufactories in China to take advantage of low-cost manufacturing. China offers a number of advantages to global competitors to meet the emerging market challenges. A-grade infrastructure in the Special Economic Zones and other industrial areas, a host of tax concessions, cheap labour and easily available skilled manpower at 10-30 times lesser cost are all working to tilt the balance in China’s favour.

But the big question is how sustainable are the Chinese competitive advantages in the long run?   First of all, Chinese statistics are exaggerated. No sooner the year 2000 closed, China declared GDP growth at 8 percent, whereas independent analysts observe that the actual could have been 6-6.5 percent. Local chieftains want to show their regions attractive for investors and thus cook the books. Chinese economy this year is supposed to have been performing robustly. But a major pump priming by the government will add substantially to the expected 7.5-8 percent GDP growth. This may however create fiscal problems, if the pump runs longer. Just released official data suggests that the export growth in first seven months of 2001 has slowed down to 8.4 percent from 27.8 percent last year. Exports are important, as they constitute a quarter of the Chinese GDP. China’s entry in WTO may further impact the export competitiveness, as many of the tax incentives for export goods become illegal.

China is yet to adopt rules and regulations of a free-market economy. Local companies like Huawei, Legend and Haier have received favourable treatments at the cost of foreign companies who entered the Chinese market with inflated hopes. Many Chinese state enterprises (SEs) have been lying closed or are on verge of closure for lack of orders. These companies, supported by bank funds are ready to manufacture at a loss, just to survive and keep workers on the rolls. Bad loans from the banks are mounting and size of non-performing assets (NPAs) is estimated to be $200-300 billions. Banking operations are kept under wraps, so that murky dealings are not exposed. Bank managers operate under directions from the local communist bosses to lend money to projects/enterprises whose long-term viability is questionable.

Labour regulations are lax and workers in many industries have to toil for longer hours. Working conditions are also tough, as workers stay in crammed dormitories inside the industrial zones, to work from 8AM to 8PM. They are not allowed to form their own associations at the national or regional level. This advantage however may not last long as workers become conscious of their rights. Even though labour issues are not raised at the WTO, such abusive practices could come under attack.

Then there are accounting juggleries. China is new to the western style accounting practices and there is a huge shortage of trained accountants. There is stiff competition amongst the SEs to capture market share leading to gross undercutting in costs to sell in the international market. Corporate governance too is a high casualty, as transactions are not transparent and managers of SEs indulge in various irregularities by siphoning-off funds offshore, which in many cases comes back disguised as FDI. Chinese capital markets are underdeveloped. Their regulations are not in tune with those in free-market economies. Foreign investors can invest in B-group shares only at Shanghai and Shenzhen exchanges and cannot indulge in trading in A-group shares meant for locals. Market has thus been regimented to provide artificial boost to the bourses. Bull-run in B-shares, which rose by 200% in past one year is coming to close. Some Chinese banks lent money to securities firms illegally, which was invested in the stock market on banks’ behalf. Stocks therefore remain volatile and subject to insider trading.

Political risk in China can’t be ignored. China’s entry in WTO will call for large scale restructuring in their domestic market regulations and practices, which currently do not allow free operations throughout China. An acceptable level of legal infrastructure will be necessary to adjudicate disputes to inculcate a sense of confidence and legal predictability.

Hence summary judgment on permanent competitive advantages will have to be held back, till China demonstrates real determination and will power to establish a free-market economy in a free society. Chinese leadership will be under tremendous pressure from various quarters to perform and create sustainable advantages for China through a consistent reformist agenda.