If you follow business news at all you have probably read these words: “China is Dubai times 1,000 – or worse”. Jim Chanos and several other 'China bears' foresee doom in China’s economic future. They argue that eased credit has led to asset bubbles, particularly in real estate. Hence they call for shorting China’s economy, with the belief that the country is set to experience a disastrous crash. But there is at least one glaring omission in the bears’ analysis: they fail to account for changes in China’s demographics and its tremendous potential to impact the economy.

How important are demographics? A paper published in 2005 by the US Federal Reserve suggests that a nation’s working age population, ages 25 to 64, may ultimately determine shifts in real estate prices. Remarkably, the model employed here accurately anticipated the real estate boom and busts of Japan’s market in 1974 and 1990, the movements in prices in the US, Great Britain and Ireland, and even foreshadowed the current collapse in real estate prices recently experienced by these countries.

Just as the populations of the United States, Japan and Great Britain were influenced by the Second World War to create a generation of baby boomers, so too have events in China influenced its demographics. At the end of the Great Leap Forward in 1961, there was a surge in the birth rate, which gradually subsided due to family planning measures implemented by the government. This generation then began having children in the 1980s, creating another spike in births despite the implementation of the One Child Policy in 1979.

Those born during the spike of the 1980s are now entering working age. The result is that the working age population in China is now at a historic peak. Numerous Chinese people turning 25 are entering a period in life where most finish their university studies, find jobs, get married and buy houses – in China often with the financial assistance of their parents, likely of the previous boom generation. If the logic of the Federal Reserve’s paper holds for China as it did for other countries, the substantial increase in working age citizens is likely the main driver behind China's real estate prices.

More manufacturers jump on the 'green' bandwagon amid stricter export regulations, growing alternatives and rising demand.

Treading the 'green' path is on the rise among manufacturers in China, albeit at different levels of adoption. Be it in the garment, jewelry, stationery, paint or consumer electronics industries, more companies are adopting ecologically safe materials, including recycled substitutes.

Suppliers are motivated by two main factors. Most are compelled to do so because of increasingly stringent product regulations in their key export destinations, namely the EU and the US. RoHS (Restrictions of Hazardous Substances), for example, curb the use of elements and compounds that are perilous to the environment. Among these are lead and cadmium. Although the EU directive applies only to electronics products, makers in other industries such as fashion jewelry are taking heed and dispensing with these substances.

A few are tapping the eco-trend as a marketing tool to help them move into upscale manufacturing, away from the cutthroat competition of the low end. Because there is a premium attached to green models, companies can charge 5 to 50% more for these items.

Natural, Sustainable Alternatives

Apart from ensuring components are free from toxins, many companies are incorporating materials that are grown with as little impact on the environment as possible.

Cotton farmers are the leading users of insecticide globally, accounting for 16% of total consumption. Organic cotton that is cultivated without toxic pesticides and synthetic fertilizers promotes healthier products, preserves biodiversity and reduces the amount of noxious chemicals which seep into the environment.

Tencel, which is a brand of regenerated cellulose fiber made from dissolved wood pulp, is another eco-friendly material that is often used in pants and in coats. It is normally mixed with cotton at a ratio of up to 1:3.

Rayon from bamboo is also incorporated in the production of garments. Aside from being biodegradable, it is one of the most efficient natural fibers in terms of moisture absorption and breathability.

Other natural materials that makers are turning to are silk, bamboo charcoal, and soybean and milk protein fibers.

Apart from the textile application, bamboo is being employed as an alternative to wood, which is currently in short supply. Some makers have even found ways to reshape the naturally hollow and cylindrical plant by processing it in high-pressure machines.

Bamboo's short maturity cycle, wide availability, and proven strength and durability make the material not only an ecologically safer option to wood, but also a more profitable one.

Recycled Substitutes

Wood pulp, the most common material for making paper, has been linked to a number of environmental issues, including deforestation, and air and water pollution. This has prompted suppliers to turn to earth-friendly alternatives, which are becoming increasingly available. Among these are non-wood pulp paper, including cotton, bamboo and reed pulp, as well as bagasse and stone variants.

