What could happen
in China in 2015?
What do you get when you add slower economic growth, greater volatility, and rising competition to more international flights and genuine Chinese innovation? McKinsey director Gordon Orr’s annual predictions.
It
seemed harder to
prepare my “look ahead” this year. On reflection, I believe this
is because political and economic leaders in China have clear plans
and supporting policies that they are sticking to. You can debate the
pace at which actions are being taken, but not really the direction
in which the country is traveling. This means a number of the themes
I highlighted for this year will remain relevant in 2015: Improving
productivity and efficiency will remain the key to maintaining
profitability for many companies, given lower economic growth
(overall and at a sector level) and the impact of producer price
deflation on multiple sectors.
- The impact of technology as it eliminates jobs in services and manufacturing will become even greater (but still not in government).
- As a result, the government will keep a sharper focus on net job creation and the quality of those new positions. Companies will hire even more information technologists to keep up in the race to exploit technology better than their competitors.
- The push to lower pollution, and now carbon emissions, will lead to even greater investment in domestic solar and wind farms, boosting the global position of Chinese producers.
- High-speed-rail construction will continue domestically and increasingly abroad, as Chinese companies become the builder of choice for high-speed rail globally.
Beyond
these, there are several additional themes that will be important in
2015. I describe them below.
What else may happen in 2015?
China
will be the focus of many, many boardroom discussions around the
world next year. Unlike most previous years, the topic won’t be
whether to double down on China—it will be whether to hold or even
reduce exposure to a particular sector or the country overall. With
China experiencing lower growth, greater competition, and more
volatility, it won’t only be multinational companies having these
conversations. Similar questions will be asked by senior executives
of many of China’s private-sector leaders, who are looking to
sustain their historic growth rates by pivoting to new sectors within
China and especially to international markets. Most companies will
ultimately decide to stick with their current China strategy, but
there will be real choices and trade-offs on the table.
What
will be at the center of these conversations? I believe that it will
be a debate about Chinese consumers and how they will behave in a
slowing economy and, ultimately, the extent to which they will be the
driver of economic growth over the next few years. Let me elaborate.
Wages
Next
year will likely see the lowest annual income growth in China for at
least a decade, with knock-on implications across the economy. Early
signs are already there. Government data show urban disposable income
rose in single digits year on year in the first nine months of 2014,
a hint at the big shift that is under way. The vast majority of the
economy has seen double-digit wage growth for the past decade, with
the minimum wage in many cities doubling in less than five years.
This has created an expectation that this is simply the new normal
for income growth. It is not. As a result, workers are pricing
themselves out of the market: for example, International Monetary
Fund research in China suggests that a 10 percent increase in the
minimum wage leads to a 1 percent fall in employment.
The
manufacturing sector provides a telling example. Manufacturing wages
are up fourfold in dollar terms over the past decade. In recent
years, private-sector enterprises have had to agree to annual wage
increases three to four percentage points higher than state-owned
enterprises in order to narrow the significant pay differential that
had developed by 2010. The challenges for low-skill assemblers in
Guangdong and Zhejiang are well documented. They are downsizing, as
countries from Bangladesh to Kenya gain share. The cost of technology
that substitutes for labor in factories has plummeted, displacing
more and more workers. Chinese assembly lines today bear no
resemblance to those of a decade ago. The best Chinese private
companies are as capital intensive as an equivalent factory in the
United States. Employers today are under enormous short-term pressure
to reduce wage costs amid ongoing weakness in the Purchasing Managers
Indexes and persistent deflation in producer prices.
Service
industries will also be affected. For example, Chinese airlines use
e-ticketing to substitute for desk agents at least as aggressively as
any mature-market airline. Telecommunications, financial services,
and retail are all being challenged by “people lite”
Internet-based business models from new competitors, which have
already led them to substantially reduce hiring. In 2015, they will
need to quietly cut back further, whether they are in the private
sector or a state-owned enterprise—it doesn’t matter. In some
sectors, such as professional-services industries, entry salaries are
actually falling. I believe 2015 will be seen as a tipping point for
wages in China.
Jobs
Job
seekers next year will realize that the historical attractions of
working in state-owned enterprises and government are not coming
back—the job for life, opportunities for status, high pay, and
other perks are gone for good. Smaller state-owned enterprises are,
in many cases, anyway destined for the more commercially demanding
world of private ownership. Many larger state-owned enterprises are
recruiting less and encouraging departures to improve efficiency.
Lower growth means fewer promotion opportunities, and the upcoming
regulatory limitations on the multiple of highest and lowest
compensation in state-owned enterprises will increase wage
compression.
