China’s spectacular growth – driven by an investment and export fueled boom over the last 30 years – is coming to an end. If one were to go beyond official GDP growth figures and look at other indicators such as electricity usage and real estate construction, one could argue that the era of spectacular growth may already be over.
The slowdown in China’s economic growth is structural, not cyclical. Depending on the pace and nature of reforms, both economic and institutional, the new normal for GDP growth will be somewhere in the 6-7 percent range. For an economy of China’s size, this will still be very robust and will make China the world’s largest economy by 2025. For companies, however, a China that is growing at a 6-7 percent rate will be very different from one that’s been growing at a 10-11 percent rate.
The slowdown will reshape China’s business landscape dramatically and will have a direct bearing on corporate strategies and outcomes.
A Slowing China
According to World Bank data, fixed asset investment in China grew from 34 percent of GDP in 2000 to over 44 percent in 2011 i.e., an average annual growth of 14 percent relative to an 11 percent rate of growth in GDP. The growth in fixed asset investment has been particularly torrid since the financial crisis of 2008. What do the future prospects look like for the three sectors that account for all of this investment – infrastructure, real estate, and manufacturing?
Take infrastructure. The question is not whether China still needs many new airports, highways, high-speed rail links, power plants, and so forth. It most certainly does. The real question is, given the infrastructure that China has already built, how much additional new investment is needed to address the still-unmet needs? If China were to increase fixed asset investment at a mere 5 percent annual rate over what it spent in 2011, it would result in a hefty 45 percent increase in real (i.e., net of inflation) fixed asset investment during the 12th 5-year plan relative to the one that just ended. Do China’s pending infrastructure needs require spending twice as much or more in the current 5-year period as compared with the previous five i.e., an unending annual growth of 10 percent or higher in infrastructure investments? It is difficult to see why or how.
Similarly, take real estate. China’s urbanization has grown from 20 percent in 1980 to over 50 percent in 2011 and will likely reach 75-80 percent by 2040. Note, however, that the next 25 million units of new housing construction will, by necessity, be in lower tier cities and for lower income families than was the case for the last 25 million units. These lower income apartments will also require fewer and less expensive appliances than was true for the last 25 million. All of these realities imply a sharp slowdown in the growth of investment in real estate as well as in factories to build home appliances.
Look also at the auto sector, one of the biggest drivers of manufacturing investment both directly and indirectly (subsystems, parts, and raw materials). During 2000-2011, the auto market in China grew at over 25 percent annually. It is now the largest in the world. Given China’s much higher population density, its auto penetration is unlikely to ever reach today’s 50 percent average for the G7 developed countries. An optimistic projection would be 35-40 percent auto penetration by 2030, a point at which China’s per capita income would still be much lower than that of the G7. Working backwards, this projection translates into at most a 6-7 percent annual growth in China’s domestic auto market during the current decade.
As the investment-driven boom slows down, urban incomes and in turn urban spending can be expected to grow at a slower pace than the double-digit rate of the last decade. The biggest beneficiaries of the expected reforms (in health care, education, pensions, banking, and so forth) will be low and middle income Chinese including those in rural areas. Their consumption should grow faster than the anemic pace of the last few years. The net effect will be that real household consumption is likely to continue growing at the historical 8-9 annual rate. Against a GDP growth rate of 6-7 percent, this will still imply a steady rise in the consumption-to-GDP ratio, thereby helping to rebalance China’s economy.
A Very Different Business Landscape
During the last three decades, China’s business landscape has changed dramatically, not just once but repeatedly – agricultural reform in the 1980s, dismantling of large chunks of the state sector and an aggressive push into manufacturing in the 1990s, followed by massive infrastructure investments and once again a bigger role for state-owned enterprises during the last decade. How will the business landscape in the current decade differ from that in the last one?
First, industries such as steel, cement, and construction machinery will see significantly slower growth not just temporarily but on an extended basis. All of these are feeder industries for infrastructure and real estate construction. These and related industries are currently running at an estimated 60-70 percent capacity utilization. Even after the capacity overhang gets absorbed, these will remain relatively slower growing industries. We also anticipate mid-single-digit growth rates in consumer durables such as autos and home appliances.
Second, relative to GDP, we should see higher growth in services as well as non-durables. With a rapidly aging population, China will need to spend a much larger share of its GDP on health care than is currently the case. Also, given widespread ownership of homes and cars, urban Chinese are likely to spend a growing proportion of their incomes on things such as home and child care services, kids’ education, travel, entertainment, consumer electronics, as well as bigger and more fashionable wardrobes.
Third, expect competition within China to become even more fierce than it has been so far. This will be a direct outcome of slower growth and capacity overhang in the economy. Thus, companies should expect growth in earnings from China to slow down even faster than growth in revenues. For foreign multinationals, there may also be the added challenge that central and local governments could become even more prone to providing asymmetric and sometimes not-so-obvious advantages to domestic players.
Fourth, Chinese competitors will start becoming marketing savvy at a faster pace than they have in the past. Slower growth and tougher competition will force them to learn the art and science of segmentation, product differentiation, and branding. Foreign MNCs will also need to reassess the skills of their own sales and marketing staff. In many B2B industries, MNCs have been able to get away with relying on people who were good at taking orders but not necessarily at marketing. Such an approach will require a major rethink.
Fifth, the war for talent will need a shift in focus. While employee turnover is likely to decline, companies can expect rising frustration among professional staff as promotions and salary increases occur at a notably slower pace than expectations or past history. Also, skills such as creativity and innovation, marketing, and people management will become more critical. Thus, within the HR function, the importance of tasks such as talent development and engagement will rise faster than of tasks such as talent acquisition and retention.
Last but not least, MNCs will need to start resetting their expectations about revenues and earnings from China. We fully expect China to become the world’s largest economy by 2025. However, it is very unlikely that we’ll see the global economy pivot from one dominated by the US to one dominated by China. Instead, what we’ll see is the emergence of a far more multi-polar world economy. If a GE, a Wal-Mart, or a Siemens wants growth, it’ll have to pursue deeply committed strategies not just in China but also in places such as India, Southeast Asia, Latin America, the Middle East, and Africa. The imperative to look across the entire globe will become far stronger than it has ever been.
Anil K. Gupta is the Michel D. Dingman Chair in Strategy at the Smith School of Business, The University of Maryland and a Visiting Professor of Strategy at INSEAD. His most recent book is Global Strategies for Emerging Asia (Wiley, 2012). Haiyan Wang is managing partner of the China India Institute, a Washington-DC based research and consulting organization. She was shortlisted for the Global Village award at the 2011 Thinkers50. Gupta and Wang are also the co-authors of Getting China and India Right (Wiley, 2009) and The Quest for Global Dominance (Wiley, 2008).