China’s Ruling Party really needs to let go

Is China serious about major economic reform? Probably not, says Tom Doctoroff

Of late, many propaganda pieces in the Chinese press have appeared extolling the importance of innovation, value creation and a fundamental rebalancing of China’s manufacturing-led economy to a consumer-driven one.

However, a big question remains – does the government truly believe its growth model has reached its peak? The key strategy continues to be urbanisation which entails: a) massive infrastructure investment inland; and b) upgrading non-productive rural workers into higher-productivity manufacturing workers. The structure of the Government’s gargantuan 2008 stimulus package is consistent with this framework. Factories are being built on hinterland farmlands, as are transportation networks to ship raw and semi-finished goods between lower-tier cities and the coast. The Party likely believes China can maintain its low-cost labour pool for at least the next decade.

Mobilisation of resources and scalification of markets remain core growth planks and this is inconsistent with any leap up value chains. That said, the Chinese model is appropriate for making an incremental crawl up the value ladder. China has been successful in industry after industry, ranging from green technology to autos. But no industry has had anything close to a paradigm shift in terms of setting global standards of innovation.

 A Consumer Economy?

In terms of stimulating consumer demand, the Government has done very little to relieve epic savings anxiety of both the middle class and the urban mass market. This would involve, most critically, fundamental restructuring of health care. Le Keqiang, Hu Jintao’s heir apparent, is charged

with leading the task force to address this need. But most observers are sceptical that insurance pools are deep enough or inclusive enough to fund significant health care reform.

To generate more innovation in state-owned enterprises, a key issue is corporate governance, or lack thereof. In China, shareholder rights are extremely weak. Goals of maintaining Party control and responding to the market are in opposition.

Chief executive officers (CEOs) are judged in implementing the party line and competition is, at best, orchestrated from above, by the Party power. The service sector, and modernisation of it, also remains a huge challenge. It is currently designed to respond to the needs of the masses.

But the emerging middle class, whose needs are more sophisticated and require a greater degree of personalisation, have been ignored. Again, key service industries (health care, financial services, real estate, etc) remain ‘strategic’ industries that are vital to the Party’s macro-management of the country. So, significant reform is nowhere in sight. Corporate structure is a barrier for innovation.

Large state-owned enterprises are burdened by byzantine hierarchies that preclude a bottom-up flow of new ideas and imperial CEOs who issue ambiguous instructions to generate anxiety and construct rival power factions to ensure that competition is horizontal, not vertical. There is also minimal investment in R&D and a dominance of short-term sales relative to marketing functions. I am not aware of any large local company that has an empowered marketing function. However, our experience with COFCO, China’s largest food conglomerate, suggests it is trying to impose a ‘framework’ for innovation and brand development.

The local brands that have made the most progress moving beyond scale/huge market capitalisation and towards value creation are, relatively, independent of the state. These are the companies fuelling JWT’s growth among local clients. But smaller private enterprises are starved of capital. When will banks begin lending based on objective assessment of return? Many doubt that day will arrive anytime soon.

Chinese companies are, rightly, focused on the China market and they are pragmatic. Recent cases, such as Geely’s takeover of Volvo, is a vanity project. It is a misguided attempt to grab a part of the booming luxury-car segment. Lenovo could only go global via a takeover of IBM’s international PC operations and results have been decidedly mixed. For the foreseeable future, ‘international’ Chinese brands will succeed only in emerging economies where the basic price-value equation of mainland goods remains a competitive advantage.

Underlying all of this is the slow progress on political reform. Despite having become the world’s second largest economy, China is still a poor country on a purchase power parity (PPP) basis.

Vast expanses of the country require strong central Government to continue the Middle Kingdom’s Great Urbanisation Project. Having said that, even ‘Friends of China’ are right to encourage the Party to begin the process of institutional-based reform, because the day when it becomes a necessity, rather than a theoretical ‘good’, will arrive sooner rather than later.

Tom Doctoroff is North Asia Area Director and Greater China CEO, JWT. [email protected]

political reform. Despite having become the world’s second largest economy, China is still a poor country on a purchase power parity (PPP) basis. Vast expanses of the country require strong central Government to continue the Middle Kingdom’s Great Urbanisation Project. Having said that, even ‘Friends of China’ are right to encourage the Party to begin the process of institutional-based reform, because the day when it becomes a necessity, rather than a theoretical ‘good’, will arrive sooner rather than later. Tom Doctoroff is North Asia Area Director and greater China CEO, JWT. [email protected] Market