The
private sector has become the driver of job creation in China, with
official statistics (likely understated) showing an increase of 50
percent or more in private-sector jobs over the past five years.
However, many of these jobs are relatively low skill and low paying.
In 2015, the service sector’s criticality to job creation will be
called out even more by the government, with expanded policies to
encourage service-sector hiring and additional focus on the quality
of jobs created.
In
the government sector, the official salaries of teachers, doctors,
and civil servants remain low, and opportunities for side
arrangements are shrinking. Eventually, the government is going to
have to pay its employees more—but I don’t see that happening at
scale in 2015, despite the growing number of cases of teachers
striking for better pay. The number of students taking the
central-government entry exam fell this year despite an increase in
open positions. There has to be a connection.
The
substitution by technology of certain categories of service jobs that
have been at the heart of the growing middle class—call centers,
shop assistants, bank tellers, insurance agents—will accelerate in
2015. Even those who retain their jobs will wonder if technology will
displace them next. Critically, their confidence in their personal
economic future will decline.
At
the city level, we will start to see signs of the “Detroitization”
(post-auto) or “Glasgowization” (post-shipbuilding) of some
Chinese cities. Many cities are heavily dependent on a single
industry, not just mining or steel but often a specific single
manufactured good—lamps, socks, or automotive wheels. While great
in times of fast growth, the reverse is also true. It’s not just
that real-estate construction is no longer a driver of growth in
those cities. Construction, even when it overshot true demand, was
always driven off the back of the success of an industry creating
jobs and incomes that enabled citizens to buy housing. That success
will no longer be there. And with loans to business often guaranteed
by other companies in the same industry in the same city, a single
default can quickly cascade into other otherwise viable companies. In
2015, we will see the first of many “city transformation”
programs as cities go through a Chinese version of restructuring and
workout. Hopefully, cities at risk will see what may be coming and
will act early to create new economic engines.
It’s all about consumer confidence
As
a result, Chinese consumers will feel less financially secure in
2015. Fewer will feel they have a job for life, most will see wages
rise more slowly, many of their real-estate investments will decline
in value, and lower interest rates will make other investment
products look less attractive. Overall, the momentum of their wealth
generation will slow dramatically after a decade of remarkable
acceleration. And if they have children graduating from college in
2015, they will likely see them struggle to get a good job.
Lower
consumer confidence may then translate into lower growth in
discretionary spending. Fortunately for many in the middle class,
they have already bought their home, car, and other core trappings of
middle-class life. Many Chinese consumers could easily postpone
further big-ticket-consumption items and, at the same time, cut back
on daily consumption spending. Price deflation reduces the perceived
opportunity cost of waiting to spend. Already there are signs of
this. Recent Nielsen numbers showed only a 3 percent increase in
annual purchases of fast-moving consumer goods. More specifically,
food and beverage company Tingyi reported a 13 percent decline in
turnover in the third quarter of 2014, while beer volume sold by
brewing and beverage group SABMiller fell in its most recent
reporting period. And remember: very few in the current Chinese
middle class were in the middle class the last time there was an
economic slowdown. They could well overreact to a small slowdown and
turn it into a larger one as a result.
With
fewer attractive investment options in China, the opportunity to
invest in Hong Kong–listed companies through the Shanghai–Hong
Kong stock-exchange connection will look more attractive in 2015.
Currently, a lack of awareness about the available stocks and a high
minimum investment are holding people back, and the fund flows are
way below daily limits. In 2015, that will change.
Where will growth come from?
The
result of all of this is that drivers of economic growth will be
harder to find in 2015. Increasing consumption has accounted for more
than 50 percent of GDP growth for the past couple years. Its share,
for reasons laid out above, will likely be smaller next year.
Infrastructure investment is directly under government control and
will likely remain at current levels and contribute to growth as it
did this year. However, property investment—historically, the
driver of around 15 percent of GDP—will probably have another weak
year. Residential supply has exceeded demand in many cities, and
investor interest has diminished as prices have stagnated. While the
picture is city specific, significant unsold inventory exists in many
cities, and new building is only adding to it. Policy support will
have some impact in growing demand, but it would take much lower real
interest rates to make a meaningful difference. Could growth be
driven by exports? Not since 2007 have net exports contributed more
than a percentage point to China’s growth. Recovery in the United
States has not led to a growth in net exports, and a big boost from
demand in Europe in 2015 seems unlikely, even with lower oil prices.
