China's Manufacturing Economy: Growth, Culture, and Risk

Introduction: China's Economic Rise

There is a time and stage for all types of manufacturing, and what may succeed in China is not likely to succeed in many other countries, such as the United States. The Chinese economy has developed very fast, and that rapid development has attracted attention from across the global business community. This has led to a rapid increase in foreign direct investment in China and a growing share in international trade. New businesses are continuously entering China, trade agreements are being finalized, and large numbers of foreign nationals are relocating there. Consultants around the world are studying the meeting point between foreign managers and their Chinese counterparts.

Some reasons for the growth of business in China are rooted in culture — one of the oldest in the world. Chinese culture has long maintained a system of client and patron relationships that kept the country's rural areas stable. The Chinese term for this relationship is kan-ch'ing.

Cultural Foundations of Chinese Business

In the historical past, and even today, the possession of good kan-ch'ing was considered essential for social well-being — for feeling at ease in society and maintaining good relationships with those around you. Farmers, for example, developed this kind of relationship with their landlords. Landlords felt that they had to depend on the goodwill of their tenants to receive rent, even when it was legally due under Western concepts. Normally, a tenant would pay the full rent on time if he could. If he faced difficulties, he would discuss the matter with his landlord and arrange to pay a smaller portion for the time being. In the event of severe hardship caused by droughts, floods, or heavy rains, the tenant could explain to the landlord that he was unable to pay in order to survive. A landlord with good kan-ch'ing would accept this explanation, and the tenant, in better times, would repay what was owed. This kind of client-tenant relationship maintained goodwill throughout the entire community, as the quality of all relationships depended on the strength of the bonds between individuals.

The business culture of greater China is also very different from that of North America. In North America, people typically develop business relationships through indirect hints rather than direct conversation. In some other cultures this is achieved through direct eye contact. In greater China, the business relationship is usually much deeper. It is built through the exchange of gifts, favors, and goodwill gestures. These relationships are called Guanxi, and this practice exists wherever Chinese people conduct business. In American terms, Guanxi might be described as "ingratiating personal relationships" — a set of mutual obligations that are assumed to exist automatically among business acquaintances. The source of these relationships is not necessarily business itself; it can stem from the city where one's parents were born, the university one attended, or even extended family connections. This leads to managerial positions in China often being filled by family members, friends, and longtime colleagues rather than solely by the most formally qualified candidates.

These relationships are grounded in trust, obligation, and mutual dependency. There is always an element of give and take. Chinese businesses have also recognized the need for managerial improvement through the introduction of new technologies in both hardware and software. This turning point in China's traditions came through the Third Plenary Session of the Eleventh Central Committee of the Communist Party, held in December 1978 — a moment widely known as the Managerial Revolution in China. It began with the introduction of new management techniques in 4,000 enterprises in Sichuan in 1979. Similar units were also established in Hunan and Anhui provinces, and the system was rapidly expanded to over 36,000 industrial enterprises. While these numbers appear large, they represented only 16% of the total number of state-owned enterprises in China — yet they accounted for 70% of the enterprises that were generating profits.

Through this process, a framework was established for the major tasks of reform: strengthening the economic responsibility system, improving management in state enterprises, and achieving better planning and financial control. This was followed by the promotion of capable people and the reduction of overstaffing through organizational restructuring. Worker discipline was also improved through strict penalty and reward systems, which further enhanced financial control. Rewards took many forms, including group incentives, individual rewards, and moral persuasion. In today's China, the moral element has been combined with material rewards. Despite this, the salary structure in China remains relatively low, though it has given opportunities to many people at the second and third tiers of society to afford better housing and clothing. Since 1990, the political element has become less significant across China, and money has become the primary motivating factor. Employment is becoming more difficult to find as companies restructure to survive or are forced to close. China is said to have more than a million millionaires, yet there are also approximately 200 million unemployed Chinese — one of the highest unemployment figures in the world, with around 3% unemployment in urban areas alone. This situation is, however, having the positive effect of encouraging many young Chinese to start their own private companies rather than seeking traditional employment.

