The Great Convergence : China’s Future Lies in its West

Julien Legrand / Yenching Scholar & Mines ParisTech Engineer / 2015-10-27

Within a decade or two, the “One Belt, One Road” initiative, even if not successful, will have paved the way to a new Asian market, where actors currently present in western China will hold a strategic advantage to access emerging markets like Kazakhstan:it is a whole new Journey to the West that is about to begin, will you join in?

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Since Reform and Opening Up began in 1978, China has witnessed exponential double-digit GDP growth. This is the story we all know. Less known though is that this growth has had two different speeds. While the coastal regions provided most of China’s GDP growth, thanks to a well-crafted export-based economy, central and western China were quickly outpaced, as they lacked both the openness and the infrastructure needed to adopt this model. Consequently, while those regions accounted for over 62 percent of the country’s population, their GDP per capita was one-third what it was on the coast in 2005. If those regions had developed at the same speed as the East, China’s GDP would have been almost twice as large as it actually was. And its growth would have been multiplied two-fold as well. As we know, this did not happen, this potential for growth therefore still waiting to be unleashed, and recent events have facilitated its exploitation.

Coastal-inland inequalities are now closing the gap for three main reasons. Firstly, the Chinese government has invested massively in building the infrastructure that is much needed in those regions, first through its “Western Development” plan, second with its post-2008 stimulus package, in which no less than 2.1 trillion RMB was invested in infrastructure for the central and western regions, and now with the “One Belt, One Road” initiative, a program aimed at reopening the historical silk road that used to link Europe to China through Central Asia. In this initiative, western regions will be likely to play a key role, bridging East and Central Asia. Secondly, the coastal provinces are also getting closer to the international development frontier, meaning that their state of development is looking more and more like the West. They are therefore losing the advantage of the convergence effect; their GDP growth rate is slowing towards much more moderate figures. Last but not least, the export-based growth model is proving less and less suited to China’s need for sustainable growth, especially after the 2008 crisis caused western countries to reduce their imports. All in all, we are now facing weaker economic growth on the coast while central and western China are gathering all the ingredients needed for a take-off.

When looking at the related data, one may be surprised to discover that those provinces didn’t actually wait until 2008 to start catching up with their eastern counterparts. The OECD has noted that inequalities have been diminishing since 2004. In 2010, while the coastal regions displayed a decelerating GDP growth of 11 percent, the central and western regions had an accelerating GDP growth rate of 13 percent. The same year, Nomura published a report stating that 43 out of 65 economic indicators were showing that central and western provinces had already outpaced the coast in terms of growth over the previous few years. And this trend is here to stay. As the East moves up the value chain and wages and land costs increase, factories tend to relocate to the West where wages are still low (Chongqing’s minimum wage, for instance, is only 60 percent of Shanghai’s) and space is abundant.

Production of low-end components is increasingly relocating to the West, as indicated by the growing percentage of gross value of industrial output (GVIO) coming from those provinces (41 percent in 2011 vs. 33 percent in 2006). Relocations are especially favoured by Chinese companies, which move their basic manufacturing factories from eastern to central and western provinces and then send their output back to the East, where it is consumed. Take for example the case of Foxconn, which recently opened a factory in Zhengzhou, Henan, forcing most of its suppliers to come along. With the western parts of China pursuing a new kind of export-led model – its output directed towards coastal regions rather than Europe and North America – one can expect them to take off very soon. And this prospect is already taken very seriously by consulting firms like McKinsey, as they forecast that the percentage of middle-class Chinese living in central and western China will reach 39 percent in 2022, vs. 13 percent in 2012. As the western regions develop relatively faster than the eastern ones, inland GDP per capita is catching up with coastal standards, the ratio between the two having shrunk from 2.2 in 2006 to 1.7 in 2013. The west is growing richer (in term of income) and its households’ purchasing power is therefore expected to increase.

Major obstacles, however, will be on the way to exploit this growth potential. Twomain ones will be addressed here. First, corruption is well-known to be endemic in those regions, with guanxi (relationships) playing an increasing role when going inland. Note that this was also the case when foreign firms arrived in China in the 1990s and early 2000s. Those companies should therefore capitalize on their experience from that time to design an adequate strategy. Xi’s anti-corruption campaign may also have prepared the local officials to reduce their dependence on guanxi, increasing the importance of market/data-based decisions. Furthermore, local officials are mostly favourable to foreign companies, with policy, tax and loan advantages available in most cases. Second, skills are a scarce resource in those regions and companies will think about sending expatriates to manage local teams. However, it may prove more difficult to send expatriates to those provinces where English is barely used and the development level is still low. But multinationals that are already in China have trained Chinese managers that may have the adequate level of training and skills to be sent inland to manage and train the local workforce. They will both be cheaper than expatriates and more adaptable to the local conditions.

Three major points should be apparent by the end of this article. The first is that “the factory of the world” is relocating westward, where human capital is cheaper and infrastructure is now mature, enabling transportation of goods from one side of the country to the other at diminishing costs. The second is that individual incomes are increasing in China’s central and western provinces in such a manner that, regardless of exporting to the coast or other countries, having factories there will make sense within the next decade any ways to address the local market. The third and final is that there will be obstacles to entering those regions, but they can be easily overcome with the appropriate strategy.

Within a decade or two, the “One Belt, One Road” initiative, even if not successful, will have paved the way to a new Asian market, where actors currently present in western China will hold a strategic advantage to access emerging markets like Kazakhstan:it is a whole new Journey to the West that is about to begin, will you join in?

Sources:

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OECD (2010), OECD Economic Surveys. China. Volume 2010/6. February.

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Yan, Sun (2010). “The Rise of Central and Western regions,”Nomura, 03 June 2010.

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“Don’t Leave, Just Move West,” JFP Holdings.

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