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The End of Cheap Labor in China

Posted in Chinese Economy, Chinese International Trade with tags , , , , , , , , , , , , , , , on 07/05/2011 by David Griffith

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Courtesy of TIME.

On May 25, U.S. businessman Charles Hubbs made the short trek to Hong Kong  from his office just outside Guangzhou, a city in Guangdong province in  southeastern China that is known for good reason as the manufacturing workshop  of the world. For the 64-year-old native of Louisiana, it was a trip that may  have marked the beginning of the end of his successful 22-year run as a  China-based exporter of medical supplies.

Hubbs was going to listen to a pitch from the American ambassador in  Cambodia, Carol Rodley, and the president of the American Chamber of Commerce in  Phnom Penh. Their aim was simple: to get foreign investors, particularly those  already with operations in China, to consider setting up shop in Cambodia. Hubbs  was all ears. To hear him tell it, the price of labor is on the brink of making  his firm, Guangzhou Fortunique, which supplies some of the U.S.’s biggest health  care companies, uncompetitive. “We’ve seen our wage costs in China go up nearly  50% in the last two years alone,” he says. “It’s harder to keep workers on now,  and it’s more expensive to attract new ones. It’s gotten to the point where I’m  actively looking for alternatives. I think I’ll be out of here entirely in a  couple of years.”(See “As China Economy Grows, So Does Labor  Unrest.”)

He is not alone. In what is supposed to be a land of unlimited cheap labor — a nation of 1.3 billion people, whose extraordinary 20-year economic rise has  been built first and foremost on the backs of low-priced workers — the game has  changed. In the past decade, according to Helen Qiao, chief economist for  Goldman Sachs in Hong Kong, real wages for manufacturing workers in China have  grown nearly 12% per year. That’s the result of an economy that’s been growing  by double digits annually for two decades, fueled domestically by a frenzied  infrastructure and housing build-out — one that, for now anyway, continues apace — combined with what was for a time an almost unquenchable thirst for Chinese  exports in the developed world. Add to that the fact that in the five largest  manufacturing provinces, the Chinese government — worried about an ever widening  gap between rich and poor — has raised the minimum wage 14% to 21% in the past  year. To Harley Seyedin, president of the American Chamber of Commerce in South  China, the conclusion is inescapable: “The era of cheap labor in China is  over.”

Mind you, that doesn’t mean that labor costs in China, even in the most  expensive parts of the country like Guangdong province, are higher than in most  other places, particularly in the developed world. They aren’t. The average  manufacturing wage in China is still only about $3.10 an hour, (compared with  $22.30 in the U.S.), though in the eastern part of the country, it’s up to 50%  more than that. The hourly cost advantage, while still significant, is shrinking  rapidly. For the vast majority of companies, whether small, medium-size or huge  multinationals, the decision about where to produce a product is always driven  by multiple factors, of which the cost of labor is but one. “For lots of  companies over the past two decades, the disparity was such that labor costs  often drove the decision,” says economist Daniel Rosen, the China director and  principal of the Rhodium Group, a a New York City–based consulting firm. “Now,  increasingly, that’s no longer the case.”(See portraits of Chinese workers.)

The ripple effects of this new reality are enormous, and they flow globally.  Start with China itself. The push for higher wages, constrained for so many  years, sparked a series of high-profile labor protests last year. (Worker  discontent was also reflected by 14 suicides at Foxconn, the large manufacturer  that produces goods like the iPad.) But higher wages have also improved things  in China’s western region, where the government has long tried to encourage  investment. In the past year, many multinational and Chinese companies have  expanded or relocated inland, where labor is still cheap.

From China’s perspective, that’s exactly the sort of trade-off it seeks. As  Andy Rothman, chief China macro strategist at CLSA Securities in Shanghai, says,  “People in Sichuan or Henan or wherever can stay closer to home and find a  good-paying job” instead of having to flood east each year to live in a company  dormitory far away from their families. “How is this a bad thing?”

Read more: http://www.time.com/time/magazine/article/0,9171,2078121,00.html#ixzz1PxkcIUQZ

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China Inflation at 34 Month High

Posted in Chinese Economy with tags , , , , , , , , , , , , on 06/21/2011 by David Griffith

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As reported by the BBC.

Inflation in China hit its highest
level in 34 months despite the government efforts to rein in rising prices.

Consumer prices in China rose by 5.5% in May, compared with the same month
last year, according
to the National Bureau of Statistics.

Food prices continued to be the biggest factor as they surged by 11.7%

The rising cost of food and commodities have pushed up the cost of living and
become a hot political issue in China.

Analysts warned that prices are likely to rise even further.

“For now, it seems certain that China’s CPI will hit 6% in June,” said Xu
Biao of China Merchants Bank.

Rate rise

Chinese authorities have said that fighting rising prices is a top priority
for them.

It has set a target of keeping the inflation rate at 4% for the year.

The country’s central bank has raised interest rates four times since October
last year, in an effort to curb lending and rein in rising prices.

Analysts said that the latest data is likely to force the bank to raise the
cost of borrowing once again.

“CPI reached a new record, increasing concerns of another interest rate
rise,” said Xian Fang Ren of IHS Global Insight

“We expect the central bank to raise interest rates next week,” Mr Ren added.

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Why Do We Fear a Rising China?

Posted in Chinese Economy, Chinese Foreign Relations, Chinese International Trade with tags , , , , , on 06/07/2011 by David Griffith

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Courtesy of TIME
by Michael Schuman

It’s hard to argue that the rise of China, taken on the whole, is anything but good for the global economy. New wealth for China’s 1.3 billion people means 1.3 billion more people who can buy stuff from the rest of the world, creating jobs from American research labs to Japanese industrial zones to Brazilian mines. A global economy no longer solely dependent on the U.S. consumer for growth is potentially more stable and prosperous.

Yet few people see China that way. Many don’t acknowledge China’s positive role in the world economy at all. Instead, they focus on the competition China has created, especially for the developed world, or the jobs many believe China has “stolen.” However, even those who realize, or even directly benefit from, China’s advance still can’t but feel uneasy about that advance. But why is that? Why do we fear a rising China in a way we don’t a rising India? Or why is an economically powerful China less acceptable than, for example, a stronger Europe?

The conflicting emotions many have about China’s rise are the subject of my latest TIME magazine story, focused on Australia’s relationship with the Middle Kingdom. What’s happening Down Under is a glimpse into the future for all of us. And for me, reporting there got me thinking about why so many of us – and not just in the West, but out here in Asia as well – are having so much trouble coming to terms with the idea of China as a superpower.

