Focus On: Marshall W. Meyer

China’s Third Quarter Turns Down — Again

Posted on October 19, 2012

China’s economy may be bottoming out in the face of a weak third-quarter GDP growth rate of 7.4% announced Thursday. It was the seventh straight quarterly decline. Although this and some other recently released indicators look gloomy, they have been partially offset by more positive economic news, all of which suggests that the hoped-for soft landing for China’s economy may be underway.

But for the Chinese economy to revive in a sustainable way, the household consumption portion of GDP “has to reverse course and start going north,” says Wharton management professor Marshall W. Meyer. Given China’s stage of development, “household consumption is extremely low, about 34%. Neither exports, given the parlous state of the EU and, to some extent, the U.S., nor capital formation, given there has been so much of it, can provide the path to sustainable growth at this point.”

China has relied on investment activity to grow more than any economy in modern history. The country’s disappointing third-quarter numbers were foreshadowed earlier in the month when the World Bank cut its growth forecast announced just five months ago from 8.2% to 7.7% for all of 2012. Still, the Bank now projects GDP growth next year will tick upward to 8.1%, albeit a bit below its May forecast of 8.6%. Holding economic growth above 8% will be possible next year because of additional liquidity injections and higher spending by the government, World Bank economists say.

Local Chinese governments have been spending heavily to grow local industry. Various reports note that some 7 trillion yuan in spending has been set loose since July.

“When you throw a trillion dollars into the Chinese economy something is bound to happen,” says Meyer. “Whether it’s a good thing is another matter.”

Already there are signs that, despite the third-quarter’s overall letdown from the second quarter’s growth rate of 7.6%, other indicators are starting to turn around. For example, China also reported this week that exports unexpectedly jumped 9.9% in September compared with a year ago. There were additional reports that retail sales, industrial production and investment all rose toward the end of the quarterly reporting period, which prevented the numbers from deteriorating even further.

But as Meyer suggests, the short-term challenge to China’s economy seems to be one of stopping the bleeding rather than offering hope of resuming the robust growth of recent years. As he notes, the Baltic Dry Index (a measure of prices for shipping basic materials and commodities) is still far below its all-time high in May 2008, and HSBC’s China purchasing managers index “was pretty low, 47.9, at the end of September.” (A number below 50 typically suggests economic contraction, while a number above 50 suggests expansion.) The August consumer confidence level, meantime, was below that of August 2011.

The World Bank also cut its forecast for the whole of East Asia this week from 7.6% to 7.2%, acknowledging the drag China’s economy is exerting on the region. That outlook marked the lowest level of GDP there in more than 10 years.

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China Is Buying U.S. Companies at Record Pace

Posted on August 29, 2012

Chinese companies are buying up U.S. companies and other assets at a record pace in 2012. The country is spending some of its huge dollar holdings before they depreciate, while acquiring — in addition to hard assets in the U.S. — the market share, technological know-how, talent and training expertise that often come with them.

In the past, China’s designs on acquiring U.S. companies have hit strong resistance on national security grounds. Last year, for example, China’s largest telecommunications equipment company — Huawei – voluntarily walked away from its acquisition of 3Leaf, a U.S. server technology company, under pressure from the U.S. government. The U.S was concerned about Huawei’s connections with Chinese security services (the company was founded by a People’s Liberation Army soldier), though Huawei said it had no connections with the Chinese government. Earlier attempts by Huawei to buy a network company — 3Com Inc. — and to sign a contract with Sprint Nextel worth billions of dollars were also turned aside over national security concerns in the U.S. In 2005, the U.S. nixed efforts by the Chinese oil giant CNOOC to buy up UNOCAL, a U.S. oil company.

To shed some light on the latest run at U.S. companies by Chinese firms, Knowledge@Wharton asked two Wharton management professors to offer their thoughts on Chinese acquisitions and the potential for a U.S. backlash. They are as follows:

Marshall Meyer:  

I view the [potential U.S.] backlash (as in UNOCAL-CNOOC) as idiosyncratic and unpredictable. Step back from particular acquisitions — or the number of acquisitions — and ask how the U.S. public views Chinese economic strength.

