Not too long ago, when multinational corporations invested in China they were putting their money to work in factories. China was the global manufacturing hub, afterall, so why not. But fast forward to 2010, and just 47% of foreign direct investment in China is going into manufacturing instead of 66% 10 years ago. The investment thesis that China’s domestic economy was going to expand and turn China inward has proven correct. The shift is taking place and can been seen in the latest round of foreign China-bound investments.
Multinationals are investing more in the service sector than in the manufacturing sector as recent as 2008, marking a structural shift in the Chinese economy. Rising wages, in addition to the changing policy landscape, have cooled investment in the manufacturing sector, especially on the coastal cities of Shanghai and Beijing. Monthly wages in China have risen by an average of nearly 12% a year in real terms over the past five years, pushing investors into higher-end sectors requiring more capital and less labor. Others are driving their investments to second and third tier cities to capitalize on the rise of the Chinese consumer.
The municipality of Chongqing, in western China, was ranked 22nd of China’s 31 provinces in terms of overall FDI in 2002. By 2011, it attracted an
estimated $10.8bn in inward investment, more than Beijing. According to a report released this month by The Economist Intelligence Unit (EIU), second and third tier cities will continue to increase their share of foreign investment, with Chongqing becoming the fourth-largest recipient of FDI in two years, ahead of Shanghai and Tianjin. Within five years, says Victoria Lai, editor of Access China at EIU, nearly one-half of foreign direct investment will go to areas outside of the eastern seaboard, compared with less than 20% in 2000. That’s not just a geographical shift. It’s a shift away from the export driven markets and into a China state of mind. What’s the Chinese are buying in Chongqing is as important to an investor as what’s playing in Peoria,Ill.
“The bulk of FDI is going towards service sectors now,” says Lai. “Over the last five years you’ve seen a 40% spike in investments in retail. That’s not for retail to be exported. It’s for Chinese consumers.”
Unilever did this in 2002 in the small city of Anhui. They built a factory primarily to produce and distribute products for China’s growing middle class. Only 15% of their goods are exported throughout Southeast Asia.
China was once a manufacturing hub to the world. That’s changing. The structural shift is now in full force. Lower skilled labor has moved to Vietnam and Malaysia. China is creating more value-added products. Moreover, as it creates more services to attend a bulging urban population — currently just 50% of the population’s total compared to around 75% in the U.S. — professional services such as medical and financial faces a skills gap.
China’s ever-expanding consumer story is reflected also in its trade surplus, now just 4% of its GDP compared to 10% in 2007. EIU expects it to be 1% by 2016. China’s done just making things for the U.S. consumer at Toys R Us and Macy’s. They’re making it for themselves. And with over a billion people to serve, and another 120 million seen moving to the cities over the next five years, that’s a big market to go after.
According to the U.S.-China Business Council, more than 70% of sales for U.S. multinationals in China were from the domestic market, with only around 8% exported back to the U.S. between 2000-08. U.S. companies in China aren’t necessarily there to sell things cheaply to Americans. They are there, more than ever, to sell products and services to the Chinese.
China is still a relatively poor country. Private consumption accounts for 34% of GDP compared to 70.5% of GDP in the U.S. and 57.5% of GDP in Germany in 2010.
China’s government is also interested expanding domestic consumption. Local companies will turn inward in response. In the meantime, China will need to open its service sectors more to foreign investment, says the EIU’s 23 page white paper called “Serve the People: The New Landscape for Foreign Investment In China”. It lags far behind economies such as Hong Kong and Singapore, whose robust service sectors became so strong only because they
encouraged foreign entry. China is placing heavy emphasis on moving up the value-added chain and having products “designed in China”, like the Apple iPhone is designed in California. But directing investment towards such areas is inefficient, says Lai.
“For its companies to truly succeed on the global stage, China will need to encourage foreign investment to create a more competitive environment that is essential for fast productivity growth,” the report states.
At the same time, the importance of services in the new wave of foreign investment means that new ventures will often require a strong training component. Inland areas will be attractive training locations given their lower wage levels. The relative winners are likely to be inland provinces with more responsive education systems.
One thing is clear, investors were right to believe in the China consumer’s strength. Even with the economy slowing, the Chinese consumer is getting better all the time.
See: Foreign Investment Into China –The Economist