What is the future of Chinese trade?

It is essential to study the international and external context of China’s opening up when China  entered the new normal, as well as associated opportunities and challenges. As President Xi Jinping pointed out in a speech concerning China’s national economy, China is now confronted with a convergence of economic deceleration, restructuring and the digestion of its previous stimulus package.

First, our external context is characterized by a post-crisis period of recovery and adjustment, which continues and will persist in the foreseeable future. Unlike the past three decades, particularly the prosperous phase before 2007, this period has manifested many new characteristics including shrinking external demand, expanding overcapacity, increasing competition, intensifying trade protectionism and growing trade disputes.

Second, international trade rules are being rewritten. They have been evolving constantly and the world has now entered a period of intesified rule change, with some new developments identified on rule-writing platforms. On one hand, the World Trade Organization (WTO) is still functional as a multilateral mechanism, with some new rules being negotiated. On the other, regional trade organizations may move ahead of their multilateral counterparts. Some new rules may first be negotiated and developed on a regional trade platform such as the Trans-Pacific Partnership (TPP), which aims to create both new regional trade arrangements and a large number of new trade rules. Enforcement of these rules will immediately generate both opportunities and challenges for all countries, including China.

Third, our comparative advantages are now shifting. Low cost has dominated China’s competition worldwide in the past three decades. This low-cost competition was driven by a combination of multiple factors, including, most importantly, our cheap labour. After three decades of development, however, China’s demographics and labour market have changed dramatically in terms of demand and supply.

According to China’s demographic statistics, its labour supply reached its peak in 2012. Since then, labour supply growth has stagnated, despite the fact that China remains a labour-rich country. At the same time, China’s population is ageing, which has fundamentally shifted supply and demand in the labour market. The number of new entrants into the workforce every year is estimated around 15 million. In 2000, colleges and universities enrolled only 1.08 million students, which means the remaining 14 million might have joined the blue-collar workforce. Today, 7 million senior high school students can go to college every year, excluding those who seek degrees through full-time self-education or adult education. Compared with a dozen years ago, only half are now entering the labour market as blue collars.

This explains why we have seen a new phenomenon on the job market: it is harder for a university graduate to find a secure and decent job. This has created new pressure for government. At the same time, employers suffer from difficulty in recruiting skilled workers and providing fast-growing salaries, as evidenced by two-digit growth for consecutive years, in the blue-collar job market. The strained supply-demand relationship has also led to some profound changes: companies are now replacing labour with machines to improve their productivity.

The downside resulting from short labour supply is frequent job-hopping, or high turnover of workers in companies. Joint research with the Chinese Ministry of Commerce reveals a blue collar turnover of up to 100%, and in extreme cases 500%, in some manufacturing and trade companies, which means that all shop floor workers will have been replaced at year end. High turnover also cuts both ways. The upside of frequent job-hopping is the exchange of skills, particularly the transfer of know-how, among different companies, which will make mutual learning more efficient. The downside is that worker exposure to a particular job is too short for them to perfect their skills. Companies in this case will be unwilling to invest in skill training, fearing workers will leave after training.

This will result in stagnation, or invisible improvement, of job-related skills, which coincides with the weakening of China’s low-cost advantage. To become more competitive in global and domestic markets, companies will have to rely more on innovation, quality, management and service. However, this will require a more skilled labour force, but labour improvement alone is not enough to build the competitiveness of a company.

The convergence of these factors will provide more opportunities than threats for China’s economic transition. Despite the challenges mentioned, such as declining external demand, trade disputes and a disconnect between skills and market requirements, there are still favourable opportunities for our transformation. Internally, the labour structure is shifting. Blue collars will face greater challenges from pressure, for example, from cost reduction and skill gaps, while university graduates will enjoy more opportunities.

They can engage in more advanced economic activities, such as in the services sector and R&D. Of the more than 7 million college graduates in China every year, around 1.8 million are trained in science and engineering. This is a great asset for manufacturing and R&D, as most R&D cost arises from labour. Internationally, advanced economies are the dominant force in R&D and only a few developing countries, like China, India and Brazil, can afford R&D. Therefore, China should not compare itself to developing countries, but developed economies, in terms of low-cost R&D, which is its valuable advantage.