First, the public believes that China is stronger economically than the U.S. (we used to believe Japan was stronger).

Second, U.S. public opinion is not particularly apprehensive about growing Chinese economic strength — we’re more apprehensive about growing Chinese military strength.)

Third, there is little or no partisan divide on attitudes toward Chinese investment in the U.S.  Democrats are prone to bash China on jobs, of course; Republicans will bash China on national security issues. Within the parties, especially the GOP, there are deep fissures on China. The Cato Institute, for example, wants open markets, while The Heritage Foundation tends to see “other-than-market” considerations driving Chinese acquisitions in the U.S. Rick Perry embraced the Hauwei investment as part of his “Texas miracle” program, and was bashed by the far, far right for his stance on Hauwei.

China rebuilt the port of Boston and no one peeped. But when a Chinese company proposed to acquire a U.S. petro firm whose assets were mainly in Asia, Congress reacted. The difference is public relations: COSCO (the Chinese shipping company that built the port) had deep experience lobbying the Congress, while CNOOC (the Chinese oil company) at the time did not. CNOOC has since gotten wiser and is utilizing top lobbyists in its current push to acquire the Canadian energy giant Nexen. But Canada’s right wing is pushing back on China, and it isn’t clear where this will end up.

China needs to spend their foreign reserves before they depreciate. But they cannot spend these reserves domestically without pushing the renminbi upward. Hence, China’s investment goes outward. The reaction [in the U.S. and elsewhere] is driven by whether the motive is interpreted as financial or “other than market.”

There are some U.S. companies starved for cash who turn to China, for example, in auto parts where Wanxiang (China’s largest auto parts maker) is buying a lot.  Equally important, there are Chinese companies wanting to diversify outside of China due to the inherent risks at a time of government transition, and that will pay premium prices for the privilege. (I cannot find another explanation for Beijing Oceanwide Realty’s investment in Lenovo’s parent company, Legend Holdings.) But don’t imagine that all Chinese companies go out from strength. Often it is from weakness. Or fear. It’s a complicated story.

 Mauro Guillen:

China holds a large proportion of outstanding U.S. government bonds. [This is] because they have a large amount of foreign currency reserves. Chinese companies would also like to buy other types of assets, especially those [that provide] access to market share, technology or other resources in the U.S.

There are several policy issues here. First, the U.S. is committed to free capital flows, so curtailing foreign investment in the form of M&As carries costs.

Second, having said that, the U.S. should be concerned if the acquirers are foreign state-controlled companies, no matter the country of origin. This is especially true for “national security” industries.

Third, we should get used to this type of headline. More and more Chinese firms, and firms from emerging economies in general, will engage in M&As in Europe and the U.S.

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A New Chinese Export — Jobs

Posted on April 4, 2012

Bucking the decades-old wave of offshoring of manufacturing jobs to China, other parts of Asia and Mexico, GE said it would move jobs back from these countries to the United States, where it will build water heaters.

Jeffrey Immelt, GE’s chairman and CEO, notes that his decision to invest $1 billion in GE’s appliance business in the U.S. is “as risky an investment as we have ever made”. Yet, this brand of “re-shoring” – returning to the U.S. some manufacturing jobs that were earlier shipped overseas — is expected to pick up over the next several years as momentum shifts somewhat away from  automatic decisions by U.S. manufacturers to operate lower-cost plants overseas. Factors encouraging this reversal include sharply rising relative manufacturing costs in China, accentuated by stagnant U.S. wages and productivity gains, steady renminbi appreciation, steeper transportation costs as oil prices rise and costlier maintenance of longer supply chains.

Hal Sirkin, a senior partner and managing director at the Boston Consulting Group, noted in this recent Knowledge@Wharton interview, that “wages are rising very quickly in China, somewhere on the order of 15% to 20% a year and maybe even higher. The renminbi … is rising at 4% a year.”

In February, GE Appliances announced it was opening a water heater plant at Appliance Park in Louisville, Ky., the first new plant at the site in more than 50 years. Eventually, GE plans to invest $800 million in Louisville, part of a $1 billion commitment to create 1,300 new jobs in the U.S. by 2014. Many of those jobs are being shifted from a water heater plant in China. In addition to standard manufacturing jobs, GE says the new facility will create “hundreds of highly skilled salaried jobs in fields like engineering, industrial design and manufacturing.”

