In a previous post, I listed the reasons for which I think that China's economy is due for a slowdown in GDP growth. However, there are plenty of very good reasons to be extremely optimistic about the long term potential of China's economy. Indeed, lots of people are impressed by the mighty Chinese economic powerhouse but for the wrong reasons. They look with admiration at the large scale infrastructure projects, shiny sky scrapers and Louis Vuitton shops which are precisely the most fragile and misleading signs of economic success.
Here is why, despite my belief that China is due for a downturn, I still have great faith in the Chinese economy's long term prospects:
- A sophisticated consumer base: in my post about the risks China faces, I placed particular emphasis on the alarmingly low (30%) share of private consumption in the country's GDP. However, while still worrying, the numbers I used to illustrate my point can be misleading. In truth, the problem is not so much that consumption is atrophied but that investment is on steroids. More importantly, the Chinese consumer is extraordinarily sophisticated, much more than his level of disposable income would suggest. Examples abound to illustrate this phenomenon amongst which the extraordinary speed with which Chinese consumers have integrated the Internet and now mobile networks in their consumption behavior. Chinese consumers are brand sensitive, tech savvy, open to trying out new products and increasingly demanding. Simply selling them tuned down versions of products designed for western markets is no longer enough (it probably never was to begin with). More and more western brands are acknowledging this and are integrating the sophistication of Chinese consumers into their strategies by launching "designed for China" products (notable examples include Hermès and Levi's). Sophisticated consumers are good for the economy since they force local firms to step up their game and stimulate product and process innovation. It also means that once structural obstacles are lifted, the Chinese consumer might well be able to make up for the fall in investment levels.
Carrefour, not Cartier
- Great companies: when western media mention Chinese enterprises, they usually pick state owned giants such as telcos, banks and insurance companies. In my view, these firms have little growth potential beyond Chinese borders and succeed mainly because they operate in ultra-protected markets and benefit from government largesse. But this does not mean that China does not have world class companies. I'm planning on devoting an entire post to the strengths of Chinese companies so I won't give too much away in this paragraph. In short: China has plenty of dynamic firms that have developed innovative products and business processes that answer the specific needs and constraints of emerging market consumers. These companies such as Alibaba, Huawei, Wahaha, Lining and other less well known firms have managed to leverage their cost and scale advantage, capitalize on their first hand knowledge of local environments and exploit market gaps left by large western multinational. They represent the future of China's economy and I'll bet an arm that in a few year's time you will have some of their stuff in your garage/pocket/on your feet.
Take that Nike!
- Shanzhai and incremental innovation: the word Shanzhai (山寨) literally means "Mountain bandit". It originally referred to counterfeiting but its sense has gradually evolved and it has come to signify the practice of incremental innovation. In short, it means outsmarting richer and better equipped competitors by building cheap but reliable products that still integrate advanced technology and focus on features that truly matter to the customer. The best example is smart phones. For the vast majority of Chinese, smart phones remain too expensive. There is no way the average Li can spend $400 on an iPhone, HTC Desire or Motorola Droid. However that does not mean that the average Li does not want a smart phone and is not willing to spend a sizable chunk of his income on one. Many Chinese companies such as Huawei (mentioned above) and Meizu have smelled opportunities at the low end of the market and have rolled out cheap smart phones that start at around $100. These models such as the M9 and the Ideos are reliable, integrate advanced technologies and take advantage of the open Android platform. What you get is a phone that doesn't look half bad, runs Android and allows you to do pretty much the same thing than the 3 times more expensive HTC Desire. This knack many Chinese firms have for delivering great value at a competitive price will prove a tremendous asset for China's economy.
WEI NI HAO APPLE!? THIS IS MEIZU AND I'M GONNA KICK YOUR ASS!
All in all, even though China may have a brief fall from grace, I have no doubt that it has tremendous long term potential, albeit nor necessarily for the reasons that are most often cited.
- A pragmatic leadership: this argument may come as a bit of a surprise but I truly believe that most people in Beijing are aware of the challenges they face and have a generally good idea of what needs to be done to rebalance the economy (even if the process proves to be painful). In my view, the problem lies mainly with local authorities who are the main drivers of credit expansion and investment and who are reluctant to take any meaningful action towards making the Chinese model more sustainable and consumption-driven. But if Beijing manages to nudge local officials in the right direction, I see no reason why China should not be able to pull the rebalancing trick off. There will be some painful re-adjustments but in the end, if everybody sings the same tune (and that tune is the right one) China's should be back in the game pretty quickly.