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Brian Schwarz's  Instablog

I'm an Adjunct Lecturer in the MBA program at Shanghai Jiao Tong University. I teach a group of foreign managers human resource management. I'm also a freelance business writer and editor. My work has been published in numerous publications such as the Shanghai Business Review, China... More
My blog:
China Challenges
  • China's Bubbles and Demographics
    In recent weeks, many experts have expressed growing concern about a bubble forming in China's stock and property markets. While investors love it when prices rise, many observers fail to realize the hidden and harmful impact it has on worker productivity, competitiveness, and demographic trends.
     
    As part of Beijing's effort to stimulate the economy, Chinese banks made $1.08 trillion in loans in the first six months of 2009, triple the year-earlier level. While most of that was intended for new roads, bridges, and factories, an estimated 20 percent was put into stocks by business managers seeking quick profits.
     
    Andy Xie, an independent economist based in Shanghai, recently warned in a blog post that Chinese stocks and properties are 50-100% overvalued. "The odds are that both will adjust in the fourth quarter (of 2009)," predicts Xie. “However, both might flare up again sometime next year. Fluctuating within a long bubble could be the dominant trend for the foreseeable future."
     
    Frank Gong, chief economist for China at JPMorgan Chase was quoted in Businessweek as saying, "Equity markets are supposed to do that." Gong and others argue it's unlikely the government will choke off credit, because no one wants to be blamed for slowing China's recovery.
     
    Xie calls China's asset markets a giant Ponzi scheme and predicts they will collapse when the US dollar becomes stronger. He warns, "The most ignorant retail investors are being sucked in by the rising momentum. They again dream of getting rich overnight. As in the past, retail investors usually lose, especially like the ones jumping in now. The final frenzy usually doesn't last."
     
    When a bubble is formed, more resources are diverted and wasted. Xie says businessmen in China are reluctant to focus on real economic activities and are devoting time and energy to market speculation. This means China will have fewer globally competitive companies in the future. “Even though China has had three decades of high growth, few companies are globally competitive,” Xie says. “The serial bubble making in the Chinese economy may be the reason.”
     
    The most serious damage that a property bubble inflicts is in changing demographics, says Xie. High property prices force many young couples to have fewer children. Even after property prices decline after a bubble bursts, this low birth rate culture cannot be changed. Many parts of Asia, such as Hong Kong, Japan, and South Korea, all went through property bubbles during their development. Xie concludes:
     
    Their birth rates dropped during the bubbles and didn't recover afterwards despite government providing incentives. China's one-child policy alone will lead to a demographic catastrophe in two decades. The property bubble makes the trend irreversible: when the government abandons the one-child policy, there wouldn't be meaningful impact on birth rate. Within two decades Chinese population could be very old and declining. Of course, property prices would be very low and declining also.
     
    Experts worry that China will become old before it becomes rich. Back in 2004, Richard Jackson and Neil Howe wrote report about demographic trends entitled The Graying of the Middle Kingdom. They calculated that in 2004 the elderly—here defined as adults aged 60 and over—make up just 11 percent of the population. And by 2040, however, the United Nations projects that the share will rise to 28 percent, a larger elder share than it projects for the United States.

    In absolute numbers, the magnitude of China's coming age wave is staggering. By 2040, assuming current demographic trends continue, there will be 397 million Chinese elderly people, which is more than the total current population of France, Germany, Italy, Japan, and the United Kingdom combined.

    Disclosure: None
    Tags: JPM, China, housing
    Aug 10 10:50 pm | Link | Comment!
  • China's Long, Slow Climb to the Skies
    China has taken another step forward in its mission to build its own commercial airplanes, but industry experts remain skeptical of Beijing's long-term objective of becoming less dependent on Boeing and Airbus-made machines.
     
    China's first domestically-developed regional ARJ21-700 jet successfully made a trial flight of 1,300 kilometers in July. It took the jet about two hours to fly from Shanghai to Xi'an, the capital of northwestern China's Shaanxi Province, according to the China Economic Review.
     
    The ARJ-21 is short for "Advanced Regional Jet for the 21st Century". The plane is also the first regional jet that China has fully developed on its own. The first ARJ-21 jets are expected to be delivered to Chinese clients late next year. The ARJ21 regional jet is able to carry 70 to 110 passengers and shaping up as China's equivalent of the A300 from Airbus.
     
    In the 1980s, McDonnell Douglas, which is part of Boeing, made about 30 MD-82 and a couple of MD-90 in China. Some critics claim the ARJ21 is a copy of similar models from Bombardier and Embraer built at the old MD plant in China.
     
