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Friday, 10 June 2011

To reach its full potential, China must create its own global brands

Financial Times
June 7, 2011

By Shujie Yao

China’s “go global” strategy is picking up pace. According to the Asia Society, the educational organisation, Chinese overseas direct investment could hit $2,000bn by 2020.

Yet for the country’s aspiring multinationals, pouring money overseas is no guarantee of international success. China surpassed Japan to become the world’s second-largest economy last year, but its inability to emulate its Asian competitors in producing world-famous brands such as Toyota and Samsung reflects fundamental weaknesses in its domestic business model.

Future economic growth in the country is tied to the fate of its big businesses. If these companies fail to have an impact in ultra-competitive western markets, then it is highly unlikely China will be able to sustain another 20 or 30 years of rapid growth.

Economic malaise poses the greatest threat to the ruling Communist party, and China’s leaders have long been mindful of the need for commercial success abroad. Having officially implemented a “go-out policy” in 1999 to encourage domestic companies to invest overseas, their global strategy is clear: let state-owned enterprises (SOEs) enjoy monopolies at home, allowing them to accrue abnormal profits, and subsidise them with generous bank credits so they can flex superior monetary muscle in front of foreign counterparts.

But cash reserves alone are insufficient for Chinese companies to secure long-term, profitable footholds in developed overseas markets.

One great weakness of China’s SOEs is their dearth of experience of genuine competition. A monopolistic environment at home has made profits too easy to come by – last year the combined profit of the two most profitable SOEs was equivalent to that of the largest 500 private firms.

These enterprises lack incentives to innovate and develop technological expertise capable of rivalling that of western business giants. Unlike South Korea and Japan, China has a seemingly limitless domestic market and companies can record impressive growth without crossing borders.

I have met the chairmen of two of China’s largest private companies, both extremely wealthy men, and neither has ever had any plans to enter developed markets overseas, citing high risks, poor technology and products that often fail to meet minimum quality standards required by the west.

Private companies not only lack state support, but also business scale and access to bank credit. Two-thirds of all bank loans are channelled to SOEs.

They also struggle with human capital. Graduates are lured by the prestige and higher pay that working for government organisations and SOEs bring, and employment in the private sector is seen as a last resort. Salaries in the state sector are 1.8 times higher than in the private sector and a government job offers attractive pension schemes and far greater job security.

China’s march across the globe has instead centred on energy deals and mergers and acquisitions. It has enjoyed success in locking in a stable supply of natural resources, securing loans-for-oil deals, particularly in South America and Africa, and purchasing stakes in western mining companies. And while these M&A deals serve to accelerate its push into western markets, there are reservations over such a strategy. Acquisitions carry high price tags and China is not yet adept at managing the purchased assets.

The takeover of Volvo by Geely, the Chinese carmaker, is a case in point: it has given China little access to technology, as the best engineers are still non-Chinese. Aggressive manoeuvres can also attract political opposition, as Chinalco, the state-owned aluminium producer, found in its failed bid for Rio Tinto, the UK-listed mining company.

Another problem with acquisitions is that they deflect attention from the need to develop strong indigenous brands recognised by western consumers, and to restore credibility to a “made-in-China” label repeatedly knocked by safety scandals.

China’s rapid economic expansion has been largely built on export processing and low-level manufacturing of consumer goods, capitalising on cheap labour and relying on technologies imitated or imported from the developed world.

To change this, the country is investing heavily in science, technological innovation and education. Project 985, a commitment to university research funding, is one such initiative, with the government increasing research investment by 20 per cent every year for the past decade. But since universities are treated like government organisations, the efficiency of this investment has been called into question.

One solution to China’s dilemma would be for the government to establish an incentive mechanism to encourage greater domestic competition, allowing private enterprises to compete fairly with SOEs. Bank credit needs to be loosened for private companies and a tough regulatory regime should be designed to guard against a state monopoly.

Will China succeed in hauling itself up the technological ladder? It will certainly be a long, painful process. The country still has a large reservoir of cheap labour, meaning the pressure for innovation and technology upgrading has not yet reached the critical point.

To meet its ambitions and become a rich and powerful nation will require multinationals to flourish overseas. But without its own respected brands, its Toyotas and Samsungs, China will always languish at the lower end of the value chain. Its future will ultimately depend on its ability to create, not to replicate.

The writer is professor of economics and head of the School of Contemporary Chinese Studies at the University of Nottingham


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