There are few countries in the world that have benefited more from China’s rapid economic growth than Australia. The boom in exports Australia has enjoyed due to surging Chinese demand, especially for raw materials, is a key reason – perhaps the determining factor – why the country avoided a recession after the 2008 financial crisis. Trade with China is also spurring investment and creating jobs. But simultaneously, Australians are becoming uncomfortable about their growing relationship with China. They fret that the economy is becoming too dependent on China for its growth. They worry China will use its economic leverage to put political pressure on the country, or employ its growing economic power to become a strategic threat. They don’t much care for Chinese companies buying Australian assets. Australians worry that what helps their wallets hurts their country politically and strategically, and the more powerful China gets, the bigger that potential danger. Hugh White, head of the Strategic & Defence Studies Centre at the Australian National University, explained the sentiment to me this way: “As China keeps growing strong enough to fulfill Australians’ economic aspirations, it grows more powerful and undermines U.S. primacy and our strategic aspirations. People are conscious that with the benefits we get from Chinese growth, there is a certain degree of vulnerability.”

I think many of us around the world can sympathize with the Australians. As David Pilling of The Financial Times recently pointed out, China’s neighbors aren’t too fond of the way Beijing throws its new heft around in the Asia region as its economic influence grows. It’s no coincidence that political leaders in Seoul and Taipei strive to maintain strong ties to Washington even as their economies become driven more and more by China. Americans are queasy that the Chinese own so much U.S. debt. The Japanese own just about as much, but that doesn’t seem to bother anybody.

Of course, 30 years ago, it might have. The reaction many have to China today is very similar to the one that towards Japan in the 1980s, when the Land of the Rising Sun was the rising economic challenger to the West. In recent years, Americans got all jittery about a Chinese attempt to buy oil firm Unocal; more than 20 years ago, Americans got all jittery over Japan’s acquisition of Rockefeller Center. Why? After the overly emotional response in the U.S. to Sony’s acquisition of Hollywood’s Columbia Pictures, co-founder Akio Morita pointed out that Australian born Rupert Murdoch had previously bought 20th Century Fox, without the drama. He was suggesting the reason was racism.

That may be part of the story today with China as well. But the issues are far more complex than that. In the West, Europeans and Americans have dominated the world scene for so many centuries that they’re uncomfortable with the notion of someone else claiming the throne of global hegemony. The concern Americans had with Japan back in the day was that the Japanese were competitors in the global economy, not partners. The fear was that Japan was trying to undermine American dominance, at least in the realm of business. Even beyond that, Japan was winning with an economic system that challenged American ideals of free markets and free enterprise. For many, the rise of Japan seemed to have something sinister behind it – a competing and unfamiliar economic, corporate and cultural system that was producing superior results to those of the West, and appeared to have only its own interests at heart. The challenge from Japan was not just economic, but ideological.

The reasons many fear China today are very similar. China, too, uses a competing economic model – “state capitalism” – that challenges the economic ideology of the West. In many ways, China also behaves in a mercantilist fashion, which gives the impression it cares little about anyone else. It keeps its currency controlled so its exports can out-compete those from other countries, and it grabs natural resources for itself wherever and whenever it can. Often state-controlled companies are doing the grabbing, making China seem like a threatening monolithic juggernaut. Worst of all, the political ideology behind China’s economic ascent completely counters Western ideals about democracy and human rights. China is not just competing with the U.S. in world markets, but offering up an entirely different economic and political system, one that at times seems better at creating growth and jobs, even as it restricts much-cherished civil liberties. China is succeeding based on ideas that Americans despise.

The concerns many in the world have with China go well beyond even that. No one ever expected Japan to become a military threat to the West, or even a contender for diplomatic influence around the world. Japan wanted to be No.1, but only when it came to its role in the world economy. Aside from that Japan was a part of the global establishment – a member of the G7 and a clear U.S. military ally. China is none of those things. More and more, China is using its economic clout to offer an alternative to the U.S.-led political and economic system. Beijing routinely complains about the primacy of the dollar and wants its own currency to play a greater international role. Chinese diplomats have tried to extend their country’s political pull across Africa and Latin America while supporting countries clearly hostile to U.S. interests (such as North Korea.) And Beijing is becoming a bigger military power as well, something that makes its neighbors, many of which have a history of conflict with China (South Korea, Vietnam, Japan, Taiwan) extremely nervous. Every extra 10% to China’s GDP translates into more money the government can spend on its navy and armed forces.

In other words, China appears to be challenging not just today’s economic orthodoxy and order, but the world’s political and military framework as well. China isn’t content just to sell more TV sets to the world, like Japan. The Chinese want to have more control over the world. And they want to use their economic clout to get it.

Or so we think. The fact is we’re only guessing at what China might do as a superpower. Since China is still a relatively poor nation today, it makes sense that at this stage in its development, its leadership tends to be focused on what’s good for China. Will China’s outlook broaden as it become richer? We don’t know.

When the U.S. took over global leadership from a waning British Empire, the world had a pretty good idea what to expect – that overall the U.S. would continue to hold to ideas of free enterprise and democracy. Now an equally important shift is taking place – the rise of the East – but it’s not so clear what it all means for the direction of global civilization. So maybe that’s what we fear most of all. The uncertainty of a fundamentally changing world

Read more: http://curiouscapitalist.blogs.time.com/2011/06/07/why-do-we-fear-a-rising-china/#ixzz1Of7Fdf25

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What Might Happen in China This Year?

Posted in Chinese Economy with tags , , , on 01/24/2011 by David Griffith

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Despite inflation, bankruptcies, and other problems, industrial enterprises should remain highly profitable.

About the author
..Gordon Orr, a director in McKinsey’s Shanghai office, peers into 2011 and finds ways China may once again surprise the world. Read his six predictions, then let us know what you would add.

Inflation in food prices will take longer than expected to control. The drivers of inflation are much more structural than cyclical. Indeed, the entire system is now so highly stressed that one snowstorm brings large spikes in food and energy prices as coal runs short. When ice shuts down the roads, as it does today in much of southwestern China, agricultural products simply cannot get to market.

Chinese consumption patterns are shifting as people become wealthier—more meat eating requires more cereals to feed the animals. The food supply chain, running at the limit, is close to breaking, and the pressures this problem creates will lead to further food quality crises. What’s more, price caps won’t be effective in creating a better balance between supply and demand. Rising food prices are a pan-Asian issue: inflation has recently surged in Indonesia (chilies), India (onions), and South Korea (cabbage and now beef as a result of foot-and-mouth disease). China, given its large absolute demand for so many agricultural products, will shape food prices across Asia.

A major second- or third-tier Chinese city will see demonstrations over food price rises, unemployment, or both, on a much larger scale than anything that has occurred in recent years. The demonstrators will probably be satisfied quickly by local action to increase financial support for them and to replace local-government leaders. Yet concerns over copycat actions elsewhere will lead to a nationwide preemptive program to support the urban unemployed.