    The ARJ21 program is important to Beijing because helps China learn to develop a commercial aircraft to Western standards, to coordinate with many subcontractors, to establish an international marketing operation, and—crucially—to prove that it can support aircraft in service. Parts for the plane are made by 19 foreign manufacturers, including General Electric, Honeywell and Parker Hannifin.
     
    China is moving forward in full-sized commercial aircraft as well.Aviation Industry Corp. of China (AVIC) announced in February it wanted "new blood" from overseas to help it compete. Local media quoted a Chinese aviation official describing the project as an "inspiration to the nation" similar to the country's manned space program. After a highly publicized global search for foreign managers to help it modernize, China's main military jet maker has hired six executives — all of them Chinese, according to a recent AP report.  
     
    The Chinese government created AVIC last November by merging its two biggest military aircraft companies.
     
    China's entry into a market long dominated by Western players has stoked an outpouring of nationalist claims and raised concerns about aviation safety and trade protectionism. Boeing is a leading American exporter and has many friends in Washington.
     
    It has been a difficult year for Boeing, which was forced delay the first flight of its much-anticipated new 787 the Dreamliner for the fifth time in June. While the military side of Boeing's business has suffered a number of setbacks recently, the US-based company continues to have some well-running and profitable programs. Chief among them is the Boeing 737, of which more than 3,000 have been sold after launching 42 years ago, according to USA Today. With the world's best-selling jetliner, Boeing expects to turn 150 to 200 more of them a year off assembly lines for another decade.
     
    Boeing realizes a new competitor is on the horizon. “There is no doubt that [China] will be someday in the commercial airline business,” Jim McNerney, Boeing's chairman and chief executive, was quoted as saying in April 2007. The former Boeing chief said he could envisage co-operating with Chinese partners, though said it would remain a “tough competitor” with its own developing product line-up.
     
    A Chinese-made Airbus
    Boeing and Airbus are using China as a production base. Earlier this year the first Airbus 320 stamped “Made in China” rolled out of the factory the European company opened in the northern Chinese city of Tianjin. It was the first time a major manufacturer has fully assembled an airliner in China. This has company employees in Europe worried they may soon be out work, says Andrea James of the Seattle-Post Intelligencer in a blog post.
     
    Airbus says it plans to make four aircraft a month by the end of 2011. “Our Final Assembly Line (FAL) here in Tianjin and this first aircraft delivery outside Europe mark an important milestone in our strategic long-term partnership with China and the Chinese industry,” Tom Enders, Airbus president and CEO, said in a company statement. “This FAL is state of the art, second to none in the world. And so are the aircraft manufactured here in Tianjin.”
     
    Airbus has been getting the bulk of China's new orders since 2004 and hopes to control 50% of the market by 2013. China has become the world's second largest aviation market after the US and is estimated to need 2,670 passenger planes in the next 20 years.
     
    Boeing is also dependent on China. Last year, the company bought parts from 11 different Chinese suppliers for its 737, 747, 767 and 787 aircraft, the company's website says. Other Chinese-made parts on the 737 include the vertical tail fin, tail cone, sections of the fuselage and the exit doors over the wings. This reliance on outsourcing for key components has angered many of Boeing's rank and file and has been a source of labor union conflict.
     
    The Challenges China Faces
    When it comes to building jets, China's low-cost workforce is not all that significant an advantage. Many investors say China is losing its global competitiveness because wages are on the rise.
     
    At same tine the yuan has already appreciated by approximately 20 percent against the dollar over the last two years, which makes imported technology and components cheaper to buy when priced in the American currency. Industry expertspredict as much as two-thirds of the airplane's components would be expected to come from outside the country.
     
    Airlines do not buy airplanes based on cost alone. The price tag of an aircraft accounts for only 3% to 5% of the plane's total operating cost over its 20-year lifetime.  Foreign certification is the key to the real prize of export sales. Expect a huge political fight if planes from China reach this stage. Analysts said that China can not rely exclusively on demand from its domestic sales in order to recoup development costs.
     
    Martin Craigs, president of Aerospace Forum Asia in Hong Kong, was quoted in Businessweek as saying, "Building an aircraft is not even half the battle. Delivering it and supporting it over a lifetime is what really matters." In the past year, both Airbus and Boeing have suffered a number of delays that have worried clients and made shareholders flee.
     
    There is also the issue of government support. Boeing and Airbus have been fighting it out in the WTO about government subsidies for a number of years. Boeing has claimed Airbus has an unfair advantage. With 100% government backing, some Western critics ask how can they not? It will never be "level" playing field with China's government support, they say.
     
    Conclusion
    Despite some well-publicized quality problems, the fact is China's industrial capacity continues to grow and improve in quality in many sectors, including aerospace. Time will tell if the ARJ21 is able to pass the quality test. Soon we will see if it is able to compete against existing players such as Bombardier and Embraer. This should give a clear indication on how they can compete in the full-size commercial aircraft business.
     