So how big a trend might this re-shoring turn out to be? “Some jobs might return to the U.S., but not millions,” says Wharton management professor Marshall Meyer. “China now has an advantage in manufacturing infrastructure — both physical and human — for example, the availability of engineers. And countries like Vietnam and Indonesia will draw manufacturers seeking low-cost labor. Some Chinese companies are already outsourcing to Vietnam and Indonesia,” among other countries.

Wharton management professor Mauro Guillen points out that “Yes, because of rising wages and currency movements, Chinese costs are rising. And wait until the dollar takes a real hit. But keep in mind that other locations are now becoming attractive, for example, Vietnam and Bangladesh.”

Meanwhile, the evolving, global manufacturing landscape is turning up some valuable lessons regarding “the hidden costs of global supply chains, including their susceptibility to catastrophic collapse – such as in late 2008 — and to fuel prices today,” Meyer points out. Ocean shipping is one good example: “The carriers are all losing money, some [of them] billions, due to overcapacity and the high cost of bunker oil, which may go higher when they are forced to switch to low-emissions fuel. Inevitably, as in the airline industry, there will be industry consolidation reduced capacity, and much higher shipping prices.”

For Sirkin, though, the trend seems clear. “I think we’re still in the early stages. You see big companies like National Cash Register — NCR — that was manufacturing their ATMs in China for the U.S. and is now manufacturing in Columbus, Ga. You see Ford adding jobs into its plants. I think they committed to 12,000 jobs …. It’s also smaller companies. So Farouk Systems, which makes hair dryers, has moved 1,500 jobs back from China to the U.S. You see Coleman, the manufacturer of water coolers, starting to build water coolers in the U.S. ….”

And it some cases, it appears, companies are moving production back to the U.S, because they no longer want their designs and processes getting copied. Notes this Chicago Tribune article: Peerless Industries  “decided in 2009 to buy equipment to make in-house its aluminum mounts that are used to fix flat-panel televisions to walls. The move followed nearly a decade of dealing with Chinese companies copying their products, said Michael Campagna, the company’s president and chief operating officer.”

For further reading from Knowledge@Wharton Today: China’s Sinking Competitiveness

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Free Trade Between China and Taiwan: This Season’s ‘Mega Trend’?

Posted on July 1, 2011

The popularity of free-trade agreements (FTAs) are something like national fashion statements — in one day, out the next. Not that the 23 million citizens of Taiwan have expert knowledge of such matters. Long blocked in one way or another by the People’s Republic of China from joining them, Taiwan has sat on the sidelines. Apart from a small number of FTAs, Taiwan has done without the no or low bilateral or multilateral trade tariffs accorded other export-dependent economies.

Even so, there probably wasn’t much celebrating to mark the first anniversary of the signing of Taiwan’s and China’s groundbreaking Economic Cooperation Framework Agreement (ECFA) at the end of June. Indeed, ECFA is as controversial today as ever, putting under scrutiny the China-friendly policies of Ma Ying-jeou, Taiwan’s president who is up for re-election early next year, and the 539 categories of Taiwanese exports to China falling under ECFA.

ECFA’s proponents in Taiwan see it as a way of addressing a major weakness in the global trade strategy of the island. Cheryl Tseng, director-general of the government’s Overall Planning Department of the Council for Economic Planning and Development at the Executive Yuan, notes that before last year, Taiwan’s only trade pacts were with a few Central American and Caribbean nations. “Those five countries – Panama, the Dominican Republic, Honduras, Guatemala and El Salvador — collectively provide less than 0.5% of our foreign trade,” says Tseng.

In contrast, mainland China accounted for 31% of Taiwan’s exports and 15% of its imports last year. Roy Chun Lee, associate research fellow at the Taiwan WTO Center, notes, “A free trade agreement [FTA] with one’s single-largest trading partner is a milestone for any country that depends on foreign trade, like Taiwan does.” He adds that it’s an important step — although more of a symbolic one, “because the actual tariff reductions will take place over the next five to 10 years.”

