New Economist

Do China's firms make healthy profits?

The Economist's latest economics focus, Profits and prophecies, argues that Chinese companies earn higher returns than is commonly claimed:

It may be the world's fastest-growing economy, but do China's firms make healthy profits? This is the subject of a lively debate* among economists, investors and businessmen.

According to the conventional wisdom, Chinese companies use capital inefficiently and have enormous overcapacity. As a result, profit margins are thin and falling, and heavy borrowing to finance unprofitable investment puts the banking system at risk.

However, Bert Hofman and Louis Kuijs, two economists in the World Bank's Beijing office, disagree. According to their analysis, based on figures reported to China's National Bureau of Statistics (NBS) by more than 200,000 state-owned and private companies, the profits of industrial companies have soared by an average of 36% a year since 1999. The average pre-tax return on equity by state-owned firms increased from 2% in 1998 to 13% in 2005; private companies' return went up from 7% to 16%. Furthermore, most corporate investment is now financed out of companies' own cashflows and only one-third from outside sources, such as banks.

This view was attacked in an article in the Far Eastern Economic Review by Weijian Shan of TPG Newbridge, one of the most successful private-equity firms in Asia. Mr Shan, an old hand at evaluating Chinese firms, says the World Bank is “deluded”: most Chinese firms make little profit, their margins are being eroded, and their investment boom is being financed largely by lending from state-controlled banks.

Who is right? The answer is important for policymakers as well as for investors. If the return on capital is indeed low and falling then today's pace of growth will prove unsustainable.

Mr Shan says that it is nonsense to argue that high profits are driving investment when business as a whole is such a big borrower. Total bank credit is bigger than the country's GDP, which is exceedingly high by international standards: in America the ratio is only 44%. Yet borrowing says nothing about the strength of profits. Firms can have high retained earnings (ie, saving) yet still need to borrow if they invest more than they hoard.

Chinese cars? Not yet

Detroit fears China's foray into the global auto market - but Chinese auto executives admit it could be 2020 before they will be ready to take on the world market, according to Keith Bradsher in today's New York Times: Not Coming Soon to a Lot Near You: Chinese Cars

Despite growing anxiety that the Chinese would quickly seek to conquer yet another important industry, it now looks as if it will be at least another several years before Chinese automakers start exporting large numbers of cars they both design and make. They had intended to start selling their own brands in the United States as soon as 2007 but have pushed off their plans by a couple of years.

And now, some Chinese auto executives admit, it could be as late as 2020 before they will be ready to take on the world auto market. That’s not to say that the Chinese will not follow in the footsteps of Japanese automakers, who first sent over chintzy cars that were roundly criticized, only to set new standards for the industry in later years.

Still, despite China’s manufacturing prowess, it is, for now, proving a lot harder than automakers here anticipated to make cars that appeal to Western tastes.

While Chinese cars are inexpensive and approaching Western levels of reliability, Chinese automakers have not yet brought their styling, safety, emissions and performance standards up to snuff, let alone their skill at marketing home-grown nameplates around the globe.

In one glaring example last year, a German automobile club tested one of 700 vehicles shipped to Europe by a tiny Chinese manufacturer of sport utilities. It came up with a result that humiliated the Chinese officials who oversee the mostly state-owned Chinese car industry: the vehicle, the Landwind New Vision, got the worst crash rating the club had ever awarded in 20 years of testing.

“Most of the Chinese companies that were preparing for exports have turned cautious, because this is a very difficult job,” said Lawrence Ang, a board member who oversees international finance at the Geely Group, a large, publicly traded Chinese automaker.

China to crack down on sweatshops

China is to toughen up its labour laws, according to today's New York Times - and multinationals are none too pleased. David Barboza reports China Drafts Law to Empower Unions and End Labor Abuse

SHANGHAI, Oct. 12 — China is planning to adopt a new law that seeks to crack down on sweatshops and protect workers’ rights by giving labor unions real power for the first time since it introduced market forces in the 1980’s.

The move, which underscores the government’s growing concern about the widening income gap and threats of social unrest, is setting off a battle with American and other foreign corporations that have lobbied against it by hinting that they may build fewer factories here.

The proposed rules are being considered after the Chinese Communist Party endorsed a new doctrine that will put greater emphasis on tackling the severe side effects of the country’s remarkable growth.

Whether the foreign corporations will follow through on their warnings is unclear because of the many advantages of being in China — even with restrictions and higher costs that may stem from the new law. It could go into effect as early as next May.

It would apply to all companies in China, but its emphasis is on foreign-owned companies and the suppliers to those companies. The conflict with the foreign corporations is significant partly because it comes at a time when labor, energy and land costs are rising in this country, all indications that doing business in China is likely to get much more expensive in the coming years.

