China has defied expectations by successfully establishing a number of state-owned, internationally competitive firms, but the country must increase its outward foreign direct investment if it is to establish a firmer footing in the global marketplace.
In the late 1980s and early 1990s there was profound scepticism that China could develop a successful market economy under the leadership of the Communist Party. Few tenets of the ‘transition orthodoxy’ were held more strongly than this. Since then, the Chinese Communist Party has increased to about 74 million members. The country’s growth performance has been remarkable, achieving average annual gross domestic product (GDP) growth of about 10%, compared with a global average of about 3%.
The ‘transition orthodoxy’ also contended that China would be unable to establish internationally competitive firms under state ownership. By 2009, China had 35 firms in the Fortune 500 and 27 firms in the FT 500, all of which were state-owned enterprises. In the FT 500 list for 2009, Chinese companies accounted for three of the top five. Chinese firms were second only to those of the US in terms of their total market capitalisation. There is a widespread feeling that China’s large firms are rapidly catching up with those headquartered in the high-income countries.
However, the capability of China’s large firms to compete in the international economy is still weak. Most of the successful ‘latecomer’ countries nurtured a group of globally competitive large firms that moved to the forefront of global technology. China is the first successful latecomer country not to have done so. For a country of China’s size, this is remarkable.
Recognising limitations
The Chinese firms in the FT 500 and Fortune 500 are mainly from low-technology sectors such as oil, telecommunications services, banking, insurance, construction, metals and mining, power generation and distribution, and transport. Although they make extensive use of high-technology products, they do not typically produce these products themselves. Their main base is the domestic market and the Chinese government maintains high barriers to foreign firms acquiring large ownership shares in these industries.
China’s leading firms have limited international production systems and only a small market share in high-income countries. China does not have any firms among the world’s 100 largest companies ranked by foreign assets. Although China has more banks than any other country in the FT 500, including the top three banks, none of them are among the top 100 global financial firms ranked by the geographical spread of their operations.
In 2008, the stock of inward foreign direct investment (FDI) stood at $378bn, more than two-and-a-half times greater than the outward FDI stock of $148bn. Moreover, only a small portion of China’s outward FDI is invested in global manufacturing production systems or global services. A large fraction is invested in natural resources, typically minority shares of relatively low-quality mines and oil fields, often in politically unstable locations.
It is difficult for large indigenous Chinese firms to acquire global firms in key strategic sectors. Although Chinese banks lead the world in terms of their market capitalisation, they were strikingly absent from the mergers and acquisitions that swept through the global banking system during the recent financial crisis. China’s leading firms face opposition from Organisation for Economic Co-operation and Development governments which are fearful of state-owned enterprises from Communist China acquiring important parts of their business system. Moreover, China’s large firms possess only a limited capacity to undertake successful international mergers and acquisitions, which require the acquirer to already have substantial international business capability.
China is exceptional among large, late-developing countries in terms of the level of integration with the international economy. The share of foreign trade in China’s GDP rose from 10% in 1978 to 67% in 2006, far above that of other large, continental-sized economies. China’s deep integration within the international economy has brought large gains from comparative advantage. However, it has made the country vulnerable to fluctuations in the international economy and helped to lock an important segment of China’s industrial economy into low-value-added activities.
International firms investing in China are crucial to its economic growth. The share of foreign-invested enterprises in China’s industrial value-added activities rose from 16% in 1996 to 28% in 2007. Nearly half of the output of foreign-invested enterprises is within high-technology industries. They account for 58% of China’s output of pharmaceuticals; 75% of its output of medical, precision and optical instruments; 88% of its output of electronic and telecommunications equipment; and 96% of its output of computers and office equipment. Foreign-invested enterprises account for nearly three-fifths of China’s export earnings and 90% of its exports of new and high-technology products.
Human resources
Behind China’s development process in the early 21st century lies the harsh reality of ‘economic development with unlimited supplies of labour’. China has a population of nearly 1.3 billion people, about 70% of whom still live in the countryside.
In 2007, the World Bank recalculated China’s national product, reducing its estimate in terms of purchasing power parity (PPP) dollars by no less than 40%. As a result, it tripled its estimate of the number of people living on less than $1 a day to 3 billion people. The average per-capita income of China’s 750 million rural dwellers is only $1.50 a day (at the official rate of exchange). In 2007, the World Bank estimated that China’s ‘global middle class’ comprised fewer than 60 million people. Although China’s population is 27% greater than that of the high-income countries, its total household consumption is less than one-tenth of that of those countries combined, while its average per-capita income is only 13% of that of the high-income countries, in PPP dollars.
In the domestic market for high-value-added, high-technology products, indigenous Chinese firms face ferocious competition from giant global firms that serve their middle-class customers across the world. In the market for low-value-added, low-technology products for the mass of the Chinese population, they face intense competition from innumerable small-scale local firms.
Industrial concentration
Since the 1970s, a high degree of global industrial concentration has emerged among ‘systems integrator’ firms at the apex of supply chains in nearly every sector. Intense pressure from these firms has cascaded down through the supply chain, leading to a high degree of industrial concentration across wide swathes of business activity. This cascade effect across the supply chain is hidden from the view of most economists and policy-makers.
The global business revolution has been accompanied by a high degree of concentration in technical progress. In 2007, the world’s top 1400 firms (G1400) invested a total of $545bn in research and development (R&D). This constitutes the main body of global investment in technical progress. The top 100 firms account for 60% of the total investment in R&D by the G1400, while the bottom 100 firms account for less than 1%. In other words, about 100 firms in a small number of high-technology industries sit at the centre of technical progress in the era of globalisation. Firms from France, Germany, Japan, the UK and the US account for 80% of the total. The ‘BRIC’ countries – Brazil, Russia, India and China – with a total population of 2.6 billion people, have only 34 firms in the G1400.
The degree of global industrial concentration that has emerged since the 1970s greatly exceeds that which confronted large firms from previous generations of latecomer countries. It constitutes a formidable challenge for China’s firms and for its policy-makers. After three decades of globalisation, the degree of catch-up achieved by large Chinese firms is much less than most people imagine. However, China is at the forefront of the global search for a sustainable development path as the world’s population grows towards 10 billion inhabitants and income levels increase. This will require new technologies to harness renewable energy for transport, buildings, agriculture and health.
At the core of China’s industrial system are about 150 giant state-owned enterprises. Under the guidance of the Chinese government, through their mutual interaction in order to achieve long-term goals, they have the potential to make a critically important contribution to global progress for sustainable development in the 21st century.
Peter Nolan is a sinyi professor of Chinese management at the Judge Institute of Management Studies, Cambridge University, UK, and author of the book China at the Crossroads