But is the FTA a lopsided one? “There is a giant sucking sound coming from China” observes Z. John Zhang, a Wharton marketing professor. ECFA is “a very intelligent move for China [because it] puts Taiwan further in the orbit of the mainland.”

According to Wharton management professor Marshall W. Meyer, “The Chinese are focusing on using trade to expand their influence.” ECFA has been a way for China to strengthen its bid for cross-Strait unification, he notes, by increasing trade rather than pursuing military means to regain Taiwan.

Lee also wonders whether ECFA will open the door to aggressive Chinese M&A. “That is something we should be worried about, given the fact that at least some people in China are hostile to Taiwan,” he says. Takeovers could be particularly worrisome if target companies have critical, high-value technologies, he adds.

Some say this is a storm in teacup. In the bigger scheme of things, Taiwan’s economic prosperity has been cemented the global exporting success of its high-tech companies, which produced 95.5% of the world’s motherboards, 95.3% of its notebook PCs and 90.7% of its netbook PCs in 2009. Despite longstanding political tensions with mainland China, many Taiwanese companies have been shipping products labeled “Made in China” for years. “At some point, it becomes hard to tell if they are really Taiwanese companies or Chinese companies, since so much of their business is in China,” says Zhang.

Billy Ho, CEO of MiTAC, a Taipei-based manufacturer of electronic devices, says, “ECFA will give more competitiveness for Taiwanese companies in the high-tech business [in China], all the way from upstream materials to devices to components to downstream products.” Established in 1982, MiTAC built its own brand of PC, and then designed PCs for Compaq, among others. In the late 1990s, it made PDA devices for HP. As costs rose in Taiwan, MiTAC closed its last factory on the island in 2006. Now, it employs over 10,000 workers in mainland China and 1,400 in Taiwan.

“The most sophisticated processes [at MiTAC] will stay in Taiwan, and we will release the less sophisticated processes to China, close to the market,” Ho says. Another major benefit will be that “Taiwanese companies may have more access to Chinese government contracts, because more of their business will be in China.” ECFA should also help Taiwanese high-value added firms such as MiTAC expand their sales outside China. According to Ho, “Free trade is a megatrend, and while most IT products already have very low or no duties, this will help us with some products in some countries.”

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China’s Sinking Competitiveness

Posted on June 1, 2011

The United States is heading towards a resurgence of manufacturing that will reclaim from China a large piece of the market for making things and will start to reverse one of the most durable trends in international trade over the last 15 years, some analysts now say.

According to the Boston Consulting Group (BCG), a “manufacturing renaissance” in the U.S. is underway as the wage gap between the U.S. and China narrows dramatically. That gap is shrinking largely because manufacturing wages are rising far more quickly in China (17% annually over the next five years) than in the U.S. (3% for the same  period) and also because the renminbi is set to appreciate gradually against the dollar in the coming years.

As that wage gap shrinks, some U.S. states will “become some of the cheapest locations for manufacturing in the developed world,” according to BCG, thanks in part also to flexible work rules and more government support. “We expect net labor costs for manufacturing in China and the U.S. to converge by around 2015,” BCG senior partner and managing director Hal Sirkin says.

Also contributing to the narrower wage gap is the continuing higher productivity of U.S. workers. Though the productivity of Chinese workers as risen tenfold since 1990, it remains only about two-thirds that of U.S. workers.

It’s not that the U.S. will become a cheaper location to manufacture versu China in absolute terms. But given that wages account for somewhere between 10% and 30% of total manufacturing costs, and given a much slimmer wage gap, the importance of wage costs in a given product’s cost will become far less important. Costs for other product inputs, meantime, are often very similar. What is likely is that the U.S. will gain significant advantages over the next five years when it comes to making certain kinds of products, such as more high-tech and individualize products requiring smaller productions runs, the BCG report suggests. China will likely maintain the advantage for large runs of standardized products.