Middle-class bankruptcies will expand dramatically. Buyers have aggressively bought multiple properties with every penny of free cash flow. All that is needed for a wave of bankruptcies is further interest rate rises (targeting inflation) that result in a blip down in house prices just as mortgage payments rise. We have seen this before across major cities in Asia. The government will probably decide that it cannot bail such people out, as that would be seen as rewarding recklessness among the haves at the expense of the have-nots. There is already significant noise on the Internet to the effect that government leaders are completely out of touch with the true cost of urban housing. These leaders must take material action to show that they are aligned with the hopes of people just getting on the real-estate ladder.

Minimum wages will rise, but productivity gains will outstrip labor costs. The profitability of industrial enterprises remained high at the end of 2010—indeed, higher, in many cases, than it had been a year earlier, despite the minimum-wage increases rolled out in 2010—and will probably remain high. Yet a government seeking to enhance its stature with lower-income workers will find that increasing minimum wages, perhaps by 15 to 20 percent, is an easy lever to pull. Once again, multinationals, especially Asian multinationals, will find themselves being monitored first for compliance. More broadly, 2011 is likely to see further increases in the number of complaints that blue-collar workers bring in the legal system against employers for failure to pay overtime and to give employees the required time off from work.

China’s economic growth will be lower than expected. The rollback of subsidies to consumers will, in 2011, lead to a slow start for consumption, which will never quite catch up during the year. In recent months, for example, automotive purchases accounted for 20 percent of consumption. With the rollback of subsidies, the imposition of quotas in Beijing (and probably other cities), and increased prices for license plates and parking, car sales are likely to plateau if not fall in 2011. This problem will be exacerbated by food price inflation, which will cause lower-income workers to cut back on nonfood and other discretionary expenditures.

China will step up its “invest out” program in the new five-year plan. The government may well seek to double the country’s cumulative outbound investment within the next five years. There will be resistance by governments in some countries (probably in Africa, Eastern Europe, and Latin America) where public opinion is not yet convinced that so much Chinese ownership of key assets is really attractive. This opposition will visibly upset China’s leaders, who may decide to sell the bonds of the reluctant governments and to increase the challenges that enterprises from these nations face in selling to Chinese state entities.

The state will again try to reduce its ownership role in business. If the government relaunches its program to sell off more of its stake in companies, domestic share prices will probably decline or at least remain flat. The program will also soak up much of the liquidity currently supporting Chinese IPOs, thus reducing the ability of entrepreneurs to cash out quickly through them. Also, private-equity firms that have been investing in pre-IPO growth stocks in China may hold on to these investments longer than planned.

Courtesy of McKinsey Quarterly.

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Unleashing Innovation in China

Posted in Chinese Economy with tags , , , , , , on 01/07/2011 by David Griffith

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by Gordon Orr  McKinsey Quarterly

China’s latest five-year plan promises to shift the economy from its dependence on exports toward domestic consumption as an engine of growth. The key to achieving this will be for the nation to enhance the ability of its economy to innovate. Yet China’s record on this score is mixed. Understanding why that is, and how to fix it, is important to estimating the likelihood China will succeed in its ambitious goals.

The first step is to appreciate the different kinds of innovation going on right now. When most people hear that word, they think of “inventing things,” and on this score China is making progress toward becoming a more innovative economy instead of merely mass-producing goods that are designed elsewhere. China’s spending on research and development has risen to 1.5 percent of GDP in 2008, from 1.25 percent in 2004, all the more impressive when you consider that GDP itself increased dramatically during that period. While China is unlikely to meet the goal of 2 percent set for 2010 in the last five-year plan, it still accounts for 12 percent of global R&D spending.

Significantly, this R&D spending is shifting from government-controlled research institutes to large- and medium-sized enterprises, which now account for 60 percent of total R&D spending. Despite frequent complaints about lax intellectual-property protections, foreign-invested companies account for fully 7 percent of this spending, spread among nearly 1,500 R&D centers established by multinational companies.

In some areas, such as telecommunications and pharmaceuticals, innovation shows through in the market. Local companies and universities have discovered multiple chemical compounds in China. Researchers such as Yi Rao and Shi Yigong, experts in genetics and structural biology respectively, are regarded as world leaders in their fields. Huawei’s and ZTE’s global gains in market share have shifted from being solely on the basis of cost to a combination of cost and innovation. For example, Huawei has developed the world’s first “100G” technology capable of delivering large amounts of data wirelessly over long distances. Overall, China for the first time is likely to overtake the United States for number of patents filed in 2010.

Yet despite so much progress, all this industrial innovation misses other, potentially more important, forms of invention. Much of the best innovation in China today is built around developing creative business models in addition to, or instead of, new physical products. Broad Air Conditioning developed a way to commercialize gas-powered air conditioning systems for large buildings. Alibaba built a new business around an online platform to connect smaller Chinese producers with buyers abroad.

This is all possible because Chinese policy makers have learned some important lessons from earlier innovation failures—the biggest being that it’s hard to impose innovation from the top down. This was especially apparent in the attempt to develop an indigenous technological standard for mobile telephony, when serviceable alternatives already existed. After investing billions to develop and commercialize the TD-SCDMA technology, Beijing has found few takers in China or elsewhere.

Beijing is also experimenting with a different innovation model that focuses on identifying opportunities earlier and creating incentives for market participants to innovate. Electric vehicles will be an important test here. This is an industry that is still very much open to innovation at the global level. Beijing is planning to invest $8 billion in R&D at various companies in an attempt to meet a numerical target for market size by 2020. Government commitments to buy the cars for official fleets combined with incentives to consumers will guarantee a certain amount of demand. But, crucially, the actual innovation will be left to the private sector.

Predictably, weak spots remain. In consumer electronics, for example, innovations tend to be derivative—refining products developed in Japan and South Korea instead of developing fundamentally new products. Innovation based on careful study of consumer preferences is rare, especially when the consumers are outside of China. Chinese companies still place too much focus on expanding global market share with just-good-enough products instead of creating markets with totally new products. And in state-dominated service sectors such as banking, there has been limited product or service innovation.

More broadly, there is still the question of how well policy makers will pick the areas where it makes sense to innovate. Although support for electronic cars is promising, China is effectively ceding innovation in traditional combustion-engine cars to Indian companies such as Tata. This is a policy gamble given the potential size of China’s market for regular cars. Indians are pushing the envelope with designs such as the world’s cheapest car, the Nano. They are also finding that innovation in a traditional area can lead to innovation closer to the technological edge—for example, the plan to build a battery-powered Nano.

There is no reason China shouldn’t aspire to that kind of innovation as well. The evidence to date shows that, given the right incentives, Chinese scientists, engineers, and entrepreneurs are eager to rise to the challenge of developing products for the global market. The policy challenge will be unleashing that innovation.
About the Author

Gordon Orr is a director in McKinsey’s Shanghai office. A version of this essay originally appeared on December 29, 2010, in the Business Asia column of the Wall Street Journal. Reprinted from the Wall Street Journal Asia © 2011 Dow Jones & Company, Inc. All rights reserved.