Foreign Investment and Market Growth

The investment surge in China is widespread. According to portfolio investment manager Jon Scharlau, thirteen years ago most residents in China used bicycles for travel around the city. Today, large numbers of Chinese citizens are driving the latest model cars. This transformation is what encouraged the Armada Small Cap Growth Fund to invest heavily in companies with significant exposure to the Chinese market. Growth in the Chinese market was expected to reach 8% in 2003, and this principle appeared to have worked well: the fund rose by 40.3% through October 2003 — a rate higher than many competitors in the same sector and more than 19% above the Standard & Poor's 500 rating. The strong performance that year was largely driven by small-cap stocks. As the market broadens and other asset classes grow in significance, the dynamics may shift. One of the fund's major investments is in a company called ChipPac (Wahlgren).

ChipPac manufactures back-end semiconductor equipment — packaging and testing semiconductors — with operations based in Shanghai. Many U.S. companies are shifting their semiconductor testing operations to China because of lower costs. Another portfolio company, Merix, makes components used in computer servers and other sophisticated electronic equipment. Here too the cost structure favors Chinese manufacturing, and Merix shifted its operations there accordingly. Equipment requiring short lead times, however, is still manufactured in the United States. The fund has also financed retailers operating in China, including Aeropostale, which sells goods at the lower end of the teen market. Sales have been increasing rapidly at stores that have been open for at least one year, and the company performed well during the back-to-school season (Wahlgren).

This performance typically signals a healthy holiday season ahead. Aeropostale is likely to show earnings per share growth of around 25% over the next three to five years across its more than 400 stores. The investor believes this chain has high growth potential, with room to expand to 800 to 1,000 stores. The fund has also invested in Radware, a company that manufactures Internet switches and has been growing faster than its own projections for three consecutive quarters. Corporate spending on networking infrastructure is expected to increase, driving higher sales. Radware is projected to increase earnings per share by approximately 60 cents for every $10 million increase in sales — a very high projected return (Wahlgren).

China has historically been a closed market and is now confronting some of the challenges that arise from prolonged isolation. All types of development are arriving simultaneously. Sweeping economic reforms are under way in both the People's Republic of China and Taiwan, and the merger of Hong Kong into China has created a powerhouse that is delivering significant benefits to major American corporations such as H.J. Heinz, McCall's, and Bausch & Lomb. Avon Products, for instance, has sold $1.5 billion worth of goods in China and realized $1 billion in profit from the market. Companies that have committed to doing business across all three territories are earning strong returns.

The concept of Greater China — encompassing Hong Kong, Taiwan, and mainland China — was originally articulated by Chinese leader Zhao Ziyang. The reunification of Hong Kong with the mainland was achieved in 1997, while Taiwan remains a separate political entity for the foreseeable future. The provinces of mainland China have nonetheless been growing at a very rapid pace. Guangdong Province in South China, for example, has grown at approximately 12.5% per year since 1985. The legal border between Hong Kong and mainland China is gradually becoming less restrictive as people on both sides move freely across it. Under the Deng Xiaoping government, China sustained a Gross National Product growth rate of approximately 10%, driven by the reform program launched in 1978. In 1993 alone, GNP grew by 10%, industrial output increased by 18%, and foreign trade rose by 18%.

Much of this growth has come from the output of a large number of small and medium-sized village enterprises operating as partners to local entrepreneurs and larger companies. Imported technology has also contributed significantly, providing China with an important source of foreign exchange earnings. By 1993, the Chinese government had approved approximately 80,000 foreign-invested projects with total commitments of around $105 billion — nearly equal to all foreign investment in China over the preceding 13 years since the opening-up began.

Conclusion

All economies follow periods of growth and development, but within any system there are also periods of correction, and it is possible that China is heading toward one right now. China is a country emerging from a long and difficult history — a society bound by material scarcity that had to find development solutions suited to its specific constraints. It leveraged its most abundant resource: surplus labor. For an economist from a country with different resource endowments, the study of China's development path offers valuable insights into alternative models of growth and the importance of tailoring economic strategy to a nation's individual characteristics.