Already, the U.S. has seen some manufacturers choose to return or remain in the U.S. Caterpillar, for example, decided to expand its hydraulic excavator manufacturing plant in Texas rather than in China, and the NCR Corp. in 2009 announced it was returning ATM production to Georgia, “in order to decrease the time to market, increase internal collaboration, and lower operating costs,” BCG noted. Last year Wham-O, the toymaker, brought half of its Frisbee and Hula Hoop production from China and Mexico to the U.S. What’s more, Ford and General Electric recently announced plans to build new plants in the U.S.

Wharton professors, meantime, offer some perspective on to this larger picture. While it is true that China looks likely to sink some because of its rising wages and currency, just how much the U.S. will benefit is less certain, says Marshall W. Meyer, professor of management at Wharton. “The U.S will never be a low-cost leader. China will cede this advantage to Indonesia, Vietnam, etc. However, when you factor supply chain risks into the equation — we have learned a lot from the March 11 earthquake and tsunami — then it becomes more plausible for manufacturing to return onshore.”

Wharton finance professor Franklin Allen agrees about the significance of supply chain issues as part of the mix. “While I do not think it is likely the U.S .will overtake China, I do think recent supply chain problems will lead to a revival in U.S. manufacturing.” He adds that “high-tech manufacturing is easier to control if done in the U.S.  Dispersed manufacturing of high tech can create significant problems as the delays in the Boeing Dreamliner 787 illustrate.”

Allen recommends more caution regarding the value of the dollar going forward. “Predicting the dollar is very difficult. Given the problems in Europe, it could strengthen against the Euro. Also, predicting the exchange rate against the renminbi is not as easy as the U.S. government would seem to believe. They focus on the current account but the capital account is arguably more important. It is not clear what the balance of capital flows in and out of China would be if capital controls were gradually relaxed.”

Mauro Guillen, a Wharton management professor, thinks it is very difficult to generalize what will happen within individual industries. “There are some high value-added manufacturing tasks that continue to be competitive when performed in the U.S., including defense equipment, advanced instruments, robotics and the like. Some of them have increased recently due to the weaker dollar and efficiency enhancements, as in machinery, metals, automobile components and other areas.” But there are many other areas — textiles, clothing and furniture – that “are gone forever, even if the dollar remains weak.”

And while the lower dollar certainly helps boost U.S. competitiveness, “innovation is the best long-term fix,” says Meyer.

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The Five-Year Question

Posted on April 26, 2011

A media storm of sorts was let loose this week by reports that China would overtake the U.S. as the world’s largest economy in 2016.

In a column titled, “IMF Bombshell: Age of America Nears End,” a MarketWatch columnist noted that according to the International Monetary Fund, the Chinese economy would grow in five years to $19 trillion, as measured by purchasing power parity, from $11.2 trillion today. Over the same period — and by the same measure — the U.S. economy is projected to grow from $15.2 trillion to $18.8 trillion. “This is more than a statistical story. It is the end of the Age of America,” MarketWatch predicted. CNN columnist Eliot Spitzer, the former governor of New York, echoed the same sentiment when he wrote: “The number of the day is five. That’s how many years we have left to be kings of the hill.”

Is this argument reasonable or alarmist? That is a matter of debate, and it depends to some extent on the yardstick you use to measure the size of the economy – which in this instance is the notion of purchasing power parity. According to economists Paul Krugman and Robin Wells, purchasing power parity is a useful tool to analyze exchange rates between different currencies. “The purchasing power parity between two countries’ currencies is the nominal exchange rate at which a given basket of goods and services would cost the same in each country,” they write in their book, Macroeconomics. “Suppose, for example, that a basket of goods and services that costs $100 in the U.S. costs 1,000 pesos in Mexico. Then the purchasing power parity is 10 pesos per U.S. dollar.” The Economist uses purchasing power parity as the underpinning for its annual Big Mac index, which is based on the cost of McDonald’s Big Mac hamburger in different countries.

Wharton finance professor Jeremy Siegel believes that purchasing power parity is “a more accurate measure of the size of the economy,” and that China will indeed be a larger economy than the U.S. in five years. This view is supported by those who distrust the most common alternate approach of measuring the size of an economy by Gross Domestic Product (GDP) at current exchange rates. Their argument is that if any country tries to under-value or manipulates its currency – as China’s critics often allege it is doing – current exchange rates may provide an inaccurate picture of an economy’s true size.

