China: Missing Global Linkages?

The Chinese economic model may not be as stellar — or as sustainable — as it appears on the surface. The two main reasons are a vastly altered global economic landscape as well as China's domestic political economy.

A major plank of East Asian growth has been export orientation, a strategy that China has adopted with apparent stellar results. China has been the recipient of a staggering $500 billion in foreign direct investment — much of it destined to use China as a base for exporting goods to the rest of the world.

But the big difference between the East Asian story and China's development is that the latter is occurring in a vastly different global landscape, one that in many significant ways operates to China's detriment.

China is often portrayed as the workshop of the world, producing low-cost, labor-intensive goods for export. But the benefits that accrue to China itself are much lower than they might appear.

Rather, these benefits accrue mostly to the regional Asian firms and multinationals that subcontract production processes to China, with the Chinese entities predominantly focusing on low-wage component assembly.

This is the case in a whole range of activities, from textile production to the assembly of electronic goods. The boom in intra-Asian trade is predicated on the division of labor based on a perceived comparative advantage.

Economists increasingly recognize China's lack of domestic linkages with foreign-owned firms. Indeed, foreign enterprises have been allowed to operate in virtual enclaves, with little transfer of technology, practices and marketing know-how.

Contrast this with some of the top-performing Asian Tiger economies, such as Taiwan in the 1980s. There, the government actively played a role in discouraging foreign enclave economies — and insisted on stringent requirements for local content and technology transfer, even at times alienating foreign investors in the process.

Another main plank of East Asian success has been a national industrial policy of some form, often structured around so-called "national champions."

This process has involved "picking winners" or tailoring policy to allow industrial targeting through measures such as financial support, subsidies, skill development and technology acquisition.

China's leadership, too, is trying to foster the growth of large-scale industrial conglomerates that could compete in global markets as part of an industrial policy of nurturing such national champions.

In the 1990s, Beijing tried to accomplish this goal through a series of preferential policies that would allow these large firms to gain privileged access to technology, finance and inputs. But it has not paid off to date.

In the FT Global 500 list released in June 2005, not a single Chinese company is represented. In contrast, India has three home-grown private sector FT Global 500 companies on the list — Infosys, Tata Consultancy Services and Reliance, all of which are products of genuine domestic entrepreneurship.

The official Chinese "go outward" strategy of acquiring companies abroad, which is being viewed with alarm by some in the West, is partly a response to this pressure to create internationally successful companies.

Some of the better-known examples are the purchase of IBM's personal computer business by Lenovo, formerly Legend, as well as the acquisition of French television-maker Thomson Electronics by TCL.

The Chinese hope that acquiring national brands at least allows some measure of pricing power for Chinese companies in a highly competitive global landscape, which might make profits easier to come by.

It is instructive to consider why China, for all its economic prowess, has not one internationally dominant corporation with its own strong brand.

A partial answer to that question has to do with the politics of economic reform. In so many of China's large companies, even those that have been restructured, the line between private ownership and the state starts to become blurred near the top of the organizational chart.

According to the World Bank, 50% of the boards of listed companies consists of government officials. The predictable result is that political objectives interfere with economic efficiency — leading to poor investment decisions as well as over-staffing of companies.

This mismanagement in turn creates strong pressures to diversify so that, for instance, electronics companies have expanded into the real estate sector, while an appliance manufacturer has entered the insurance business. It raises the question of how such firms can compete with more focused multinationals.

Inefficiency and lack of domestic competition is one major reason why foreign-owned firms have found it so profitable to enter and operate in China even in sectors where they could easily subcontract work.

The failure of industrial policy and the resulting inefficiency is now pushing China further down the avenue of private ownership — although it is never referred to as "privatization."

Accusations of corruption in the process of management buyouts have slowed down the privatization process. The bottom line is that there is no getting around the sticky issue of private ownership — and eventual political change — in China.

China certainly has made impressive strides in its economic development in the last 25 years. But a more informed debate on China's development needs first and foremost better data on its industrial and export sector.

With growing intra-Asian trade and splintering of production across countries, it is essential to understand where the value-added and profit accrues.

Any realistic appraisal of China's economy also needs to focus on broader measures of human development indicators — rather than narrowly defined income figures — in an era of massive rural to urban migration.

Finally, the question of whether state ownership can coexist with laissez faire economics in China is still an open one in many ways. Only when we understand these inter-linkages further will it be possible to fully evaluate the sustainability of the Chinese development model.