    Some industry experts say that fears about China quickly taking orders away from Boeing and Airbus are overblown. It is likely to take China decades to develop a range of jets to mount a proper challenge to the Boeing-Airbus duopoly.

    Disclosure: No positions
    Tags: BA, GE, HON, China, airlines
    Aug 07 05:07 am | Link | Comment!
  • China's Giants Try to Make the Transition From Products to Services

    Although it might seem counter-intuitive, China's manufacturing sector has emerged strengthened by the global economic downturn and the world’s factory is moving up fast on the services front as well. As I mentioned in my previous post, so says a recent report from PricewaterhouseCoopers (PwC) on the relative attractiveness of emerging markets for foreign investors.

    China's manufacturing sector has shot up from 14th position in PwC's index in 2008 to become the fourth most attractive destination in 2009, beaten only by Malaysia, Chile and Bulgaria, which are all much smaller economies. Of the so-called BRIC countries -- Brazil, China, Russian and India -- China was the only one to improve its position.
     
    This strength hides some deeper concerns in the sector. The fact is cost advantages at Chinese factories are disappearing as more companies search for ways to create value by adding services. Citing a recent report from the American Chamber of Commerce in China, Richard Brubaker, founder and managing director of China Strategic Development Partners in Shanghai recently wrote this passage on his All Roads Lead to China blog:

    "Even with the current economic conditions, manufacturing in China has become more expensive. Companies reported that costs are still rising – up to 15 percent in 2008 compared to an increase of 10 percent in 2007 – particularly in compensation costs for management, support staff and blue-collar workers as well as raw materials. Although labor and raw materials costs have come down from the premium levels of last summer, they are expected to rise again once market conditions improve." 

    Following the path of IBM and others, the key question facing some Chinese companies can they transform themselves from sales-driven manufacturers to global service suppliers?
     
    In early 2008, the Chinese government announced plans to invest in the service sector. This investment involved capital bailouts and tax breaks, covering everything from professional services though to IT outsourcing. “And they are encouraging business leaders to become familiar with service business so that they can penetrate the international market in services in a very serious way,” says Laurie Young, a former PricewaterhouseCoopers global marketing partner.

    The combination of price pressures and competition brings “margin squeeze” back into the China vocabulary as profit margins begin to erode in many industries. Concerns about inflation are also now becoming more widespread as price pressures mount, says China watcher Jack Perkowski at his Managing the Dragon blog. According to a recent article in the Wall Street Journal, “manufacturers in China face rising costs as some commodity prices grow, but economists say producers may not pass on the costs to consumers because of fierce competition.”

    Despite sluggish exports, China's manufacturing expanded in July at its fastest rate in a year as domestic demand, a recent survey showed, highlighting the importance of the central government's huge stimulus in driving the country's economic growth. Hong Kong brokerage CLSA Asia-Pacific Markets said China's monthly purchasing managers index, or PMI, rose to a 12-month high of 52.8 on a 100-point scale where numbers above 50 indicate an expansion. That was up from June's 51.8.

    Young says     Western companies will soon face a growing challenge from Chinese competitors in his fourth book, From Products to Services: Insight and Experience from Companies Which Have Embraced the Service Economy (Wiley).In a recent interview with China Knowledge@Wharton, Young noted a number of Western manufacturers, such as IBM and Unisys, have not made the transition from manufacturing to services successfully. China-based Lenovo, of course, bought IBM’s struggling PC division in 2005.
     
    As a manufacturing economy, many Chinese seem to approach services with a manufacturing mentality which doesn't help in enhancing service levels. “In China, there's an awareness-raising process that's just beginning,” says Young. “But I think what you see here in China is a government that is serious about understanding the different dynamics of the service business – what are the strategies, and how do you run it?”
     
    In March, Shandong-based manufacturer Haier announced that it was leaving direct manufacturing and concentrating on building the company’s brand and service network. China is seeing the beginning of a government-led move to raise awareness of what Young calls “the service opportunity.” Together, this spells an opportunity for Chinese companies to grow global service businesses, in addition to benefiting from an expanding domestic market.
    Services, which today makeup between 70 to 80 percent of GDP in Western economies, took 25 years or so to develop. China’s transition is expected to be even faster. Young concludes, “Nowadays, with the dominance of the service sector in so many Western economies, manufacturing companies older than ten or twenty years have to ask if their traditional businesses are dead dogs, and whether they should be moving into services.”

    Disclosure: None
    Tags: China, manufacturing
    Aug 04 10:41 pm | Link | Comment!
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