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Is China Catching Up with the United States?

Posted in Chinese Demographics, Chinese Economy, Chinese Foreign Relations, Chinese International Trade, Chinese Markets, Doing Business in China with tags , , , , , , , , , , , , on 12/06/2010 by David Griffith

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Courtesy of ETHOS (Issue 8, August 2010, pg 12-16), a biannual publication of the Centre for Governance and Leadership, Civil Service College, Singapore

Recent relations between the United States and China have been wideranging, serious, mature and basically cooperative — in the sense that both sides want to see the relationship work. The U.S.-China relationship is one of deep interdependence, whether in trade, security issues, or a number of other aspects of international affairs. Each does better because the other is doing reasonably well, and if either nation runs into deep trouble, it affects both of them. Although there are significant disagreements, there are also common or compatible interests on major global objectives at a broad level. Both countries want a world that is basically stable and peaceful; both seek prosperity as a very high priority goal; both want the world to be able to engage more effectively in the fight against climate change; both feel threatened by terrorists and cooperate on counter-terrorism initiatives. Both leaderships want the bilateral relationship to go smoothly. Neither is seeking to cause a major problem for the other as a key objective of national policy.
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In a sense, as President Obama has suggested, no bilateral relationship in the world is now more important than the one between the United States and China. Since early 2009, truly global issues have moved to the centre of the U.S.-China relationship for the first time: recovery from the global economic and financial crises and the related restructuring of the global financial system; nuclear proliferation in North Korea and Iran and beyond; climate change. It is certainly the case that these and other major global issues become potentially easier to manage if the United States and China can either cooperate in dealing with the issue, or at least act in a reasonably parallel fashion in their approaches to the issue. Conversely, every global issue becomes much more complicated and difficult to manage if the United States and China are fundamentally seeking to undermine each other in their respective approaches.

Related to this new understanding – that China has become a critical player in dealing with global issues – is a significant shift in perception that the gap in what might be termed Comprehensive National Power (CNP) — overall hard power, economic capability and reputation — has narrowed between the United States and China. This is a narrowing that has resulted primarily from the different track records and responses to the global financial and economic crises. The United States suffered enormous losses over the last two years. At the same time, China has fared better than any other major economy in the same period, and has emerged from the crisis with lower levels of government debt than any other major economy, meaning that it has more degrees of flexibility going forward, financially, than the rest of the world.

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China’s new pragmatic consumers

Posted in Chinese Demographics, Chinese Economy with tags , , , , , , , on 11/11/2010 by David Griffith

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Courtesy of McKinsey Quarterly

Increasingly, Chinese consumers are behaving like their counterparts in the developed world. They are more demanding and pragmatic than ever as their horizons expand beyond basic concerns about product features. Also, they are willing to pay for better value and quality and are spending more time researching and are exploring product nuances. Yet McKinsey’s 2010 survey of China’s consumers also found that they are blazing a uniquely Chinese trail (see sidebar “About the research”). The country obviously offers some of the world’s biggest growth opportunities—but only for consumer product companies that understand and respond to this rapidly evolving marketplace.

About the research
McKinsey Insights China conducted its first study of Chinese consumers in 2005 and has since surveyed over 46,000 of them. The 2010 survey, conducted from December 2009 to March 2010, covered 15,000 consumers in 49 Chinese cities across all major geographic regions, city clusters, city tiers, and income segments. The research addresses the evolution of the Chinese consumer’s overall attitudes, behavior, and preferences and identifies purchase patterns and motivations relevant to key consumer goods categories, including apparel, automotive, consumer electronics, food and beverages, and home and personal care.

Back to topChinese consumers remain brand conscious but, unlike shoppers elsewhere, they focus on value so intensely that brand loyalty is often secondary. The needs or interests of their families have greater importance for them than for their counterparts in the developed world. Word of mouth has become a more significant source of product information than it is elsewhere, thanks largely to fast-growing use of the Internet, which Chinese consumers see as a credible information source (see sidebar “Chinese consumers and the Internet”).

Chinese consumers and the Internet
The Internet in China, new McKinsey research shows, is poised for rapid growth and change. It is already an important, even routine, part of making a purchase; Chinese consumers use it to learn about products they have considered buying and to hunt for bargains. Even among the majority who have so far spurned e-commerce, use of the Internet to research purchasing decisions is extensive. And it’s striking how quickly connectivity has woven itself into the texture of daily life. More than 75 percent of users agreed or somewhat agreed that “I cannot live without the Internet.”

Like most things in China, the numbers are staggering. As of June 2010, China had 420 million Internet users—more than five times as many as India and nearly twice as many as the United States—and was adding new users at a rate of 6 million a month. About half of China’s urban population uses the Internet, and one in every seven rural residents. By 2015, we expect, urban Internet PC penetration will reach 66 percent, a level similar to that of Western Europe today, and rural penetration will double, to almost 30 percent. All told, China will have more than 750 million Internet users, including those with mobile devices.
Here we present a summary of the most important findings from our 2010 survey.

Internet usage in China: Who and howCompared with the average Chinese citizen, Internet users are younger, more educated, and more prosperous. Of China’s Internet users aged 15 to 65, 70 percent are under 34. Forty-one percent have college degrees (but only 25 percent of the population), and 71 percent make at least 55,000 renminbi, the threshold we define as middle class (compared with 33 percent of the population).

For companies marketing to China’s consumers, most of the key target audience is already online. Among middle-class Chinese, for example, 88 percent use the Internet. While 47 percent of Chinese aged 35 to 44 are online, Internet penetration rises to 84 percent (in the same age group) among people with a middle-class income and a college degree.

Once the Chinese start using the Internet, there is little difference in the amount of time they spend online (19 hours a week). Even the applications used are similar. Among the five most popular—music and video streaming, instant messaging, social networking, gaming, and reading—there are only minor differences across groups, regardless of age, income, or location.
We do see variations in the way people in different regions use the Internet. In the Shenzhen area, just across the border from Hong Kong, 60 percent use e-mail, compared with just 26 percent in next-door Guangzhou. Why such a big difference? More than 85 percent of Shenzhen’s residents are migrants, compared with 27 percent of Guangzhou’s; they use e-mail to stay in touch with family.

Reaching Chinese consumers on the Internet For marketers, an important question is how much to spend on the Internet and how to spend it. TV remains the biggest expense for large advertisers; spending more online, then, implies spending less on television. In fact, recent inflation in the cost of TV advertising, combined with a decline in viewership, means that advertisers must spend more today than they did a few years ago to reach the same number of viewers.