But it is not clear how effectively such a new labor law would be carried out through this vast land because local officials have tended to ignore directives from the central government or seek ways around them.

China’s economy has become one of the most robust in the world since the emphasis on free markets in the 80’s encouraged millions of young workers to labor for low wages at companies that made cheap exports. As a result, foreign investment has poured into China.

Some of the world’s big companies have expressed concern that the new rules would revive some aspects of socialism and borrow too heavily from labor laws in union-friendly countries like France and Germany.

Signs of creeping social democracy perhaps? Oh, the horror! Barboza continues:

It's official: EU shoe wars

Just over a month ago I asked: EU to start a shoe war with China and Vietnam? The answer came today, and was in the affirmative. A two year tariff will commence this Saturday, replacing temporary duties already imposed. Lucia Kubosova at the EU Observer has the story: EU imposes tariffs on Chinese shoes after bitter debate

BRUSSELS - The EU's shoe-producing countries have won a battle for a two-year anti-dumping regime against imports of Asian footwear starting from Saturday (7 October), with European retailers and consumer groups strongly criticising the move.

After weeks of debate on the controversial issue, the European Commission got the go-ahead from member states on Wednesday to impose tariffs of 16.5 percent on leather-shoe imports from China and 10 percent on Vietnamese imports.

Under EU rules, the commission's plan could not go ahead if it was opposed by a majority of the 25 member states. But while this was the case during previous rounds of trade talks, Wednesday's vote saw 12 countries rejecting the protectionist move with nine voting in favour and four abstentions -which count as approvals in this case.

Sweden and the UK featured among the strongest advocates of the free trade approach, while countries with a strong shoemaking sector like Italy, Spain and France favoured safeguard measures.

The final compromise is based on a proposal tabled by Paris to reduce the period during which the tariffs should be applied from the usual five years to just two years. "In the final stages of the negotiations, the length of this period was the main and only issue we debated as a possible compromise element," said one diplomat.

A Finnish EU presidency official told EUobserver that the agreed deal - to be formally rubber stamped by ministers tomorrow, just one day before the deadline of 6 October for the EU to adopt the anti-dumping scheme - is viewed as the right "balance between the interests of EU producers and consumers."

EU trade commissioner Peter Mandelson also defended the move, insisting that it was in line with the member states' prevailing views on the issue which is "certainly not a protectionist line of thinking."

"If we're going to stand up for global free trade we must also keep in place some safeguards against unfair trade" as practised by some trade players outside the EU, suggested the commissioner.

Hmmm. 'Unfair trade' like, say, agricultural subsidies Peter? The piece continues:

China vs. India: which is more productive?

Last week I mentioned the new World Bank book Dancing with Giants: China, India and the global economy. There were also a series of background papers commisoned for the project. One of them compared the productivity and performance of manufacturing businesses from China and India. Their conclusion? Chinese businesses invested more, and reaped higher productivity growth, than comparable Indian manufactureres. More flexible labour markets and access to finance also helped account for the differences observed.

The paper was written by Taye Mengistae, Lixin Colin Xu, Bernard Yeung: China vs. India: a microeconomic look at comparative macroeconomic performance (Word doc). Here is the abstract:

In comparable random samples of manufacturing businesses drawn from the two countries, Chinese establishments are found to have higher total factor productivity on the average than their Indian counterparts. Controlling for initial size, age, and line of industry, the average employment growth rate is higher for Indian establishments. Chinese plants grow faster in value added terms, nonetheless.

This is mainly because the average net investment rate in fixed assets is higher in Chinese businesses. To a lesser extent, it is also because productivity grows faster on the average in Chinese plants. Partly because of this, the aggregate productivity growth rate that we compute industry by industry is larger for the Chinese sample.

A second reason why the aggregate productivity growth rate is higher for the China sample is that allocative efficiency gains are larger in Chinese industry. By this we mean that market shares are reallocated from less productive plants to the more productive more rapidly (or steeply) in the Chinese sample. This is consistent with another finding: catch up effects and life cycle effects in productivity and growth, are stronger in the Chinese sample than in the Indian sample.

Lastly, such key elements of the business climate as labor market flexibility and access to finance are major sources of the productivity and growth gaps between Chinese and Indian plants. If nothing else mattered, the average Chinese businesses would be more productive and would grow faster than its Indian counterparts on account of business climate differences between the two countries. This is not so much because business climate indicators are better in China than in India as because the marginal return to improvements in indicators is higher in China.

Has China displaced other Asian countries' exports?

The short answer: Yes.   The long answer:

This paper uses gravity modelling to explore whether and how the growth of China 's exports is displacing exports of other Asian countries to third markets over the period 1990-2003. Chinese exports are defined both narrowly and more broadly to include exports from Hong Kong . We investigate whether the displacement effect on Asian exports differs when exports from Hong Kong and China are combined compared to the narrow case of Chinese exports only.

