The China Effect: The Good, The Bad and The Ugly

The China Effect: The Good, The Bad and The Ugly

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There’s no doubt about it – China has changed the way the world does business. And with its increasingly massive clout and the state’s growing closeness to the South African government the Asian giant is likely to play an even greater role in the lives of business owners here in future years.

In just over two decades China has catapulted from its spot as the 10th biggest economy, to become the second biggest economy in the world. It’s now also the globe’s biggest exporter and its hunger for resources has made it the third biggest importer in the world, after the US and Germany. Estimates are that it will overtake the US to become the world’s largest economy in the next seven to 15 years.

In the meantime, China will continue growing at  breakneck speed, albeit at a lower forecast average of 7,5% over the next four years. This is more than double South Africa’s expected growth over the next three years, but down on the 11,2% a year China recorded between 2006 and 2010.

Local manufacturers suffer

In the last decade cheap Chinese imports have wiped out large swathes of local industries. There is already evidence that fewer South Africans are setting up factories. Figures from Business Partners reveal that between March 2004 and March 2007 (the year before the recession), the SME financier’s investments in manufacturing grew from just 107 a year to 119, bottoming out to 105 the following year.

During this time the manufacturing sector, as a percentage of the financier’s total number of deals, shrunk from 20,9% to 17,9% of its portfolio, before falling to 15,7% in 2008. This was at a time when the local economy was pumping, but these figures suggest that not many South Africans were rushing out to set up factories.

On top of this, vacancy levels for Business Partners’ industrial properties had moved from 5% five years ago to 10%, says managing director Nazeem Martin. He adds that many of the properties which were once filled by small factories are now filled by businesses with repair shops or suppliers of goods to the services sector.

In the furniture sector where manufacturers have been hard hit by cheap imports, Michael Reddy, chief executive of Seda furniture incubator Furntech, says the only way for furniture manufacturers to stay in business is by supplying fewer goods at higher prices.

In Brazil, the South American country is ratcheting up support for small firms. But cheap Chinese imports only make up 3% of consumption in the Brazilian market, according to Lawrence Edwards, associate professor in the School of Economics at UCT.

Edwards, who is studying the effect of Chinese imports on South African businesses, believes that Chinese imports make up a much greater percentage of the market here – easily 5% or more. The penetration of Chinese imports into South Africa will be higher because the country has a small economy with a small scope for manufacturing, he says.

Yet, it’s only in recent months that the government has appeared ready to step in to assist local firms hit by the China effect, with the Minister of Finance Pravin Gordhan’s announcement in the 2012 Budget Speech that billions would be given in incentives to improve the competitiveness of local businesses.

Edwards believes that despite SA’s more defensive trade policy approach, following the stalling of the Doha round of World Trade Organisation (WTO) talks, South Africa won’t be bringing down tariffs, which are as high as 40% to 45% on clothing.

This might be good for some local factories, if it continues this way, but it won’t stop Chinese entrepreneurs from coming to South Africa. More local companies are being approached by Chinese companies that want to sell them raw materials.

Colin Mkhonta, the chief executive of Seda’s chemical sector incubator, Chemin, says he receives “almost weekly” requests from Chinese firms to sell raw materials for cleaning products to incubatees.

Now, as they have done in other parts of Africa, Chinese firms are steadily moving into South Africa to take shares in mines and manufacturing companies. Chinese investors are also likely to keep an eye on infrastructure projects announced by President Jacob Zuma in his State of the Nation address in February.

Already three Chinese automotive manufacturers are set to move into the country soon, according to Martyn Davies, emerging markets analyst and chief executive of Frontier Advisory. But Davies, who is helping the South African government to bring Chinese investors to the country, says local businesses won’t necessarily score big, as many Chinese firms will bring their own suppliers with them when they set up here.

Peter Draper, a trade analyst and senior fellow at the South African Institute of International Affairs (SAIA), believes China’s demand for commodities will be key. He argues that China’s enormous economic might presents certain opportunities for local entrepreneurs, including a quest for land, as the Chinese are looking for land from which to export goods or foodstuffs to China.

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New opportunities

Yet it’s not all bad. The China effect, as some have termed it, has helped spawn new businesses, such as suppliers and importers, and opened up a large new market in the Asian giant itself.

The Johannesburg Chamber of Commerce and Industry (JCCI) has set up a matchmaking programme with chambers in Sao Paulo, Brazil; Shanghai, China; and Delhi, India, to allow local entrepreneurs to interact with one another over the Internet.

“We are going to work with the new BRICS (Brazil, Russia, India, China, South Africa) thing, instead of fighting it,” concedes JCCI chief executive Keith Brebnor. “China is not going to go away, so we are embracing them. If you don’t embrace them these other countries outside Africa will go direct to African countries. So we should move in.”

China’s continued rise is likely to bring with it both threats and opportunities for South African entrepreneurs. Here are some predictions:

  • Chinese exports to move to high-tech

Chinese goods will continue to land on our shores in large numbers, but years ahead these are likely to include more sophisticated, high-tech products. Even if prices are expected to be a bit more expensive than before, local factory owners manufacturing high-end products will have to ensure they have cornered a niche market and can compete on price and delivery with Chinese products, by turning to just-in-time delivery or doing small runs.

Some say China is where Japan was in the 1960s – producing cheap goods which were often of dubious quality, before shifting to more technical electrical and computer products.