Many advertisers are therefore awaiting the tipping point when Internet advertising becomes a real alternative to TV. In McKinsey’s view, they will have to wait at least a few more years. The Internet is far from replacing TV as a way to communicate with consumers. In 2010, an average of 85 percent of them, across a number of categories, said they had received information from TV in the previous two months. That’s a big number but a noticeably lower one than gave the same response in 2008—98 percent. Online sources, by comparison, reached, on average, 24 percent of consumers. The mass reach of television means that it remains essential. Many Chinese consumers won’t even consider brands they haven’t first seen on TV, believing that those capable of affording expensive advertising spots must be backed by successful companies.

But the Internet has its own advantages. In our 2010 survey, more consumers rated online advertising (56 percent) than TV (46 percent) as credible—a stunning change in perception. In 2009, TV ads were credible to 55 percent of consumers and online ads to only 26 percent. The Internet is gaining clout in other ways too. One in four Chinese Internet users will not purchase a product before researching it online, a sharp increase from 2008. Then there is the growing credibility and popularity of social media, an increasingly important factor in motivating product and brand choice.

Another important consideration is that the Chinese trust the Web sites of retailers and manufacturers and are more likely than consumers in other countries to go there for information. In the United States, consumers prefer to consult consumer and third-party reviews. Of Chinese consumers doing research before purchases, 66 percent browsed company Web sites.
Online shoppingOnline sales are growing fast in China but are still limited—no more than 2 percent of the total, McKinsey estimates, although the numbers are difficult to track. So it isn’t surprising that for many companies, e-commerce, by and large, has not been a high priority.

But that may be the wrong way to look at the market; if you consider instead growth and potential, e-commerce matters. The market research firm iResearch estimates that China’s online retail market nearly doubled in 2009, to $39 billion, from $19 billion in 2008. That makes it the world’s second-biggest e-commerce market, after the United States ($156 billion). And the Chinese e-commerce market could get much bigger: only a third of the country’s Internet users shop online, compared with two-thirds in the United States.

Once people start buying things online, the Internet can quickly command a sizable share of their shopping. Apparel is the most popular category, accounting for 36 percent of online Chinese consumer goods spending; personal digital products come next, with 29 percent. In food and beverages (the biggest retail category), e-commerce is still nascent—only 8 percent of online consumers buy them online. That accounts for just 2 percent of online sales and 0.2 percent of all such spending.

Online shoppers are even younger, more educated, and wealthier than online users: 75 percent of online shoppers are 34 or younger, 53 percent have a college degree, and more than half are middle class or above. It’s worth noting that the top 20 percent of online shoppers account for 70 percent of all sales—and this group is still younger, richer, and better educated than the rest.

Back to topMost intriguingly, though, China’s consumers prioritize purchases across different product categories by trading off among them: the Chinese maximize their buying power by spending more in the categories they care about most and less in others. Also, the size and reach of China’s far-flung markets mean that any trend’s impact may vary from place to place, depending on local circumstances (see sidebar “A geographically diverse consumer base”).

A geographically diverse consumer base
In our 2009 China consumer study, we introduced the McKinsey ClusterMap, a way of segmenting the country’s many discrete markets not only by geography and city tier but also by income, dialect, economic and trade linkages, and common consumer attitudes and preferences. This approach helps companies to identify synergies among sales forces, distribution channels, and supply chains and to access more coherently defined demographic groups than would be possible on a single-city basis or simply by carving up China into arbitrary geographies. Regional variations can have a major impact on the way the trends outlined in this article play out. Consider a few examples.

More than just the basics. The overall trend holds true in most clusters. Nonetheless, the importance of status as a key buying factor for purchasers is far greater in Shanghai than in the cluster around Wuhan, where sales for the high-status category declined sharply from the 2008 to the 2010 surveys.Bigger baskets, fewer trips. The trend toward larger basket sizes but fewer shopping trips holds for most city clusters, but not all. Some registered no change, while the central cluster (cities surrounding Zhengzhou) and the Chengdu cluster reported increased shopping frequencies and, in the case of Chengdu, decreased basket sizes.Smarter shopping and word of mouth. Significant deviations from the norm also occur, most prominently in Shenzhen, the only major cluster to report a preference for TV ads over word of mouth as a source of credible product information. This peculiarity may result from the high proportion of Shenzhen’s population who come from other parts of the country and thus live away from their extended families. In addition, Shenzhen’s consumers appear to have a disproportionate preference for what, in other clusters, would be considered niche channels, such as bus ads and billboards.No one-size-fits-all approach will work in China, because consumer behavior patterns differ widely across regions and income groups. Managers should tailor their product portfolios to meet local tastes and manage by geographic clusters that cater more effectively to the country’s evolving consumer environments.

These trends bear witness to a transformation in the behavior of the Chinese as they develop into some of the world’s most complex consumers. China is now the planet’s second-biggest economy, after the United States, and its consumer sector may be the healthiest of any major country. In the past, consumer companies could enter China with their existing products, strip them down to basics, and then sell them at low prices throughout the country, thus hitching their wagons to China’s double-digit consumption growth. Today, local consumers, like those in developed markets, appreciate and demand better products. Many companies that have struggled to find a niche in China may therefore now find a market for their products and attract partners. Conversely, companies that have relied on low-cost, low-quality business models may end up on the losing end of trade-off decisions and could require a shift to value. In this article, we highlight the major changes in Chinese consumer behavior and offer some ideas about how to address them.

Fewer trips, bigger baskets
Historically, Chinese consumers have shopped about five times a week more often than their US counterparts, but their average basket size has been only a quarter of the US equivalent. Our research this year, however, found that shopping frequencies were declining and basket sizes growing. Overall, in China’s home and personal-care category, the number of weekly purchasing trips fell from 0.6 in 2008 to 0.5 in 2010; the average basket size rose from 18.42 renminbi in 2008 to 24.10 renminbi in 2010.

The trend toward fewer but more costly shopping trips reflects the Chinese consumer’s convergence with developed-world norms. One reason for this change is that Chinese shoppers are increasingly attracted to modern retail formats such as hypermarkets, which offer a broad selection of attractively priced goods of consistent quality. Also, the Chinese have more money than they did and can spend more on each shopping excursion, so they don’t have to waste time making multiple trips to stores. This finding suggests that as the Chinese consumer’s quality of life improves, time becomes more valuable.

One unusual aspect of the evolving behavior of Chinese consumers is their enthusiasm for shopping as entertainment: families transform shopping trips into fun days at the mall or hypermarket. In our survey, some 73 percent said they regarded shopping as a leisure activity, 45 percent identified it as one of their favorite pursuits, and just over half said it was among the best ways of spending time with the family. Those numbers are greater—by an order of magnitude—than those for consumers in the West. Chinese consumers often shop without any intention of buying. Sometimes they are window-shopping or comparing prices. At other times, they may be shopping as a sport, competing with friends to find the best deals.

