China in Transition

What If China is Only a Big Producer But Not a Big Market

Chi Hung KWAN
Consulting Fellow, RIETI

Many Japanese companies view the expansion of China's production capacity as a threat, while at the same time finding little attractiveness in the Chinese market. As suggested by the GDP identity, income, and thus the size of the market, should grow at the same pace as output. Moreover, due to the high degree of complementarity between the two countries, Japan should enjoy advantages in penetrating the Chinese market. Market information may be biased as companies making money in China prefer to remain mute while those incurring losses are crying out in a loud voice, causing increased pessimism. If in fact market expansion is lagging behind production in China, it may reflect the following three factors.

First, foreign affiliates hold a large share of production as well as corporate earnings in China, so that the country's GNP is far below its GDP. The dividends paid by these foreign affiliates do not become income for the Chinese people, and may actually be transferred overseas. This makes China more attractive as a production base for exports than as a market. Among the foreign companies in China, if US firms and European firms are making money while Japanese firms are not, then the latter should reexamine their corporate strategies.

Second, at the macro level aggregating the household, corporate and government sectors, China has a high rate of savings, so that expenditures are far lower than income. The difference does not translate into demand for goods, but rather is used by monetary authorities to build up foreign exchange reserves. In this case, Japan should persuade China to invest a larger proportion of its foreign exchange reserves in yen assets. Unfortunately, the lion's share of this "Chinese money" is flowing to the US instead of to Japan.

Third, China's terms of trade has been deteriorating as rising exports drive down export prices, so that the same amount of exports can be exchanged for less and less imports. This fall in purchasing power has been reflected in the yuan's sharp depreciation over time, and the slow growth in GDP in dollar terms. Under these circumstances, Japan should benefit by importing cheap products and components from China, which would allow lower prices for consumers while cutting costs at Japanese companies.

Thus even if the Chinese market is not growing as fast as production, there are various ways that Japanese companies can take advantage of China's growing economy. While importing goods produced in China through OEM and other schemes is going relatively well, Japanese investment in China has stayed at a very low level.

In contrast, the US and European countries view the emergence of China as a business opportunity, rather than as a threat, and success stories of their companies in China are on the rise. Indeed they now lead the list of top ten foreign companies in China, which does not include a single Japanese company. Among automakers, for example, Germany's Volkswagen has a market share of 50%, while the mobile phone market has been dominated by Motorola of the US, Nokia of Finland, and Ericsson of Sweden. Even in China's electronics sector, Japanese companies are losing share as many Chinese firms emerge. Thus Japan should better worry about being left out of the fast-growing Chinese market, rather than about the hollowing out of its industry as more and more Japanese companies move to China.

May 31, 2002

May 31, 2002