Recycled paper such as the kraft type is also a green option. In terms of quality, recycled paper holds up against conventional versions. It has some usage limitations, however, including unsuitability for color printing.

"Although products made of eco-friendly paper are priced higher, the acceptance of customers is high. Both our old and new customers place orders actively for such products," said Wang Hao of Zhejiang Guangbo Group Co. Ltd, a stationery maker.

Toy makers cited recycled sawdust, which is usually discarded as a wood byproduct, as a suitable substitute material. Apart from yielding environmental benefits, it improves crack- and heat-resistant properties in toys such as role-play sets. Being easier to process than wood, this alternative also has a shorter production time and simpler molding procedures.

In the beauty and cosmetics line, the trend is reflected in the simpler and recycled or recyclable packaging being adopted by many makers. Refills are likewise being promoted with greater frequently.

This posting was contributed by Global Sources, a leading business-to-business media company and a primary facilitator of trade with greater China.

This marks the most favorable international brand recognition to date for Chinese companies. In 2005, WFBA included only 27 Chinese companies in its list of 500. Other global brand rankings still do not have a significant Chinese presence, however. A 2009 top 100 brands’ list produced by Interbrand for Business Week magazine was topped by the usual suspects – Coca Cola (1), McDonald’s (6), Toyota (8) – without a single Chinese representative on the whole list. Another by Millward Brown entitled 'BrandZ Top 100' reserved five places for Chinese companies. China Mobile made it into the top ten at number seven. The remaining four were banks.

The discrepancies between the lists are due to different evaluation techniques utilised in each ranking system. To qualify for Interbrand’s list, for example, a company must derive at least a third of its earnings outside its home country, must be recognisable beyond its customer base, and must make its marketing and financial data publicly available. These standards, particularly the first, would eliminate most Chinese firms, and is part of the reason why Wal-Mart and Visa are also not recognised.

China’s ‘going abroad’ policy is a relatively new phenomenon. Chinese companies will increase their earnings abroad, become more widely recognised and achieve a greater presence on these lists of leading global brands. So we will be keeping a look out for a China-based company in Interbrand’s list for 2010.

Government imposed currency controls have gradually been reduced in China in order to enhance the RMB’s appeal. As of 2008, revenues from commercial transactions are fully convertible. In fact, all current account transactions – including international payments – have been eliminated. For private accounts, the limit for converting RMB into foreign currency has been raised from USD 10,000-USD 20,000 to its current level of USD 50,000.

Besides the easing of restrictions, China’s government has also advanced several initiatives to increase usage of the RMB internationally. In April 2009, the China Foreign Exchange Trade System (CFETS) was launched in conjunction with Reuters. This system allows member banks to trade the RMB against the US dollar, the yen, the Hong Kong dollar, the euro, and the pound sterling. Then in July, five Chinese cities – Shanghai, Guangzhou, Shenzhen, Zhuhai and Dongguan – were authorised to settle international transactions in Chinese currency. Through these conduits, the RMB is being promoted for use in trade with Hong Kong and ASEAN nations. Also in 2009, China’s government engaged in currency swaps with Argentina, South Korea, Indonesia, Hong Kong, Malaysia and Belarus. The central banks of these countries now possess RMB 650 million worth of foreign exchange reserves to facilitate trade using China’s currency.

The results from these policy changes are still pending, yet data from the Bank for International Settlements (BIS) shows that the RMB is traded far less frequently than many of the world’s other currencies. As of 2007 the RMB was ranked 19th, behind even Poland’s zloty, the Danish krone and the New Zealand dollar in terms of exchange frequency. Average daily turnover for the RMB has been increasing, however, whereas trade in major currencies such as the yen and US dollar have declined. As a result of policy changes, in Hong Kong deposits denominated in RMB have increased - from RMB 895 million in early 2004 to RMB 62.7 billion at the end of 2009.

To view the trend in currency usage from another angle, with more recent figures from the IMF, one can observe the composition of foreign reserves held at central banks. Although still an overwhelming favorite of central banks, holdings of the US dollar have fallen from a high of 56% of total counted reserves to around 36% as of Q3 2009. Similarly, the yen has declined from 5% to just under 2%. The share of ‘other’ currencies – the catch-all category that would include the RMB – has increased, but only to 1.7% of all foreign exchange reserves.