Aggregate and disaggregated analyses are undertaken. In the latter, we explore whether the displacement effect varies across Asian countries and in trade with different types of countries. We find evidence of a displacement effect which is more pronounced in developed markets and stronger for Hong Kong and China combined. Further it is the high income Asian exporters that experienced a greater displacement effect. We also investigate whether China's development has generated any offsetting effects on its neighbours' exports to China itself and find that Chinese growth has indeed increased China's imports from the Asian countries in the sample and in particular Japan and Korea.

Source: Has China Displaced Other Asian Countries' Exports?, by David Greenaway, Aruneema Mahabir, Chris Milner (GEP Research Paper 06/21, Leverhulme Centre for Research on Globalisation and Economic Policy)

New book: 'Dancing with Giants: China, India and the global economy'

A draft volume of the new World Bank report Dancing with Giants: China, India and the global economy has been posted online:

Drawing upon the latest research, this volume analyzes the influences on the rapid future development of these two countries and examines how their growth is likely to impinge upon other countries. It considers international trade, industrialization, foreign investment and capital flows, and the implications of their broadening environmental footprints. It also discusses how the two countries have tackled poverty, inequality and governance issues and whether progress in these areas will be a key to rapid and stable growth.

The background papers are also available. It's an impressive collection:

Can India Attain the East Asian Growth with South Asian Saving Rate? Deepak Mishra

China, India and the World Economy, T.N. Srinivasan

China's Politicized Capitalism, Victor Nee and Sonja Opper

China vs. India: A Microeconomic Look at Comparative Macroeconomic Performance, Taye Mengistae, Lixin Colin Xu, Bernard Yeung

The Coming Age of China-plus-One: The Japanese Perspective on East Asian Production Network, Masahisa Fujita and Nobuaki Hamaguchi

A Comparative Study of the Role of the Service Sector in the Economic Development of China and India, Deunden Nikomborirak

Does ‘Good Government’ Draw Foreign Capital? Explaining China’s Exceptional FDI Inflow, Joseph P.H. Fan, Randall Morck, Lixin Colin Xu, and Bernard Yeung

The Domestic Financial System and Capital Flows: China, Chong-En Bai

The Emergence of the Chinese and Indian Automobile Industries and Implications for other Developing Countries, Gregory W. Noble

External Liberalization and the Evolution of China’s Exchange System: an Empirical Approach, Min Zhao

Growth, Governance, and Institutions: The Internal Institutions of the Party-State in China, Susan H. Whiting

How Integrated Are Chinese and Indian Labor into the World Economy? Richard N. Cooper

How Will China's Saving-Investment Balance Evolve? Louis Kuijs (aslo published as World Bank Working Paper Series Number 3598)

IMACLIM-R: A Modeling Framework for Sustainable Development Issues, Renaud Crassous, Jean-Charles Hourcade, Olivier Sassi, Vincent Gitz, Sandrine Mathy, Meriem Hamdi-Cherif

Impact of China and India on Global Commodity Markets: Focus on Metals & Minerals and Petroleum, Shane Streifel

Indian Manufacturing: A Slow Sector In A Rapidly Growing Economy, Devashish Mitra and Beyza P. Ural

The International Balance Sheets of China and India, Philip R. Lane

The Interplay Between Capital Flows and the Domestic Indian Financial System, Ila Patnaik and Ajay Shah

Large Domestic Non-Intermediated Investments and Government Liabilities – Challenges Facing China’s Financial Sector Reform, David D. Li

The Politics of Infrastructural Spending in India, Steven I. Wilkinson

Hat tip: Nitin at the Indian Economy Blog

Yuan band to widen

China's central bank governor Zhou today repeated earlier comments that authorities would push for yuan convertibility: China says no timetable for yuan band widening

BEIJING, Sept 21 (Reuters) - China has no timetable for widening the yuan's daily trading band but will continue to take steps to gradually make its currency fully convertible, central bank chief Zhou Xiaochuan said on Thursday.

A recent acceleration in the yuan's strengthening has stoked speculation that Beijing could let it trade in a wider range  -- it is currently allowed to rise or fall by 0.3 percent each day against the dollar and by 3 percent against other major currencies.

Asked by reporters on the sidelines of a financial forum whether China had a timetable for widening the band, Zhou said: "There is no need (for that)."

Pressed on details of a potential band widening, Zhou replied: "It depends on whether the band is enough for the market." Zhou made similar comments last weekend at a meeting of Group of Seven nations in Singapore.

The yuan hit 7.9230 against the dollar on Thursday, its highest level since Beijing revalued it by 2.1 percent and untethered it from a peg to the dollar last July. It has now strengthened a further 2.36 percent since then. But in daily trade, it has normally risen or fallen by only a fraction of what the band would allow.