Another competitive edge for China is its fast-expanding home market. China has evolved from the originally so-called “potential market” into a big market in reality and continues to grow at a yearly pace of 7%. This is a remarkable accomplishment. China recorded a $10 trillion GDP for 2014. A 7% growth will create $700 billion of wealth. Turkey is the world’s 16th largest economy, with a GDP  valued at $800 billion. This means that China’s yearly addition to GDP is equivalent to the size of the world’s 17th or 18th largest economy. At current price, China’s GDP last year is 55% of the US size, which means the US will have to grow 3.5% to offset the newly created output from China’s 7% growth. This is no easy task for the US. As the Japanese Yen has depreciated, China’s GDP is already twice the size of Japanese economy, which will have to expand by 15%, an impossible mission, to catch up with China. New demand from such a large market will actually bring about many new opportunities, attracting global investors to rush to China. If foreign investors wish to be successful here, they need to base their R&D in China.

In the past few years, we have observed that many multinationals have accelerated the transfer of their regional headquarters and R&D centers to China. The shift in China’s comparative advantage has become a magnet for advanced economic activities and talent. There are no accurate statistics in terms of how many foreign R&D engineers and executives are based in China, but one figure is telling – the yearly number of overseas students returning back to China.

In 2004, this number was just above 20,000, but jumped to over 50,000 in 2008 after the breakout of the global financial crisis. Last year, it skyrocketed to 345,000. This trend is a convincing example of the promise and potential of China’s economic prospects as well as the huge opportunities associated with them. They will attract more advanced talent and factors of production, beneficial to China’s economic transition.

China also faces considerable opportunities in the global market. The first opportunity comes from the worldwide craze for infrastructure construction. Advanced economies need to renew their infrastructure, while emerging markets need to build new infrastructure to satisfy growing needs. Whether it is the reindustrialization strategy proposed by the Obama administration, or the Industry 4.0 initiated by Germany in Europe, all such economic revitalization strategies need the support of better infrastructure. High-speed railways and telecommunications infrastructure like 4G are all hotspots in the infrastructure boom.

Developing countries, particularly emerging economies, are in more urgent need of better infrastructure to accelerate their industrialization and urbanization. Chinese companies are strong players in this sector. Their success in securing infrastructure contracts will also drive China’s export of equipment packages. China’s latest power generation, transport and telecommunications equipment are much more technology- and capital-intensive, with greater added value. Driven by global infrastructure development, China’s export mix will be optimized.

There is still another opportunity in overseas investment. From a small investor and a big recipient of capital, China has become a big capital recipient and investor in the global market. China’s investment overseas has jumped from $2.85 billion in 2003 to over $100 billion last year. Diverse reasons motivates Chinese companies to invest globally – some to develop markets, representing the largest share, others to access resources, as demonstrated by the purchase contracts of mines and oilfields abroad.

The most important form of global investment is acquisition, which allows Chinese companies to access technology, R&D capabilities, brands and international channels. Acquisition can also help Chinese companies combine international advanced technology, brands and sales channels with its local manufacturing strength and low-cost resources, thus strengthening their competitiveness across value chains. Chinese companies have made some progress in this respect, such as Sany’s purchase of Putzmeister and Geely’s takeover of Volvo.

Of course, Chinese buyers will have a lot to do in terms of post-acquisition internal integration, but the aftermath of the financial crisis presented Chinese companies with low-cost M&A opportunities, through which they can integrate global resources and climb up the value ladder. Conclusively, new opportunities for China’s opening up should be considered more of a qualitative nature, rather than quantitative. And when developing new open-door strategies, China should consider opportunities from fundamental shifts in external environments.

To understand China’s opening strategies in the new normal, we first have to know what are the new normal requirements for China’s opening up. At the APEC 2014 Summit, President Xi Jinping elaborated on China’s new normal from three perspectives: first, China’s economy has slowed down from super-high growth to medium and high growth. This may be simply perceived by some as economic deceleration. Actually, this speed remains relatively high at the global level, especially for an economy as large as China. To maintain economic growth at around 7% is a big challenge for China, but a great contribution to the world economy. Second, China is undergoing an economic transition, accelerating economic restructuring, as a response to the new normal in terms of demand, supply and industry. Third, China will transform its economic growth drivers, which means that China will reduce its decade-long dependence on investment, factors of production and scale, and increase its reliance on innovation, quality and brand for economic growth. At the 2014 Central Economic Work Conference, President Xi Jinping also introduced nine trends in relation to the new normal.

I think this topic can be explored on two levels: in terms of economic transition, China should, for its transition and change of growth drivers, address the question of how it can fully leverage the international market and resources through strategy adjustments to accomplish its goal. At the second level, China faces new requirements as an emerging big power. China’s economic slowdown in the new normal is a result of the laws of economics and many catch-up economies once experienced similar situations. What lies behind China’s slowdown is an expanded economy. According to the International Monetary Fund (IMF), China’s economy has already caught up with the US if measured at purchasing power parity (PPP), although people practically use current price for this purpose. As the world’s second largest economy and an emerging big power, China’s rise will surely exert a considerable impact on international politics, governance and trade. If China cannot properly address its relationship with the international community, it may find it difficult to capitalize on external markets and resources to support its economic growth.