Even so, comparing purchasing power parity between the U.S. and China is complicated. According to Wharton management professor Marshall Meyer, “If you compared supermarket or real estate prices in Shanghai and New York or Beijing and Washington, D.C. today, you would find Shanghai/Beijing higher than New York/Washington, D.C. in dollar terms. Given the three times to four times gap in household disposable income, it will take a while for Chinese purchasing power to catch up with the U.S. Of course, prices are much lower in rural China, but so are household incomes. Per capita income in urban Shanghai, for example, is about 10 times that in rural Gansu Province. The gap between the wealthiest counties of Connecticut with the poorest counties of Mississippi or Alabama, by contrast, is around three times.”

From this perspective, purchasing power parity has its limitations in measuring the size of an economy. At least the IMF appears to think so. According to an IMF spokesperson, as quoted by Canada’s The Globe and Mail newspaper, “The IMF considers that GDP in purchase-power-parity (PPP) terms is not the most appropriate measure for comparing the relative size of countries to the global economy, because PPP price levels are influenced by non-traded services, which are more relevant domestically than globally. The fund believes that GDP at market rates is a more relevant comparison. Under this metric, the U.S. is currently 130% bigger than China, and will still be 70% larger by 2016.”

The Financial Times notes, “The IMF projects US GDP in dollars will be $15.2 trillion this year while China’s will be $6.5 trillion, rising to $18.8 trillion and $11.2 trillion by 2016, meaning the U.S. looks likely to stay the world’s top dog economically if current growth rates are maintained.”

Few people doubt that as the center of gravity of global economic activity gradually shifts to Asia, some day the Chinese economy will surpass the U.S. But as for whether the day will arrive before or after five years, that debate continues.

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Open Sesame…Oops, I Mean, Close Sesame!

Posted on February 22, 2011

As the Wall Street Journal recently reported, Beijing-based Alibaba.com, China’s largest business-to-business online auction house, has just given marching orders to David Wei, the company’s CEO, and Elvis Lee, the chief operating officer. The reason, according to media reports, is that “an internal investigation found that more than 2,300 sellers on the e-commerce site committed fraud, sometimes with the help of Alibaba sales staff.” The news hit the headlines on February 21, when markets in the U.S. were closed for President’s Day. By Tuesday, February 22, Alibaba.com stock prices were down by 9% in Hong Kong, which dragged down the Hang Seng index. Yahoo, which owns 40% of Alibaba.com, also saw its stock price drop on Tuesday.

For the time being, order has been established by installing Jonathan Lu, CEO of the Alibaba Group’s retail site, Taobao.com, as Alibaba.com’s CEO. Media reports indicate, though, that the problem seems serious. According to a report in Time.com, Alibaba executives discovered during an internal investigation “an increase in fraud claims beginning in late 2009 against sellers designated as ‘gold suppliers,’ which means they had been vetted by an independent party as legitimate merchants. The investigation revealed that about 100 Alibaba.com sales people, out of a staff of 5,000, were responsible for letting fraudulent entities evade regular verification measures and establish online storefronts.”

Alibaba.com uncovered fraudulent transactions by 1,219 of the “gold suppliers” registered in 2009 and 1,107 of those in 2010. These accounted for some 1% of the total number of those years’ gold suppliers, according to the Time.com report, which added, “the vast majority of these storefronts were set up to intentionally defraud global buyers” by advertising consumer electronics at cheap prices with low minimum order requirements.

Wharton management professor Marshall Meyer, who has done a lot of research on Chinese companies, believes this episode will not have a major impact on e-commerce in China or other high-tech Chinese firms. “The adverse impact on Alibaba will be slight assuming that the scandal does not touch Alibaba Group chairman and CEO Jack Ma,” he says. Meyer adds that the Alibaba Group has a strong integrity and compliance statement; it assures investors that the company is “committed to the highest standards of business conduct,” among other things. “I think they mean it,” Meyer adds.

Reassuring words. Now, if only those pesky stock markets would listen….

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