Chinese consumers still shop much more frequently than their counterparts in developed markets do, but we expect the trend to fewer visits and bigger basket sizes will continue, at least among segments such as young professionals with families. As a result, we think many current global retailing practices will become more relevant in China—from bigger package sizes to home delivery services to loyalty programs. Also, fewer shopping trips mean fewer chances to hook consumers, so companies will have to maximize each opportunity, perhaps using promotions such as instant coupons and bundled-product discounts. Compelling in-store displays will rise in importance.

Attracting consumers to the stores will increasingly be front of mind. In several cities, the French hypermarket chain Carrefour runs a fleet of regularly scheduled buses for shoppers and offers free parking. In the future, making the shopping experience even more a form of family entertainment could prove fruitful—for example, putting restaurants on the premises of stores, adding children’s play areas, or opening adjacent movie complexes.

More than the basics
For years, Chinese buyers have regarded a product’s functional attributes—does it work reliably or taste good?—as the most important buying factor. That’s still true, but our survey also found a shift toward more sophisticated criteria. Flat panel–TV buyers, for example, are now concerned not only with picture quality but also with aesthetic appeal or innovative features. Purchasers of laundry detergent increasingly demand a “good scent” (up to 61 percent this year, from 40 percent in 2008) and “appealing package design” (28 percent today, compared with 16 percent in 2008). As in other parts of the world, this development reflects a transition to an environment where consumers have the means to demand more than basic product features, and catering to refined tastes is increasingly the norm.

Nonetheless, a local perspective informs purchase decisions. After a spate of food safety scandals, Chinese consumers, like their counterparts in the developed world, have become more health conscious. Much more than elsewhere, fear of possible contamination has driven a broader concern about unsafe products, especially everything used by children (food, beverages, toys, and apparel). As a result, Chinese mothers have become among the most sophisticated in the world at looking for materials or ingredients they deem potentially harmful for their children.

Chinese shoppers are also moving in the direction of consumers elsewhere in that emotional considerations increasingly influence purchase decisions. In particular, the importance of any given purchase’s status value has grown strongly since 2008, especially for aspiring or lower-middle-class consumers, for whom the appearance of success is most significant. Another fast-growing key buying factor is the “what fits me” (or “what’s good for me”) category emerging in China’s younger (and more affluent) mass-market demographic. These shoppers are less concerned about following the crowd or the way what they buy defines them in the eyes of others than about how specific products fit their real-life needs. This factor is the main reason consumers trade up when their circumstances change and also explains why they tend to be more satisfied with better products. The “what fits me” mentality, prominent mainly in major cities such as Shanghai, will probably grow in significance nationwide as incomes rise throughout the country.

In addition, intangible, emotional factors are beginning to drive the purchase decisions of younger, often better-off consumer segments. This trend favors companies that had problems marketing products in China but can now create effective strategies resembling those long used in Western markets. These companies could create emotionally driven consumption occasions (in social settings, for example) or introduce brands aimed at satisfying emotional needs (for example, self-indulgence or rewards).

Brand appeal, but only at the right price
One tenet of Chinese retailing is that consumers are extremely brand conscious: 45 percent believe that higher prices correspond to better quality, compared with just 16 percent in the United States and 8 percent in Japan. Likewise, far more Chinese consumers than shoppers elsewhere are willing to buy more expensive branded products.

Chinese consumers are extremely pragmatic, however, so they base purchase decisions on more than just branding. Indeed, the fact that Chinese consumers are conscious of brands does not necessarily mean they are loyal to them. While consumers tend to gravitate toward the biggest brands, the assessment of relative value offered by a handful of competing products is often the basis of choice. Our survey showed that 23 percent of shoppers in China would go out of their way to buy from stores that offered the best prices, compared with 18 percent in the United States and 12 percent in Japan. While quality remains a critical consideration, value is the most important one.

Chinese shoppers first budget for purchases, then compile a shortlist with a handful of specific brands, and finally hold a “beauty contest” to determine the most appealing one. The decision often involves significant research, perhaps conducted in leisure time window-shopping. Since consumers generally make the final purchase decision in stores, promotions and ads in their premises are still effective to tip the balance toward particular brands. In addition, promotions often lead shoppers to make impulse purchases as they seek to maximize value by stocking up on perishables.

The pragmatic trade-off
As income rises in China, so does the desire to buy more and better products. In our survey, we found that three-quarters of urban households said they had traded up in at least one product category. This trend accounted for half of all consumption growth nationwide in 2009. But trading up is only half the story. Chinese consumers are doing so by explicitly choosing to finance increased spending in categories that mean the most to them by “trading off”—cutting expenditures—in less important categories. That’s why 2010’s 74 percent upgrade rate is misleading (Exhibit 1); in reality, only 24 percent of consumers upgraded without trading off. Fully 50 percent of Chinese urban residents actively traded off spending increases in one product category with reductions in others. Trading up in one to three categories involved corresponding reductions in as many as seven (Exhibit 2).

Obviously, trading off isn’t a specifically Chinese phenomenon. When we compare China with developed countries, differences are clear, however. Consumers elsewhere tend to trade up as they get wealthier. Some start relying on credit, often spending more than they can afford. Not in China. Consumers there remain very concerned about financial stability and spend within their means. When Chinese consumers decide to spend more in a category they particularly value, they generally trade down in one or more less compelling categories. These behavior patterns underline our assertion that the Chinese have become among the world’s most pragmatic consumers, willing to make explicit choices about spending their growing income. This is an important insight for marketers seeking growth opportunities.

Our survey found significant trade-off activity in seven product categories. More than 70 percent of trade-up demand for dining out and 50 percent for alcohol come from white-collar men who want to improve their standing with clients or colleagues and trade down on personal-care and packaged-food and snacking products to balance their overall spending. Some 80 percent of trade-up demand for higher-quality clothing, shoes, and accessories came not from high-income “fashionistas” but from lower-middle-income consumers looking to impress job interviewers or advertise their ascent from the working to the consumer class. In each case, trade-down decisions in three to four product categories balanced increased spending.

This distinctive consumption trend has implications for the way companies develop local marketing strategies. For one, they can invest more in consumer education (for example, through corporate Web sites or in-store promoters) to encourage trading up. Manufacturers that focus on convincing consumers of the importance of a particular category—and, within it, of a better, more expensive product—have a stronger chance of persuading potential buyers to upgrade in that category rather than another one. Apparel manufacturers, for instance, often emphasize the importance of owning better, trendier clothes to showcase one’s status. We find that consumers who buy into this idea are much more likely to upgrade their purchases of clothes and accessories, trading off in other categories.