With the US dollar and yen gradually giving way (perhaps given its recent troubles, the euro as well), the trend – although unwinding only incrementally – seems to be one toward a wider array of currencies in use internationally. This shift, along with China’s policies for further integration with the world’s financial markets, will continue to increase the role of the RMB in cross-border trade, although not as rapidly as other aspects of China’s economy.

Beyond language and legal barriers, such as the requirement of GOST R certification, businessmen have to consider another important issue: payment terms. This is especially true given that Russia’s economy is still suffering from the financial crisis, recovering more slowly than other countries. Establishing acceptable payment terms can cause substantial delays to the progress of a deal.

There are three aspects of the payment process which tend to produce problems when setting the terms of trade between Chinese and Russian companies.

1. Russian buyers traditionally prefer to settle trades through cash.

2. The Russian banking system has yet to mature. By the end of 2008 there were approximately 1,300 banks in Russia. Over 800 of these were extremely small, with a capital base equivalent to less than USD 1 million. An extra element of disorder exists in Russia’s banking environment, in that many banks have a reputation for not honoring issued letters of credit. Furthermore, one-third of Russia’s banks may face bankruptcy as a result of the crisis; solvency is an important consideration when choosing a Russian bank’s services.

3. The level of cooperation between Chinese and Russian banks has yet to fully develop. Communication between both sides is inefficient. Chinese banks lack enough representative offices and agents in Russia, and vice versa.

Hence the situation suggests that extreme care must be taken when making payment arrangements for a Chinese supplier exporting to Russia. Some important steps to take include requiring the buyer to use a top, recognisable international bank when issuing the letter of credit, and asking for a risk-adjusted down payment when establishing the terms of trade. Additionally, the supplier may consider using the services of a company such as Sinosure which insures letters of credit against business and political risks. This type of service incurs extra charges but may be worth the cost for large traded values.

Just like any other prospective new market, Russia presents its own unique challenges. By overcoming the language barrier, by obtaining certifications to reduce the perception of poor quality and by taking extra precautions regarding the terms of payment, Chinese suppliers can prosper from increasing bilateral cooperation with Russia.

Having only two food choices available for one-fourth of the year sounded terrible to me. “So what did you eat in winter?” she asked. Well, I ate the same things as in the summertime – except maybe more cups of hot chocolate. Although winter likewise halted regional agricultural production, bananas, broccoli, seafood – you name it – managed to find their way to grocery stores in the American Midwest – where I grew up.

How could our childhood experiences in the 80s and early 90s have been so different? At least part of the disparity may be due to differences in the availability of transportation within China and the US.

As anyone involved in sourcing knows, although goods may be available in one location, the challenge remains of connecting them with their prospective end users, often many kilometres away. The greater the ease of connecting point A to point B, the cheaper the cost, hence, the more feasible trade becomes. This process requires infrastructure.

China has done a lot to improve its infrastructure since the 1980s. When imports arrive from overseas, they usually do so by boat. Not only does China now host some of the world’s busiest ports, but it has also has increased the length of its navigable inland waterways from 101,000 kilometres in 1985 to over 110,000 in 2008. From these inlets, the goods must then traverse land to reach their destinations. To this end, China has upped its railway length to 80,000 kilometres, as of 2008, from 55,000 in 1985. Even more substantial is the increase in highway availability, now at around four million kilometres, an increase of almost 300% from only 20 years prior.

The result of these advances in infrastructure: more goods are able to make it across the Chinese mainland to the people that need them. The amount of freight traffic within China, measured in ton-kilometres, has increased more than three times its 1987 value. Just as the wintertime shelves of the grocery stores in my hometown are filled with goods from the warmer southern US states, Mexico, and South America, similarly those in Shenyang can now be more readily stocked with products from southern China, the Philippines, or elsewhere.

The increase in transportation channels has reduced the contribution of shipping costs to goods’ retail prices, lessened the impact of food expenditures on one’s budget, and has enhanced the well being of Chinese consumers. This is evident when comparing the Engel’s coefficients – the percent of the typical household’s income spent on food, used as a general measure of a country’s standard of living – between China and the US. This statistic suggests that my roommate’s family may have spent about 55% of their household income on food in the 80s. The affect of both rising incomes and greater transportation availability since then have reduced this to less than 40%.