Under its current 12th five-year plan (2011-2015), China is looking to aid seven priority sectors as it moves to focus more on high-technology. These are: renewable energy, energy conservation, new materials (such as high-end semi-conductors), biotechnology, IT, high-end manufacturing in telecoms and aerospace equipment and clean-energy cars.

China is also making significant investments in the development of new products and between 1998 and 2007, the country along with Korea, showed the biggest increase in R&D spending, according to the Beijing Axis.

At the same time wages are set to rise. In February the Chinese government released a job market plan to set minimum wage levels at 40% of average local salaries within three years. Cheap labour, which up until now has been supplied by the country’s poorer interior, is also becoming more scarce.

Also, under the current plan the country is making a concerted effort to strengthen its domestic economy, or the share made up by private consumption, but Chinese exports won’t slack off. According to a KPMG report, exports will continue to grow – from ¥11,3 trillion last year to an expected ¥16 trillion in 2015. So expect more high-tech goods at higher prices to start streaming into South Africa in coming years.

  • Opportunities in Africa

Much has been made of Chinese businesses backed by easy finance, moving into Africa, particularly where infrastructure projects are rolled out in exchange for mineral resources. Some liken it to neo-colonialism, others say the Asian country’s projects are a godsend to a poor developing continent.

China’s growing presence on the continent may even create big opportunities for South African firms in financial and other services.

Barrie van Wyk of Beijing Axis points out in a September 2011 edition of Beijing Axis publication, China Analysis, that China’s increased business in Africa has also created demand for services, and thus opportunities for legal firms, banks and other service providers. These are areas of strength for South Africa, and more local companies should be exploring the African market.

Standard Bank economist, Jeremy Stevens says that while China’s focus is turning towards domestic matters, the Asian dragon is also eyeing Africa now more than ever – particularly with the uncertainty in traditional northern markets of Europe and the US.

Africa remains a key market for China, particularly when it comes to its demand for commodities,including minerals and oil. Last year China-Africa trade hit a high of $155 billion.

Africa is also growing fast, and has already been outlined by McKinsey and others as one of the most attractive markets over the next few years. Yet despite this, Africa is in need of an urgent infrastructure overhaul. Stevens estimates that the continent needs about $100 billion a year to build new roads, erect new powerlines and maintain and develop other key infrastructure.

And although it will mean stiffer competition for local firms operating on the continent as they struggle to compete against cheaper Chinese turnkey projects, Stevens, who has been based in Beijing for six months, believes it also means more opportunities for South African entrepreneurs.

He stresses that it makes “long-term structural sense” for China to partner with South Africa, the biggest manufacturing sector on the continent. Added to this, many larger South African firms have become household names across the continent. Stevens believes Chinese firms could also help with another South African problem – unemployment.

  • Prospects to enter the Chinese market look good

With over 1,3 billion people China has become a valuable market for entrepreneurs to tap into. Chinese consumers are on the rise and the country is already the biggest car manufacturer and second biggest energy consumer in the world, as incomes have tripled between 2000 and 2010, according to Beijing Axis.

China is set to become the largest market for luxury goods by 2015, when it will account for 29% of consumption of luxury goods, according to the Boston Consulting Group.

And China’s goal to increase technological capabilities in a range of sectors will mean that Chinese regulators will welcome advice and training from experienced foreign companies, according to public affairs global giant Apco.

South Africa is looking for a slice of the action and the Department of Trade and Industry last year presented the Chinese Ministry of Commerce with a list of ten key sectors that they would like to promote to Chinese consumers, including wine and vehicle manufacturing.

But, trade analyst Draper cautions that South African entrepreneurs who export food products to China will come up against health checks and have to compete with China’s heavily subsidised local agriculture sector.

For South African firms looking to invest in China, having expertise in a cutting edge technology or service is far more important than arriving with briefcases of cash, says emerging markets analyst Davies. China, with the world’s largest dollar reserves, isn’t short on funds.

Breaking into the market, he says, will also require good people skills, as doing business in China is a very human relations-dependent exercise. There is also the issue of language. Any meaningful transactions will require knowledge of Mandarin.

According to Davies, about a dozen or more South African companies have a presence in China. These include Kumba Iron Ore, Naspers, SAB Miller, Anglo American, Hollard, Old Mutual, earth compacting company Lanpac, Barloworld, FirstRand, Capespan (which invested 20% in a food distribution company in Shenzhen) and Discovery Health.

Despite this, Davies says the number of South African companies in China remains limited, particularly compared with Australian firms which have been there for some time.

“South African companies have been late to the party,” he says, adding that a small country like Switzerland already has 500 companies based in China.

This means that entrepreneurs will have to keep a watchful eye on China – be it exporters looking to expand into new markets or  business owners looking to roll out a new factory. The Asian giant offers both opportunities and threats, but, with careful planning, the opportunities can outweigh the threats.

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Stephen Timm is a freelance writer at Entrepreneur Magazine.
  • sugarequip

    Its interesting that I recently learnt that in Pakistan that the government raises or lowers customs duties to earn foreign exchange and to protect local manufacturing / employment. Why do we not do the same seeing as employment read jobs is so widely discussed??

  • Andrew Blaine

    Unless South Africa initiates a serious programme for the beneficiation of both raw materails and small manufacturing organisations in the very near future the country is destined to become a vassal state to China who will control our raw materials. The evidence supporting this contention is everywhere in Zimbabwe but then we could not follow that example courld we?