Companies can also use cross-category promotions to influence purchase decisions in a category consumers have targeted for upgrading. Since consumers who upgrade their entertainment venues may well upgrade their alcohol consumption, wine and spirit vendors might partner with trendy bars and restaurants. Consumers who upgrade dairy products are likely to upgrade their snacks, chocolates, and health supplements, creating further copromotion possibilities.

Smarter shopping and word of mouth
Chinese consumers have adopted various techniques to help them decide which products to buy. Online comparisons or reviews are increasingly important research tools for younger audiences and for the middle class and above—the Internet had about 420 million users in mainland China by June 2010.1 These trends are broadly in line with consumer behavior throughout the world.

In our 2010 survey, 56 percent of Chinese consumers said they regarded online advertising as credible, up from 29 percent in 2009. Similarly, 70 and 67 percent of Chinese shoppers said they found retailers’ and manufacturers’ Web sites, respectively, credible. (In the developed world, by contrast, consumers prefer to get product information from third-party sites.) The fact that online information is so highly regarded in China makes the Internet extremely important for shaping consumer opinion. On average, 25 percent of mainland shoppers said they never buy a product without first checking the Internet, compared with half that percentage in the United States. For big-ticket items, the proportions can be significantly higher in China, approaching 45 percent for autos.

Chinese consumers do much more research before purchasing a product than average consumers in the developed world do, so middle-class consumers often take a long time to make decisions, if only because some things can cost more than their monthly income. In a survey on PC purchases, for example, Chinese consumers said they might take three to six months to buy a computer and visit a store three to five times. Decision making is especially protracted for big-ticket items but can take quite a while for foods, beverages, and personal-care offerings, as well, given the increasing number of brands and new products available.

Word of mouth has grown strongly in recent years as a source of consumer information: shoppers are sounding out family and friends and getting advice online through chat forums. True, television advertising continues to dominate in China as an information channel for products and brand awareness. But word of mouth is by far the next most popular source of leads: in 2010, 64 percent of respondents said that it influenced their purchasing decisions, compared with 56 percent in 2008. Word of mouth and online research also play an important role in complementing TV ads by helping consumers to analyze the merits of different products and to arrive at their final decisions.

Word of mouth may be more powerful in China than in developed countries. An independent survey of moisturizer purchases, for example, observed that 66 percent of Chinese consumers rely on recommendations from friends and family, compared with 38 percent of their US counterparts. Word of mouth seems to have become such an important channel because a huge number of brands and offerings now tempt Chinese consumers—who are not accustomed to such product diversity—as well as the fast pace of product innovation. While TV demonstrates which brands are big (and therefore a “safer” choice), it is not a trusted medium; in-store information is critical but mostly influences the final decision. Chinese consumers therefore want to shape their short list with help from family and friends. Often, they also aim to make sure that their choices make them look smart.

For companies, these findings suggest that it has become essential to invest in and develop a world-class Web site that provides extensive information to consumers. Viral marketing is crucial too. In one product category we recently researched, we found that recommendations from SMS (short message service) text messaging accounted for nearly a quarter of the influence on the final brand selected. Some manufacturers have set up sites on the Web to promote discussion of their products in forums they control.

One of the clearest messages from our 2010 survey is that as Chinese consumers become more like their developed-market counterparts, they are also creating a distinct identity. They have not only distinctive tastes and priorities but also unique ways of choosing and buying products. As new offerings emerge and more people in China find themselves with significant discretionary income and choices, consumer product companies must adapt their strategies to capture the opportunity.

About the Authors
Yuval Atsmon is an associate principal in McKinsey’s Shanghai office, where Vinay Dixit leads McKinsey’s Insights China, Max Magni is a principal, and Ian St-Maurice is a senior expert.

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A Truer Picture of China’s Export Machine

Posted in Chinese Economy, Chinese International Trade, Chinese Markets with tags , , , , , , , , , , , , , on 10/04/2010 by David Griffith

Courtesy of McKinsey Report.

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Is China’s economic growth largely dependent on exports, or is it becoming more domestically led? That’s a question economists are vigorously debating—and an important one for policy makers and executives alike. An increasingly consumption- and investment-focused Chinese economy could improve the chances of more balanced trading relationships with developed economies. At the same time, businesses operating in China or planning to enter it could find greater opportunities as the economy accelerated its transition from a manufacturing center to a key consumer market.

To shed light on this question, we developed a new way of measuring the role of export growth in China’s overall economic expansion. We found that exports have been a major driver, but not one as dominant as commonly believed. Indeed, there are clear signs that a shift toward domestically driven economic growth is well under way. The picture that emerges of the Chinese economy has implications for the growth and supply chain strategies of businesses in China and elsewhere.1

A different way to measure exports

Arguments over the true nature of China’s economic reliance on exports have been rooted in the difficulty of appropriately measuring the export sector. The traditional measure governments and most analysts use is the growth of total exports as a share of GDP growth. This measure indicates that export growth has accounted, on average, for almost 40 percent of the total growth in real GDP since 1990—rising to almost 60 percent since 2000.2

Yet these numbers, portraying a dominant and growing role of exports, are at odds with the fact that China was one of the few countries that escaped the great 2008–09 global downturn without a major economic slowdown—suggesting that internal growth played an important role. That’s one reason other economists have used a very different measure: growth in net exports (total exports minus total imports) as a share of GDP growth. By that metric, exports contributed only between 10 and 20 percent of China’s annual 10 percent GDP growth in recent years.

We contend that both measures are misleading. Using total exports neglects the fact that many of China’s export shipments include a fair number of imported goods that are reassembled, combined with domestic content, or otherwise modified before being exported. Failing to remove these imports from the total export figure overstates how much value exports contribute to GDP. On the other hand, a strict net export measure (exports minus imports) underestimates the contribution of exports to GDP, because many imports aren’t used in assembly and exported but rather sold to Chinese consumers and businesses.

We calculated a measure we call domestic value-added exports (DVAE) to assess more accurately the role of exports in GDP growth. DVAE is what you get after subtracting from total exports only those imports used in the production of goods and services that are subsequently exported. In automobiles, for example, finished imports are not subtracted from our measure of exports. But engine parts imported to manufacture motor bikes for export would be.

 

Governments usually don’t break out total imports into those used domestically (for production, investment, and consumption) and those used for exports, and China is no exception. So we estimated the country’s DVAE by using data from three different sources, each with its own strengths and limitations. The results were remarkably consistent—and collectively shed a powerful light on the evolution of supply chain strategies, Chinese consumption, and Chinese economic performance during the global downturn (see sidebar, “About the research”).

Supply chain shifts

On average, our analysis suggests that imported goods accounted for 40 to 55 percent of the value of total exports from 2002 to 2008. Put another way, roughly half of China’s exports represent domestic value added. Concurrently, DVAE’s share of exports generally has risen over time, suggesting that China has become less of a pure assembler of imported goods—a publicly stated government policy goal.