It is interesting to consider how much more this is likely to improve in the future. I think for the Chinese New Year I will indulge in a little variety and buy my roommate both oranges and pears – fresh green ones– to celebrate the holiday and the progress made by China.

Trade sanctions have clearly strained China’s steel industry. Seamless steel tubes, Oil Country Tubular Goods (OCTG), drill pipes, steel mesh panels, wire shelves... the list of newly sanctioned Chinese steel products goes on. Among the numerous made-in-China products impacted by international trade frictions, China’s steel industry has been hit the hardest, and given the severity of these trade disputes, the consequences for China’s steel enterprises are substantial.

Price and quantity decreases

Proposed last April, the oil well pipe anti-dumping and anti-subsidies action undertaken by the US International Trade Commission will adversely affect Chinese exports of as much as USD 2.8 billion. These exports are supplied by around 200 steel mills, and these provided oil well pipes to the US during early 2008 and Q1 2009. The monetary value at stake makes this the largest steel trade dispute in US history.

The oil well pipe anti-dumping and anti-subsidies case is only a sample of the international trade sanctions that have targeted Chinese steel makers in recent years. Since 2008, the EU, the US, Russia, India and other countries have successively launched anti-dumping and anti-subsidy surveys on China’s seamless steel pipes, oil pipes, drill pipes, steel mesh panels and other steel products. As a result of the financial crisis, global market demand has rapidly declined, exacerbating ongoing trade frictions – particularly within the steel industry. According to China Customs, in December 2009 China exported 3.34 million tons of steel, which contributed to a total of 24.6 million tons for the whole year 2009. This annual figure represented a 58.5% y-o-y decline.

Of all steel goods, pipe products were the most severely affected. In 2009, China's seamless pipe exports dropped by almost 50% compared to 2008. In 2009, China's export price for oil well pipes to the US was only USD 1,600/MT, well below highs of USD 3,600/MT in 2008.

Entering new markets

Some Chinese producers have adjusted their strategies in response to the sanctions. As an example, take one of China’s major seamless steel manufacturers, whose exports accounted for 48% of total sales volume before the financial crisis. In 2009 its shipments to major regions such as North America and Europe fell by more than 70% compared to the previous year, yet its total 2009 export volume dropped by only 10%. Its secret weapon: new markets – the company’s sales in Asia increased by 30% and African sales by 100%.

Other steel mills have followed suit, successfully exploring new markets such as Southeast Asia, the Middle East and Africa, thereby weathering the decline in demand from mature markets.

Along with the shift from mature to developing markets, export product structures are also changing. Many manufacturers are shifting their focus from high value-added products such as oil well pipes to a number of oil and gas transmission pipeline products, primarily in demand in countries in Southeast Asia and Africa. These regions are without well-established steel industries, ensuring less risk of new trade frictions arising from local competition.

Expanding domestic demand

Many Chinese steel mills capitalised on the national stimulus package which enlarged the domestic market in 2009. One of China’s largest stainless steel mills stated that although their exports declined by more than 50%, domestic sales increased by 58%, causing profits to remain consistent with those of 2008.

As of November 2009, China's net exports of steel have been largely restored to earlier levels. Nevertheless, China’s steel exports are facing more difficulties as overcapacity problems mount and international protectionism becomes more severe. As a consequence, China’s steel industry may yet have to adjust again in the near future.

Pressure from the national government and tightening regulations in overseas markets are compelling a growing number of suppliers to modify their business strategies and incorporate ecologically safe processes. The transition is neither extreme nor desperate, but the impact could be widespread as many midsize and small companies are also taking "green" initiatives. Due to the sheer number of these suppliers, they account for a large portion of the pollution and wasteful practices in the country.

Irrespective of size, companies are introducing long-term strategies anchored on recycling, waste reduction and sustainable energy adoption.

