How China is becoming the center of the world

Enrique Ibáñez December 2010 http://exprimiendonaranjaschinas.blogspot.com Version 6 Conclusions from a one-month trip to China

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How CHINA is becoming the CENTER of the WORLD

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Illustration by Harry Camp, The Economist

“The economic future of the world for the next 20 to 50 years is going to be dominated by China” Guy Hands, chairman of Terra Firma

“China is clearly going to be the no.1 economic power and it is already full of potential” Bernard Arnault, chairman of LVMH

“’We are the masters now’, that was certainly the refrain that I kept hearing in my head when I was in China” Niall Ferguson, journalist The Economist

1. A huge country-size with an increasing global impact

“China invested $78bn in the 2010 Shanghai World Expo, 5x the budget for the 2012 London Olympic Games”

Illustrative highlights

• Population: <1.4bn people, c.20% of world population. Divided in 32 provinces plus the autonomous zones -‐ with c.50m people on average -‐ and 100 cities with more than > 1m habitants

• GDP: $6.5tr., 9% of world economy, although <5%

5-‐yrs. ago. Just behind US ($15tr.), but it has been growing close to +10% p.a. for the last 20-‐yrs. -‐ By 2030, China is expected to be the largest

world economy with a 24% share - according to Standard Chartered

-‐ By 2050, China is expected to be over 10x larger than it was in 2009 and 4x the size of the 2009 US economy -‐ according to Goldman Sachs

• Commodities: China accounts for broadly >30% of

worldwide demand. In fact, China: (a) increases yearly its electricity consumption by the size of U.K. and (b) is setting up 30m car production capacity per annum vs. 18m at the peak in US

Map of Chinese main cities

Source: The China Strategy, Edward Tse


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“When you go to Shanghai, you visit The Bund and typically take a picture of the skyscrapers of Pudong. Actually, I also took a picture of all the Chinese that were just walking on The Bund. Imagine when they will start consuming”

CHART: Astonish forecasted growth of the Asia-Pacific middle-class

Global middle class in 2009 and prediction for 2030

Source: Standard Chartered, OCDE

2. Two radical population segments

“When I saw an old tricycle at the base of the modern Shanghai World Financial Center skyscraper, I realized the huge differences that the fast-growth was generating”

CURRENT: Urban-affluent consumers

• The inflated asset price in property and stock markets has created tremendous wealth effect, as well as, the fast-growing middle-class, which it is another strong growth driver. At the same time, huge revenues disparities are arising

• The Chinese luxury goods market represents >€20bn in 2010, accounting for 32% of the global share and it grew at +23% (09-‐10). Thus, massively benefiting Western luxury brands

• Example -‐ Montblanc has 95 stores in China (vs. 34 in US) and expects 130 by 2015. Note that a Montblanc watch costs between $5-‐15k

• There are already almost 1m people with more than >$150k financial assets. However, GDP per head is <$4.800 vs. $48.010 in US, and it was just $1.700 five years ago

FUTURE: emerging middle-class in rural / smaller cities

• Chinese private consumption is still in its

infancy levels: $1tr (<20% of GDP) vs. $9.5tr in US (>70% of GDP) in 2007

• However, “China's urban population will expand from 572m in 2005 to 926m in 2025 and hit the 1 billion mark by 2030” McKinsey

• “80% of middle-class consumption is in 340

cities. In 2020, it will be in 550” BCG

• Rural population still has very low consumption. E.g., penetration rates in home appliances: 10% air condition, 30% fridges, 50% washing machine vs. 100% in urban areas

• According to BCG, during the next decades households with income >$9.000 will increase from 150m to 400m and 2/3 of them will resided in small cities


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“At the end of the meeting with one of the largest Chinese private equity funds, the managing partner told me:

‘I would love to buy a flat in Barcelona’ … ‘but if it is 12-hour flight away!’ I though” Chinese people love the style of Western well-known cities

Table: Significant increase of Chinese buyers of luxury homes in Western cites

Source: “China towns”, Financial Times Nov. 12th 2010, Knight Frank

3. Two phases in the international expansion

“After attending a couple of trade fairs, you quickly discover that the Chinese started producing cheap, then cheap and high quality, and now, they are directly buying Western brands and distribution networks”

Illustration by Bill Butcher, The Economist

PAST: exports that generated an enormous trade surplus

• An extraordinarily high savings rate -‐ due to the lack of the social safety net -‐ and an undervalued exchange rates have fuelled a rapid export-led growth, and hence, the world’s biggest current-account surplus

• Exports represent >40% of GDP, a significant increase from the just 20% ten years ago -‐ In 2009, China over passed Germany as

largest world exporter -‐ Moreover -‐ as a matter of reference -‐ just

Shenzhen exports as much as India: $162bn

• As a consequence, China: (a) has become the largest world exporter with >30% global share (e.g. China exports $15bn to Spain and only imports $2bn) and (b) has dominant world production shares on products such as: cameras 50%, tv 35%, air conditioners 34%, apparel 32%

• However, the current world economy situation

has generated a significant production overcapacity, and therefore, price pressure