That has implications for many companies’ supply chains and business models. If your company is a manufacturer in China that is primarily processing intermediate components for reexport—a Taiwan-based original-design manufacturer (ODM) of household goods, for example—it’s probably time to consider alternative locations for the assembly work. With China moving up the value chain and beginning to export more skill-intensive goods and services, chances are that pure assembly will soon be less costly in other parts of Asia.

Exports, consumption, and strategy

We also applied our DVAE analysis to reassess the contribution of exports to GDP growth in the years for which we have overlapping data among our three metrics. We found that China’s export sector contributed 19 to 33 percent of total GDP growth between 2002 and 2008 (Exhibit 1). That’s only about half of the export contribution indicated by traditional total-exports measures.3

 
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In other words, DVAE analysis suggests that exports have been an important driver of China’s growth, but not the dominant one, and that most common wisdom overestimates the role of exports while underestimating the role of domestic consumption for China’s growth. Any Chinese or multinational company that currently manufactures goods in China and primarily exports them to other countries should ask itself whether it needs to scale up its domestic strategy to get a bigger piece of the pie. This involves developing a more granular understanding of the Chinese market, making products that appeal to the Chinese consumer, and finding ways to market and distribute them effectively—all while contending with increasingly formidable Chinese competitors.4

China’s ‘downturn’ and the road ahead

A comparison between DVAE’s contribution to growth and that of other major macroeconomic components shows that DVAE topped private consumption, but was less important than investment, over the 2002–07 period (Exhibit 2). In the downturn years, 2008 and 2009,5 exports contributed much less to growth than other factors did, which explains why the Chinese economy could not fully match its GDP growth rates in the earlier part of the decade. However, the shift to a greater role for private consumption, investment, and finished imports explains how China could weather the downturn well and indicates movement toward a domestically focused economy, even though exports will probably continue to play an important role when the global economy picks up.

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Of course, continued changes in the value of the renminbi in the coming years will also affect the evolution of Chinese trade. The more value-added-focused export sector suggested by our DVAE analysis implies that a greater share of exports will consist of higher-priced goods that compete more directly with those of developed nations. That, coupled with an appreciating Chinese currency, points to the creation of more balanced trading partnerships with the rest of the world—and an important shift in context when businesses consider future strategic moves in China.

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From Singapore, an Optimistic Forecast

Posted in China Politics, Chinese Economy, Chinese International Trade, Chinese Markets, Doing Business in China with tags , , , , , on 07/20/2010 by David Griffith

HOUSTON, July 12, 2010 – Prime Minister Lee Hsien Loong of Singapore delivered an upbeat assessment of prospects for growth and stability in East Asia, downplaying lingering effects of the global financial crisis and offering a benign take on China’s growing economic and political clout.

“I believe the fundamental transformations in East Asia will continue, and for a long time,” the Prime Minister told an audience of 350 at the Hyatt Regency Houston.

Houston Mayor Annise Parker introduced Lee for his luncheon address, which Asia Society Texas Center and Greater Houston Partnership co-hosted and which drew a cross-section of the city’s corporate and civic leadership.

To watch this video clip, CLICK HERE.

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World Bank Says China’s Economy Slowing

Posted in Chinese Economy with tags , , on 07/16/2010 by David Griffith

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 Elaine Kurtenbach, AP Business Writer, On Friday June 18, 2010, 2:17 am EDT

SHANGHAI (AP) — China’s economy is showing signs of softening after its strong stimulus-fueled rebound last year, the World Bank says in its latest quarterly update.

Industrial production and other key indicators show the pace of growth moderating albeit remaining relatively strong, supported by real estate investment and a recovery in export demand, said the report, released Friday.

“China’s economic outlook remains favorable,” the World Bank said, forecasting growth at 9.5 percent this year and 8.5 percent in 2011, with “risks both ways.”

China’s economy, the world’s third largest, shook off the global recession to expand a stunning 11.9 percent in the first quarter but is certain to decelerate in coming months, the report said.

“Growth is probably going to ease a bit from the very rapid pace in the first quarter. … But it’s still, in our understanding, a very healthy rate of growing,” Louis Kuijs, the World Bank’s senior economist and the main author of the report, said in a news conference.

The World Bank likewise forecasts “favorable” prospects for the global economy, with growth estimated at 3.2 percent for this year and 3.3 percent for 2011. But it said risks to that outlook were large because of the debt mountains that some countries are burdened with.

The run-up in debt in countries using the euro “could turn into a real and contagious debt crisis” that threatens still fragile economic recoveries in Europe and the U.S., it said.

In China, private real estate investment has helped make up for an easing in government-backed stimulus spending, the World Bank said. But concerns that excess investment and speculative purchases were driving prices to unsustainably high levels prompted a tightening of bank lending, cooling growth in the property sector.

Strains on local government finances following the blow-out spending of the past couple years and possible increases in bad loans are among the most serious risks, the report said.

China needs to rebalance growth away from investment, while remaining flexible, it said, urging greater flexibility in interest rates.

China’s export growth remains strong, though rising costs for raw materials have eroded the country’s cost advantage since prices for manufactured goods have not risen at the same pace, the report said.

There has been an apparent upsurge in labor activism among migrant workers who have begun pushing for higher wages and better working conditions, but the report said it was unlikely to “set in motion an unwarranted wage-inflation spiral.”

Reliable figures on migrant wages are hard to come by. But the report said average rural wages rose 16.4 percent in the first quarter of the year from a year earlier.

Kuijs said recent minimum wage raises were cyclical and not structural, and in line with China’s wage rises in the past decade. They appear distorted but only because the labor market was hit by the global financial crisis last year, he said.

“These take place after last year when wages, especially the minimum wage, rose very, very modestly,” Kuijs said

Relatively strong job creation has helped support robust consumer demand, helping move China toward greater reliance on domestic-led, rather than export-driven growth.

Kuijs said the inflation rate is likely to peak in the next four to five months, but when compared with other countries the rate was relatively moderate.

We don’t expect that it will get out of hand so easily,” he said.

The World Bank report praised Beijing’s recent moves to encourage more investment by the private sector, noting that state-owned companies have benefited disproportionately from the government’s 4 trillion yuan ($586 billion) stimulus package and other moves to support growth after the economy stalled in 2008.

But it suggests the government should rein in its relatively expansionary monetary policy to reduce risks from excess investment.

“Heightened uncertainty calls for policy flexibility rather than continued stimulus by default,” it says.

One key to keeping spending under control will be to improve incentives for local authorities, who tend to focus only on their own interests — such as maximizing revenues from taxes and land sales — to gain from longer-term rebalancing of the economy, the report says.

In the longer term, World Bank research suggests that China’s annual economic growth rate will fall to an average of 7 percent in 2016-2020 — about the level the government has said is its target for sustainable growth.

Associated Press researcher Bonnie Cao contributed to this report.

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