McKinsey's View Of The Big Themes For China In 2014

|
Includes: FXI
by: QFinance

By Anthony Harrington

Back in January 2014, McKinsey Director Gordon Orr took a stab at looking at the major trends and pressures on China in 2014. He began by outlining some of the very real constraints and pressures faced by Chinese business:

"China’s labor costs continue to rise by more than 10 percent a year, land costs are pricing offices out of city centers; the cost of energy and water is growing so much that they may be rationed in some geographies, and the cost of, capital is higher, especially for state-owned enterprises. Basically, all major input costs are growing, while intense competition and, often, over-capacity make it incredibly hard to pass price increases onto customers."

China's solution to this problem is to seek to shift its business to a higher productivity model. If the days of simple "made-in-China" assembly lines, where 1000 worker factories do screwdriver assembly jobs at a super low cost for western companies, are not quite over, they are nearly so. Chinese companies are already seeking to adopt global best practices, wherever they can be found. As Orr argues:

"This is why recent international field trips of Chinese executives have taken on a much more serious, substantive tone."

He expects this uplift in improvement to extend beyond manufacturing to agriculture, arguing that the pace at which larger farms will emerge, should start to accelerate. Larger farms will spur mechanization and more efficient irrigation, giving farmers the ability to finance the purchase of higher-quality seeds. The impact on services is inevitable since labor costs are soaring, so a sustained edge in productivity will make a huge difference. The search for productivity will inevitably lead to the take up of disruptive technological solutions by a range of companies across multiple sectors:

"[...] in industry after industry, companies will feel the disruptive impact of technology, which will help them generate more from less and potentially spawn entirely new business models."

Orr's view of China's economy being forced to evolve is one that sees China coming up with solutions. However, the constraints facing the country might be worse than he thinks, particularly on the water front. A recent report, highlighted by RT News, points to a deep environmental crisis in the country, with around 60% of the country's water reserves polluted to the point where they cannot be used for drinking directly:

"China’s Ministry of Land and Resources has been monitoring at least 4,778 areas in 203 Chinese cities in 2013, the official Xinhua news agency said. According to an annual report unveiled by the ministry, in at least 43.9% of the monitored sites, the underground water was ranked as “relatively poor” and in 15.7 percent of cases as “very poor.” This means that about 59.6% of underground water can’t be used directly for drinking."

The continued deterioration in water quality in China is being caused by population pressure and rapid economic growth, together with lax environmental oversight. In April, RT News points out, cancer-inducing benzene was found in the water supply of the city of Lanzhou, considered to be one of the most polluted cities in China. Residents were forced to lay in caches of bottled water as the city authorities warned them not to drink tap water for the next 24 hours. China blamed the city's water supplier, but the supplier immediately pointed to surrounding industrial plants, saying that the pollution was a direct result of industrial contamination. The smog that covers so many Chinese cities, a function of both industrial pollution and gridlocked roads, also has an impact on water quality.

Nor is it just water. The Ministry of Environmental Protection produced a report in April 2014 saying that one fifth of Chinese farmland - this in a country facing enormous and increasing food pressure - is polluted as a consequence of rapid industrialization. Heavy metals such as arsenic and cadmium are the main pollutants.

Twenty-first century China has some enormous problems to deal with, even as it creates others for itself by saber-rattling in the South China Sea. A bright and prosperous future is not guaranteed...