Zhou also said China would gradually push to allow the yuan to be freely convertible and step up efforts to improve the openness of its financial sector. While the yuan is convertible on the current account, which covers trade, China still restricts most capital account deals and analysts say full convertibility could be years away.

"We will continue to redouble our efforts to develop our financial markets, to widen the openness of our markets gradually and in an orderly way, and to steadily push for free convertibility of the renminbi," he said, referring to the alternate name of the currency.

Doing business: Singapore is No 1

Singapore overtook New Zealand as the most business-friendly economy in the world in 2006, while the United States held steady in third place, according to the World Bank's Doing Business 2007 report - published today.

The dominance of the Anglo-Saxon and Nordic countries continues (see my post on last year's report). Other economies in the top ten for ease of doing business were: (4) Canada, (5) Hong Kong, (6) the United Kingdom, (7) Denmark, (8) Australia, (9) Norway, (10) Ireland.

The top 10 reformers were, in order, Georgia, Romania, Mexico, China, Peru, France, Croatia, Guatemala, Ghana and Tanzania. In Africa, a more business-friendly approach has seen the region move up from last place to the middle of the pack among world regions in carrying out changes that make it easier to start and run a business.

The report praised China's acceleration of reforms, which saw its ranking improve from 108th to 93rd:

Watch out, rest of the world: China is a top-10 reformer. The government sped business entry, increased investor protections and reduced red tape in trading across borders. China also established a credit information registry for consumer loans. Now 340 million citizens have credit histories.

Although reforms improved India's ranking over last year, "it still ranks relatively low at 134 and lies 41 places after China, which is reforming at a faster pace than India."

Among Europe's biggest economies, Germany ranked 21st, France 35th and Italy 82nd, down from 69th in the previous report. Meanwhile, Venezuela plunged to 164th from 144th.

Why does this matter? As the report notes:

Publishing comparative data on the ease of doing business inspires governments to reform. Since its start in October 2003, the Doing Business project has inspired or informed 48 reforms around the world. Mozambique is reforming several aspects of its business environment, with the goal of reaching the top rank on the ease of doing business in southern Africa. Burkina Faso, Mali and Niger are competing for the top rank in West Africa. Georgia has targeted the top 25 list and uses Doing Business indicators as benchmarks of its progress. Mauritius and Saudi Arabia have targeted the top 10.

Comparisons among states or cities within a country are even stronger drivers of reform. Recent studies across 13 cities in Brazil and 12 in Mexico have created fierce competition to build the best business environment. The reason is simple: with identical federal regulations, mayors have difficulty explaining why it takes longer or costs more to start a business or register property in their city. There are no excuses.

You can download a 12 page overview (PDF, 1.8Mb), press notice, rankings, country reports and details of the methodology used from the extensive webite: www.doingbusiness.org

EU to start a shoe war with China and Vietnam?

I warned of this back in February (see From 'bra wars' to 'shoe wars') and now it seems increasingly likely: a 'shoe war' with China and Vietnam. Clearly, the European Commisison has learned nothing from last year's bra wars debacle. Helena Spongenberg of the EU Observer website reports Brussels pushes ahead on China shoe tariffs:

The European Commission has pushed for new measures against leather shoes from China and Vietnam despite member states' representatives having rejected two previous proposals this summer.

A proposal by trade commissioner Peter Mandelson to levy a 16.5 percent duty on 'leather upper' shoes entering the EU market from China and 10 percent duty on those from Vietnam was adopted by the commission on Wednesday (30 August).

The proposal has now been put forward to the bloc's 25 trade ministers who have one month to decide on the issue before temporary duties expire.

The commission said the plan was an effort to combine the different economic interests while also respecting the evidence from a 15-month long commission investigation showing that Chinese and Vietnamese shoes received unfair subsidies from their governments.

European footwear production has shrunk by 30 percent since 2001, alongside the rise in imports dumped on the EU market below the real cost of production, according to a commission statement.

"Our job is to tackle unfair competition where it exists. We have found this in these two cases and that is why we have taken the measures that we have proposed," commission spokesman Peter Power told journalists in Brussels. "It is now up to the member states to take their responsibility to decide," Mr Power said, adding that the "case is complex and highly sensitive."

...When member states next month meet to decide on the proposal, at least 13 of them must back the plan or abstain from voting for it to come into effect when the provisional duties end on 6 October.

...EU member states are divided between northern European countries, which at an early stage moved their shoe factories to Asia and are now importing them, and southern European countries that still have an active shoe industry.

The commission warned that member states rejecting Wednesday's proposal "could in theory be challenged in court to legally defend their position."

Temporary tariffs expire in October, and EU members now have a month to decide whether to back the new move.