Students reinvent themselves for the jobs of 2015
It
will be another year of frustration for students, both those
graduating and those still in school considering their prospects. A
substantial proportion of new graduates will not find jobs that
require a degree. Indeed, many will find what they learned and how
they learned at university has done little to prepare them for the
2015 job market in China. Other than for an elite minority, starting
salaries will be flat yet again, at levels less than the income level
of a full-time taxi driver (student starting salaries have only
increased 1 to 2 percent annually over the past five years, one of
the few categories in the economy where wages have not risen). The
consequences will become increasingly obvious—graduates will be
unable to pay off their education debts, let alone save to buy a home
or a car or to become meaningful middle-class consumers.
The
way forward for most is finding employment in the private sector,
services, or small and midsize enterprises, or becoming an individual
entrepreneur—none of which average students have been prepared for
by their education or their family. Growth in vocational schools is
being boosted by many newly graduated students who realize they need
to gain more work-relevant skills. Those students still in school
will become more vocal in demanding change in what and how they are
taught.
Individuals going global
Governments
around the world will compete harder to capture a greater share of
China’s international tourism and outbound-investment boom. The new
US ten-year multientry visa sets a bar for other countries to follow.
The United Kingdom’s guaranteed 24-hour turnaround on visas for
premium business travelers sets a bar for speed, although the
$1,000-plus price is eye watering. Beyond visas, many countries also
offer popular investment paths to a passport or permanent residency.
The majority of those using these schemes in most countries are
Chinese. In the most popular countries, limited supply is allowing
governments to push up the required investment dramatically. We might
hear about a $10 million passport this year.
Airlines
are also big beneficiaries of this growth in international travel,
with a new wave of growth in direct flight connections to key global
cities from second- and third-tier Chinese cities (two recent
examples are Wuhan to San Francisco and Changsha to Frankfurt). While
these routes have been subsidized initially by local Chinese
governments, the subsidies won’t be needed for long. The big Middle
Eastern airlines are also expanding beyond Beijing, Guangzhou, and
Shanghai, for example, with Qatar Airways now flying into Hangzhou.
Next year will see the launch of dozens more direct flights to
non-Asian destinations from second- and third-tier Chinese cities.
Chinese innovation—seriously
Does
China innovate? Next year, we will finally stop asking that question
and focus on the global impact of the innovation that is clearly
taking place. The number of Silicon Valley–based investors visiting
China to learn from Internet-enabled business is now remarkable.
These folks don’t waste their time on sight-seeing trips.
Beyond
the Internet, hundreds of midsize companies in the Chinese industrial
sector are creating their own version of the German Mittelstand,
providing ever-more-serious competition to Fortune 1000 competitors.
No longer focused simply on cheap, they deliver great value, listen
to what customers want, and develop products in response. Only this
month, on a visit to India, I noticed a tipping point. No longer were
there complaints about the low quality of Chinese industrial goods;
instead, there were compliments about their remarkably high quality.
Biotech, pharmaceutical, consumer electronics, medical tech, drones,
graphene, and telecommunications equipment are just some of the
sectors where aggressive Chinese midsize companies lead the way in
their field, often privately owned by a founding chairman or CEO who
has a true passion to become a global leader.
Rule of law increases its impact in 2015
A
comment you’ll hear less in 2015: I
can do this—it’s China.
Businesses will more fully recognize that anticorruption initiatives
and rule of law with Chinese characteristics are long-term
foundational elements of this leadership’s platform—they’re not
optional, and they’re not going away. Companies will need to become
clear about how recent statements—such as President Xi declaring
that the objective of advancing the rule of law is conducive not only
to updating state governance but also to deepening reform—apply to
them.1
We
will see the government standardize more of its approaches to
decision making on business and regulatory issues, using the
precedent of cases heard. For example, reviews of acquisitions should
be faster, with clearer conclusions. We will also see the government
leveraging technology more to monitor, audit, and impose sanctions on
bad behavior, from tax avoidance to overly aggressive entertainment
of government officials. Where could anticorruption investigations
bite in 2015?
- in an Internet company where a senior executive gets investigated for begging forgiveness, rather than asking permission, once too often
- in local government, where rapid asset sales made it possible for some sales to be made to favored individuals at below-market prices
- in companies that have yet to fully get their sales forces under control
Return of the DVD store
Shops
offering pirated DVDs will make a comeback in 2015 as the rule of law
extends to what can and cannot be shown online, pushing very popular
international series off the Internet. US series including The
Big Bang Theory and The
Good Wife have
already been blocked, and rules announced in September by the State
Administration of Press, Publication, Radio, Film and Television
require unapproved shows to be removed from websites by the new year.
Perhaps only in China will the selection of available online content
be more tightly controlled than the availability of physical content.
Or maybe the international providers of virtual private networks will
learn to accept payment from UnionPay cards, and demand for their
services will skyrocket. Cinemas will likely
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