FUTURE: acquisition of all-types of foreign assets

• Foreign reserves: foreign investment + trade surplus = >$1.3tr. Largest in the world and more than 60% of them invested in US$ assets

• China is progressively increasing its power on

supranational institutions. Moreover, Chinese companies are focusing on their internationalization and they are becoming very active in overseas auctions, investing in companies, financial assets and real estate

• Moreover, China is heavily investing in raw

materials in Latam/Africa and narrowing links with other emerging countries in a deliberate hedging strategy to reduce economic dependence on the West

• At the same time, China still needs: much

more brands, larger distribution networks and more investment on research and product development


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4. A major State power

“When I booked my trip to the Great Wall, the travel agency was State-owned, same as the coach company, the restaurant where we ate, the silk company we visited and the companies managing the Ming tombs and Great Wall”

One thing = Party + Government + large companies

“Fast economic growth, but slow political change”

-‐ Government has 2 key objectives: GDP growth >8% (“baoba”) and social stability (“baowen”)

-‐ High State control: c.30% of the economy e.g., ownership of the 150 largest companies: -‐ Great to implement quick measures and

shift the direction of the economy -‐ Positive long-term view. Govnt. objectives

based on a 5-‐year plan, with high pressure to reach the goals. Note elections are restricted to top members of the Party

-‐ Widespread corruption as well as fraud and not

much developed business ethics

Regional/local governments cannot be undervalued “The mountains are high and the Emperor is far away”

• China is not a singular market, but a regional one. Therefore, the importance of regional and local governments is significant

• Moreover, the vast majority of Chinese

companies still only have regional coverage. Hence, a significant amount of domestic industry expansion, and consolidation, will necessary occur over the coming years

• Note that strategic sectors are still restricted to foreign investment, such as: communications, transport, energy, oil, steel

5. Doing business in China

“We knew what we ate, not what we paid” a restaurant bill illustrates the huge communication barriers.

Chinese food is rich and diverse, however it is so different that I really enjoyed when I was sharing the table with a local

High cultural barriers – China is not Westernising

• Strong importance of personal relationships - “guanxi”: concept of personal relationships and reciprocal favours that underpin all deals “first friends, then businesses” a Chinese proverb

• High importance of social reputation, image and status -‐ “mianzi”: concept to express the extremely high importance that the Chinese gives to something that it is much more than just the person’s brand

“They always wanted to meet me at the Mandarin Oriental, the first upscale hotel in Hong-Kong” that’s when I understood the importance of “mianzi”

• Patience and perseverance is a need -‐ it always takes more time than expected. E.g.: Alsa, a Spanish coach company, spent 3 years negotiating with the Chinese partner and another 2 to get all permits

• Flexibility is a must, such as accepting new proposals, suggestions from the local partner or public bodies. However -‐ at the same time -‐ it has to be clear which are the unchangeable parts for a foreign player

• Overall, I saw that the Chinese work hard (easily >60 hours/week), have a strong desire to learn, to cope with change and are highly entrepreneur/competitive. (e.g., China has 85m private companies vs. 25m in US and c.1.5m in Spain). However, they are also quite individualistic and fully driven to succeed

“I was really surprised in Beijing when this old man took out from his bag a book about: how to learn English”

I wish we would see more examples like this in US and Europe


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6. Conclusion -‐ my personal view

• Despite the potential instabilities in the way through -‐ such as the property, equity, commodities bubbles – long term I am quite confident on China and agree this is just the beginning of the so-‐called Asia century

• How much time it will take to become the world most important country? It will pretty much depend on

how successful they are in developing their middle-class. This is a necessary step to push their internal private consumption, and hence, shift away from an export-‐led growth model. Equally important would be the Government ability to handle a potential social unrest, if GDP slows and unemployment rises

• In order to achieve it, I believe their individuals have an admirable attitude and their political system

the strength to set up and quickly execute challenging objectives 7. Appendix: 10 books on China (ranked by preference)

1. Mr. China, Tim Clissold: raising, investing, managing …and losing a $400m private equity fund in China

2. Managing the Dragon, Jack Perkowski: an how to build a one billion company in China

3. The next Asia, Stephen Roach: a macroeconomic view of Asia by the chairman of Morgan Stanley Asia

4. Think like Chinese, Zhang Haiuhua and Geoff Baker: understanding how to do business in China

5. A bull in China, Jim Rogers: analysis from an investment perspective of different sectors in China

6. The China Strategy, Edward Tse: a senior partner from Booz&Co describes how to enter the Chinese mkt.

7. China Inc., Ted Fishman: an American view of the Chinese rising power

8. Chinamerica, Handel Jones: an overview of the US and Chinese industrial evolutions and their relationships

9. El siglo de China, Ramón Tamames: revision histórica y económica desde Mao a la primera potencial mundial

10. To Live!, Yu Hua: an epic and heartbreaking journey spanning four decades of recent Chinese history

...by the way, they love you tell them how much you admire their long and rich history! It goes back 5000 years

How China is becoming the center of the world

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