Recycling is the most common practice among factories, one that is carried out internally or through third parties. This, however, goes beyond reusing offcuts and scrap materials. Highly polluting industries such as leather tanning have always been required to invest in wastewater cleaning systems, but very few actually do. Now, many are investing large sums in such facilities not only to comply with local ordinances but also as a marketing tool. This comes as an increasing number of buyers are including social responsibility as a criterion in supplier selection.

Fujian Guanxing Leather Co. Ltd in Shishi, a city under the municipality of Quanzhou in Fujian province, has invested USD 3 million in a 6,000-ton capacity wastewater processing station. Once operational, the facility is expected to save the company USD 1.4 million annually.

In fact, waste recycling is becoming the norm in the city, one of the major garment and textile hubs in the province. More than 20 manufacturers have now installed treatment systems such as those from Carrousel. The majority of Fujian factories that dye fabrics in-house have similar facilities for their sewerage as well. Moreover, several local governments have set up complementary wastewater recycling services to help ensure a continuous supply of fresh water.

When it comes to material refuse, many large enterprises contract professional disposal services. Small and midsize businesses often transact with recyclers and junkyard operators.

Guangdong Weiermei Underwear Co. Ltd, for instance, sells fabric cutoffs to waste collectors. Watch exporter Shenzhen Full Success Gift Mfg Ltd and lock specialist Make Locks Manufacturer Ltd vend metal scraps to recyclers.

Some companies involve customers in their green efforts. On request, Shenzhen FJY Electronic Co. Ltd uses recycled materials during production. Doing so has the additional benefit of lowering unit costs.

Adopting degradable materials, however, does not always bring a similar effect. In the beauty and cosmetics industry, bottles made from such substances are about 20% more expensive than conventional plastic.

While recycling and reusing are gaining more adherents, only a handful of operations are tapping sustainable energy sources such as wind or solar power. Cynthia Garments Making (Dalian) Co. Ltd has taken steps to do so by using solar water heating at its workers' dormitories.

This posting was contributed by Global Sources, a leading business-to-business media company and a primary facilitator of trade with greater China.

Both India and China are capable of world class manufacturing processes. A study performed by the London School of Economics on the supply chains of the two countries’ automotive industries found that two-thirds of their domestic suppliers were able to provide inputs with defect rates of less than 100 parts per million – the typical threshold for suppliers in the US, Europe, and Japan. It was observed that both Chinese and Indian auto manufacturers domestically outsourced component production at similarly high rates, suggesting an adequate availability of competent local suppliers. Whereas the study found higher productivity levels in India, in terms of capital intensity, delivery frequency and stock-turn ratios, China had the edge. In a more recent, broader assessment across multiple industries, Deloitte found that the average number of days an item sits in inventory favored China at 24.2 compared to India’s 32.5.

Beyond the factory floor, connecting products to end users poses different challenges in China and in India. Within India there is a heavy reliance on roads. Their network is the second largest in the world, behind the US, at over three million kilometres. However, only around half of these roads are paved, and their width is generally too narrow to allow the passage of anything beyond smaller, two-axel trucks. Road transit is further slowed by a fragmented Indian trucking industry and by state border checkpoints. China, in contrast, has a far less extensive network of roads. Out of its million-plus kilometre road network, only around 300,000 kilometres are paved. But what China lacks in actual length, it makes up for by having newer, more passable roads. It has five times the number of multiple lane highways than India.

China also has more transport options available to its supply chains in the form of rail, air, and waterways. Over 78,000 kilometres of terrain are connected by rail in China compared with 63,000 in India. Goods can be flown in and out of China by way of 500 airports whereas there are only 334 locations to take to the sky in India. Thanks to geographical endowments, China also has more navigable waterways. Besides some of the world’s most active ports, commerce in China moves on 110,000 kilometres of inland aqueous passageways. This is more advantageous than India’s 16,000 kilometres of waterways, particularly in the movement of bulk commodities.

These transportation differences are partially reflected in the World Bank’s Logistics Performance Rankings. China is rated the highest of all BRIIC (Brazil, Russia, India, Indonesia and China) countries at 27^th in the world. Its comparatively higher scores in customs clearance, infrastructure adequacy, logistics, timeliness and tracking ability place it above India, ranked 47^th globally. Some of the largest discrepancies between the two countries are shown in survey data collected by the World Bank. Responders reported much higher frequencies of compulsory warehousing/transloading and involuntary payment solicitation in India, while in China greater expenses were incurred in the form of agent fees.

