China

An export boom is reanimating the economy, but cooling world demand would be painful, because Beijing’s reforms of the rest of the lumbering economy have yet to take hold

FUZHOU, China – For a glimpse of what’s right – and wrong – with China’s economy, stroll through China Fuman Toy Co.’s factory in this tree-lined port city on the country’s southern coast.

       Sitting behind long rows of wooden assembly tables, more than 1,000 Chinese workers delicately piece together plastic arms, legs and heads for toy dolls, all soon to be exported to buyers in the U.S. and Japan. It’s a decidedly low-tech business, but one that few other countries can do as cheaply and efficiently as China, the world’s largest toy maker. And it’s earning enough money, Fuman managers say, to pay for a big expansion later this year, including plans to build a new factory, hire additional workers and raise salaries.

       “Our business is built on cheap labor, but the impact this one factory has on the local economy is huge,” says Lin Weihan, deputy general manager of the company, stepping around a plastic mould machine that Fuman purchased nearly 15 years ago, when it became the first foreign joint-venture toy factory to set up in the city. “We’re helping solve the city’s unemployment problem.”

Record Exports

       It’s not just Fuman that’s helping out. China’s entire export sector is on fire, helping pull the economy out of seven years of slowing growth and paving the way for even stronger export growth once the country joins the World Trade Organization later this year. In the first eight months of this year, exports rocketed 35% higher to $159.3 billion – a single-month record – padding China’s already hefty trade surplus and boosting first-half economic growth to 8.2%. So powerful is the boom that even Beijing’s normally staid statisticians have raised their estimate of full-year growth this year by a full percentage point to 8%.

       Yet the power of China’s export sector is in many ways also a picture of everything that’s wrong with the economy – a modern, well-oiled and largely foreign-funded export machine grafted atop a vast but lumbering continental economy, large parts of which remain unstirred by booming foreign trade and three years of massive government investment. The result: a lopsided economic rebound that’s missing many of China’s poorest regions. Worse, this bifurcated economy suggests that any slowdown in the red-hot global economy could potentially snuff out China’s budding recovery.

Inconspicuous Consumption

       “The export boom has been the driving forcing behind the economy,” says Xi Junyang, an economics professor at Shanghai University of Finance and Economics. “And due to sluggish domestic demand, it will remain so for the next three to five years,” he says

       The divide between the export economy and national economy is most conspicuous in the countryside where more than half of China’s 1.25 billion population, mostly farmers, are struggling to earn a living. Though two years of painful price deflation officially ended earlier this year, prices for China’s most important commodity – grains – are now in their fourth year of decline, flattening income growth and consumption across a large swath of the country. So difficult has life in the countryside become that the number of rural Chinese living below the government’s own poverty line – 70 cents in income per day – actually rose last year, one of the only times in recent decades that’s happened, according to a recent World Bank report.

       Reversing this trend has become a top priority, underscored by Beijing’s new campaign to rebuild its western region through huge new investment, like a 4,000-kilometer-long gas pipeline stretching from Xinjiang to Shanghai. But changing the economics of China’s poorest region overnight will be difficult.

       Grain prices, for example, are falling due to massive oversupply, the result of a government pledge to purchase grain from farmers at artificially high prices. That policy was aimed at ensuring the country’s food security by encouraging farmers to grow rice regardless of market demand. It’s bad economics, costing the country nearly $5 billion a year in subsidies. But Beijing apparently feels it has no choice given the hardship that its farmers face. Indeed, last month it raised its official purchase price for grains yet again.

       Increasingly, China’s dual economy isn’t just limited to the countryside. It’s also emerging in parts of its more developed eastern regions, in the form of deep-pocketed foreign investors who are racing ahead of their domestic state-owned competitors.

       In Shantou, a coastal town just a few hundred kilometers down the road from Fuzhou, Kodak Corp. is putting the final touches on a sleek new facility, a spotless glass and white-walled building that boasts modern magnetic film equipment and a state-of-the-art water purification system, all staffed with Chinese engineers. Kodak already counts China as its second-largest market behind the U.S. But it’s investing more to cement its position, including the $1 billion it spent last year to buy assets owned by three struggling state enterprises, which spent heavily on modern manufacturing equipment but never learned how to use it.

       Today, Kodak’s plant stands as an example of the growing divide between foreign companies and China’s state owned enterprises: right next door to Kodak’s facility is the antiquated ERA Film Factory, a government company that sold its best assets to Kodak to pay off its debts last year. Though ERA is still technically operating, on a recent sunny afternoon a handful of workers loiter at the main gate of the company, while the rest of the building appears devoid of activity.

       For sure, foreign investors like Kodak provide a huge boost to China’s economy, bringing it valuable technology and management skills, while absorbing the growing pool of unemployed. And they’re likely to play an even bigger role after China ascends to the World Trade Organization, which by some estimates could lead to an extra $20 billion in foreign investment each year, much of it concentrated in mergers and acquisitions and information technology industries.

       But for China, its alliance with for eign companies is an uneasy one, a delicate balance between upgrading its economy and protecting its biggest and most important state companies. In a sign of this concern, some government officials say they fear foreign companies could largely control China’s economy two decades from now.

       To prevent that, Beijing is trying to overhaul its state enterprises through stock-market listings and technology upgrades, while slowly removing long standing restrictions on its private sector – all part of efforts to create globally competitive Chinese companies. Yet continued government meddling in the business realm often undermines these efforts. The upshot: China’s exporters and foreign firms will likely continue to lead growth in the years ahead.

       Offering large salaries, Mr. Lin of Fuman Toys says he intends to hire 25 new Chinese university graduates this year to develop a new line of toys under its own brand name. And it also plans to spend heavily on a new marketing campaign to expand sales in the U.S. Says Mr. Lin, walking past shelves full of toys designed by its original Japanese partner, Bandai: “We’re very confident about our future.”

CHINA BY THE NUMBERS

Source: National Statistical Bureau, World Bank

Forecasts: Goldman Sachs, Credit Suisse First Boston

Growth in real GDP

Consumer price index

Growth in money supply (M2)

Prime interest rate (on a one-year loan, Dec. 31)

Year-end exchange rate (yuan/$)

Trade

Forecasts: Credit Suisse First Boston

Forecasts: CITIC Securities Co., Ltd. (Shanghai B shares)

Guosen Securities Co., Ltd. (Shenzhen B shares)

Bonus Statistic: The number of registered stock investors is 44.8 million compared to 10.6 million in 1994

Source: Shenzhen and Shanghai stock exchanges