China needs to answer the next two questions to develop new opening strategies: How can external markets and resources facilitate China’s transition while China faces the challenge of transition in an expanding economy? And how should China deal with its relationship with the outside world through strategy adjustments to create an enabling environment for its development. Compared with the past three decades, when our major goal in opening up was to increase exports and earn foreign exchange to speed up industrialization, there has been a fundamental change in our current aim.

Analysis points to this question: What is the new objective of China’s current opening strategy and what is its strategic priority?

China’s current opening strategy will be adjusted based on changes in internal and external contexts. For one, a growing China needs to create a favourable external environment for peaceful development; and China needs to make full use of external markets and resources to expedite its economic transformation. Moreover, China should also improve its position in increasingly globalized value chains.

To accomplish its strategic goals, China needs to establish new strategic priorities.

First, China should focus its efforts on creating an enabling environment for international trade. A small economy should seize opportunities and avert risks. As a large economy, China is an “independent variable” in the world economy, which can affect the external environment. A large economy needs to first explore how to create opportunities. It needs to respond to the concerns and expectations of the international community. It is justifiable for the global community to expect a responsible role from China, but what role should an emerging great power play in a changing global governance system? Should we repeat the governance approach dominated by a single country like the UK or the US, or should we create a new governance framework in this increasingly multi-polar and democratic world? How can China balance the interest of its own and other countries while it is involved in global economic governance and the writing of new rules? These questions merit China’s close attention in its effort to open itself wider still.

China used to be a passive follower of existing rules. Now China should consider new developments in global governance and play a role in rule-based governance. This requires us to strengthen our ability in this regard. China will have to build up its soft power before it can translate its hard power into contribution to global governance. In future governance, China should never be a selfish country that only cares about its own interest, but a responsible stakeholder that balances its own interest with those of the rest of the world. Such new rules will also be a contribution to all of humanity.

Our current attempts, including the concepts of the Silk Road economic belt and the 21st century maritime Silk Road proposed by President Xi Jinping, are all based on such considerations. In terms of how to deepen economic and trade cooperation with the international community, he proposed “five connections” (policy exchange, road network, trade talks, currency circulation and people-to-people friendship), which encourages cooperation at practical, rule and cultural levels. The point is to enable all countries to share development opportunities in a mutually beneficial and win-win climate. This concept is not completely new, but it needs to be urgently addressed and given greater weight in China’s new strategy.

In addition, China needs to accelerate the implementation of its free trade zone strategy through regional trade arrangements, whose content should be enriched to cover liberalization and facilitation for trade and investment.

Second, China should focus on opening the services sector in improving its business environment. There are significant changes in China’s use of foreign investment. The first is that China has shifted its focus of opening from manufacturing to services. The second change has taken place in the administration of foreign investors. The bilateral investment treaty (BIT) being negotiated between China and the US on the basis of pre-established national treatment and a negative list will not only drive changes in approach in government behaviour and administration, but is indicates a shifting government mindset.

Third, China should treat overseas investment as a new priority. Overseas investment can deepen China’s cooperation with host countries, which can help Chinese companies better use global resources and become competitive multinationals. However, China will face a herculean challenge, at both the macro and micro levels, in the shifting of its focus from licensing and administration typical of its previous foreign-investor management practice, to a service-oriented approach characterized by in-event and after-event supervision. Companies will also face new challenges in such areas as global operations, global strategy development, international talent, internal management, as well as global corporate citizenship and cultures.

The key to the success of China’s new opening strategy is the creation of a supportive institutional arrangement, or an open system for economic development. China’s economic system should not be reformed for the sake of reform, but to implement a new strategy. Institutional innovation is a means, not an end. Therefore, the new economic system must centre itself on the goals and priorities of the opening strategy.

For China, opening up has also played a special role. Over the past three decades, opening has  accelerated the connection of domestic and international markets and resources, but it has also driven domestic reforms. The 3rd Plenary Session of the 18th CPC Central Committee clearly points to the direction of driving reform through opening further. Therefore, accelerating reform of international investment and trade will greatly catalyse China’s reform of its whole economy.

Author: Long Guoqiang is a Senior Research Fellow and Director-General at the General Office of the Development Research Center of the State Council of China. He is a participant in this year’s Annual Meeting.

Image: A man looks at the Pudong financial district of Shanghai November 20, 2013. REUTERS/Carlos Barria.