The infrastructure and logistical differences may explain why India is a more common site for the outsourcing of services, particularly IT services, which do not require a physical good to be brought to market. However, India should not be entirely discredited as a sourcing destination for manufactured goods. Both it and China have allocated over 10% of their GDPs toward infrastructure development which will enhance their future logistical abilities in bringing their products to the world’s consumers. The greatest similarity between China and India: neither can be ignored by the sourcing professional.

After its signing in 2002, China and the six veteran ASEAN members – Brunei, Indonesia, Malaysia, the Philippines, Singapore and Thailand – have incrementally reduced their tariff levels, typically at 5% per annum. As of January 1 2010, 93% of the commodities exchanged between these countries will have their tariff rates reduced to zero. The newest members of ASEAN – Cambodia, Laos, Myanmar and Vietnam – are scheduled to follow suit with most of their intra-ASEAN tariffs eliminated by 2015.

The trade agreement seems to have been effective. Since the first provisions of the treaty went into effect in 2002, trade has soared between China and ASEAN countries. The exchange of goods among China’s top five trade partners in ASEAN – Indonesia, Malaysia, the Philippines, Singapore and Thailand – expanded at an average rate of 22.9% from 2004 through 2008. In the four newest ASEAN members during this five year time period, imports to China have grown at an astounding rate of 36.1%, albeit with great variation between countries and years.

From this rapid increase, China has edged out the United States to become ASEAN’s third-largest commercial ally, behind Japan and the European Union. China-Asian trade totalled USD 231 billion in 2008. Although the first half of 2009 saw a decrease of 24% over the same period the previous year, indications of a global economic recovery suggest that expansion should once again resume in 2010.

Currently, trade between China and its southeast Asian counterparts is characterised by China swapping finished products, such as electronic equipment and machinery, for inputs such as oil/lubricants, plastics, rubber and intermediate electronic components. The effects of the free trade agreement may gradually change this. It is expected that a number of Chinese manufacturers may expand into areas with cheaper costs.

Take Cambodia, for example. Due to its net exporter status of cotton and to its low production and labor costs, Chinese garment factories may be enticed to relocate given these factors and the extremely competitive environment of China. Provisions of the free trade agreement, such as fair treatment of foreign investment and impediments to nationalisation make foreign direct investment within treaty participants a more viable option for such manufacturers.

Despite the progress already underway through this new agreement, there are still a number of obstacles that must be overcome in order for it to reach its full potential. Road and rail networks are limited between China and ASEAN members; exchange almost exclusively takes place by sea. The Chinese government has allocated USD 25 billion to alleviate this problem, but the construction process will take years to complete. The fact that the free trade agreement has been made without the guidance of the WTO is also a concern. Given the lack of transparency in China and in several Asian countries, restitution in legal disputes may be difficult to obtain.

But the effects of these glitches seem to be minimal. The ASEAN Secretariat estimates that the agreement will contribute an additional 0.3% to China’s GDP and another 0.9% to the GDP of the whole of ASEAN. One may expect that at the beginning of the next decade, the ASEAN-China Free Trade Agreement may yet truly rival those in North America and Europe.

The new January 2010 edition of The China Analyst is now available. We are pleased to once again provide this publication as a free resource online. In this edition, we look at the the threat of protectionism facing China; we delve into China’s prominent role in the rare earths industry; and we look at the new era for China and Africa after November’s FOCAC meeting.

Then of course there all the usual sections analysing China's economy in range of perspectives: Macroeconomic Monitor, China Souring Strategy, China Trade Roundup, China Facts & Figures, China Capital and China Business News Highlights. The four regional focus sections analyse the latest trade and investment relations between China and Africa, Australia, Latin America and Russia. In this edition we also launch a new Strategy section, which includes a map comparing China's economic performance in 2009 with the rest of the world, and a section discussing the business strategy of China International Marine Containers (CIMC), a great success story for China Inc. 

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