China 2012: The Trends Ahead

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Op-Ed Commentary: Chris Devonshire-Ellis

Dec. 13 – Yesterday I looked at budgetary issues for businesses in China and dealt with some of the general perceptions of what could happen over the year, from the impact of the new generation of leaders coming in, to social welfare for foreigners being introduced. The article can be found here. In this piece, we’ll examine some of the trends starting to occur in China, and especially those that affect foreign investors in the country.

Localizing of workforce
The impact of social welfare being imposed upon expatriates in China does add a significant chunk of expense to corporate overheads as the employer has to contribute the lion’s share of this amount. The localizing of workforce in China has been going on for as long as I can remember, and occurs when Chinese knowledge meets expatriate and then becomes more operationally desirable due to communication and expense issues. This will impact on non-essential expatriates in China with limited language or expertise skills. I’ve written about the options such personnel have in terms of India and looking for work elsewhere in Emerging Asia, however this trend is one that will carry on over the next 12 months. It’s already impacting upon our firm, Dezan Shira & Associates, where for slightly different reasons two of our senior expatriate managers in Shanghai and Guangzhou are being relocated to Delhi and Hanoi to deal with expansion and growth in those markets. However, their China replacements will be ethnic Chinese professionals and not Europeans or Americans. Your China expat friends and colleagues may end up elsewhere in Asia during the course of the year.

The importance of being inland
While I mentioned yesterday that I felt China GDP would grow at a rate of 7 percent to 8 percent during 2012, what I didn’t suggest was that this will not be uniform across China. Some cities next year will see a drop below this (although I doubt that will crop up in official stats), others will perform rather better than others.

Growth is occurring at a faster rate today in the third and fourth-tier city level than in the first-tier right now (for the same mathematical reasons I also spelled out yesterday). Simply, when a city like Shanghai has a Maglev, two airports, and all the luxury brands you can fling an Amex Platinum card at, how much more can you grow? Compare that to Wuhan, Chengdu or even Changsha or Lanzhou, and clearly, growth in infrastructure and consumerism has further to go in these locations.

It’s also all about spread. China’s middle class market is estimated to be at 250 million (that’s roughly equivalent to 78 percent of the entire population of the United States) yet rather selfishly, they’ve not all congregated into one ultra-super-duper mega city that is easy to access. Instead they’re living all over the place. With 30 mainland China provinces, it’s easy to name 60 cities in one go, all being the first and second largest in each province. Expand that to the top four biggest cities in each province and you get a sense of the scale. Most are not coastal; where much of the growth has been taking place. This simple dynamic stresses the obvious – its inland China that is set to boom.

There are also three important drivers to this. First, the inherent growth rate increases as they begin to play catch up with their wealthier coastal cousins, which is defined by a State-driven policy to encourage this. Secondly, the lower wages on offer compared to the coast are proving attractive enough for many businesses to relocate there. Thirdly, a rise in the wealth of China’s lower class to becoming middle class is underway in these cities, pushing demand for consumerism – also a matter of State policy.

This all means that manufacturers looking for lower labor costs, and companies wishing to sell products nationally, are simultaneously expanding inland. Dezan Shira & Associates will too – we’re targeting Chengdu as a strategic investment for 2012, and are also looking seriously at Wuhan and Chongqing down the line. But for some far larger MNCs, the phrase “second-tier city” is already old hat. As Gordon Orr, the Asia Chairman of McKinsey, told me over lunch together at a recent China conference, the new dynamics are all about reaching into the six and seventh-tier cities in China.

Passage to India
The truth concerning India, seemingly poised by the media either as the next best thing or a chaotic mess, is that it lies somewhere in the middle but much more on the positive side (India’s chaos is much like chaos theory, that apparent randomness is actually all by design). As the world’s largest democracy, it’s much more a bun-fight than even the EU can muster these days, and adding in several large doses of madras curry powder too. It may appear volatile, but things are increasingly getting done.

Once the much awaited tax reforms are passed, India’s trigger as a hot destination will have finally been pulled and FDI will pour in. Forget the China comparisons, they’re largely meaningless. What you need to know is that China-India bilateral trade is booming, that India has a free trade agreement with ASEAN, it has an insatiable desire for infrastructure projects and development, its GDP growth will overtake China’s next year, and that it is demographically poised to become the world’s new cheap labor pool while at the same time possessing a middle class population of some 250 million (similar to China).

Unlike China today, India offers both cheap labor for export-driven manufacturing and a massive domestic market to sell too. Next year, 2012, marks Dezan Shira & Associates’ sixth year of operations there, and our India budget has to be highly aggressive just to keep up with growth and investment demands to keep pace. If any of those stats look of interest, you and your business should be evaluating the Indian market. Check out the details on our sister web site India Briefing or contact our primary office in Delhi for orientation assistance if you need help with understanding the country or legal/tax advice. Our Doing Business in India Guide is also a national best seller there.

It’s as simple as this – MNCs need to be in India now if you want to get into a market growing at 10 percent a year for the next two decades. India is taking up the baton from China’s development and population dividend.

Don’t be an ass about ASEAN
ASEAN is a trading block of 10 Southeast Asian nations with a combined population of some 580 million and a total annual GDP of some US$1.8 trillion. That’s an economy about the size of Brazil – one of the BRICS of course. ASEAN includes regional giants such as Singapore (its de facto financial capital), Indonesia, Malaysia and Thailand, while also including oil rich Brunei, Cambodia, Laos, up and coming Vietnam, the Philippines (currently the world’s largest destination for BPO) and newly friendly Myanmar.

If that isn’t enough, it also has significant free trade and double tax agreements with both China and India. That means it is possible to site a business in ASEAN and sell throughout Asia, including to China and India, from there at tax-reduced rates. This is why Singapore especially is developing as a regional hub – see my piece on Singapore versus Hong Kong for holding Asian operations – and is also why Dezan Shira & Associates established an office in Singapore earlier this year.

For investors who can afford to expand internationally more good news awaits in much of emerging Asia as well – most of these economies are also doing exceptionally well when compared to the United States or Europe. Asia (and ASEAN) are the places to look for growth.

China and Asia. What’s the deal?
We’ve also provided a complimentary PDF download of the current issue of China Briefing – The Asia Tax Comparator – to better illustrate the tax incentives and differences on offer between China, India and 15 other Asian destinations, including all the ASEAN countries. You can access the download by clicking on the image.

Going beyond borders
Essentially what I’m saying here is that as China slows (although it’s still going to be a great year), investments from China will also spill out into the rest of Asia. Foreign investors should be looking not just at China, but at these markets too, and this will become a trend. Already, at the high value conferences I attend in China and Asia, increasing numbers of chairmen and CEOs are taking control of not just one market – China – but India and ASEAN as well, and folding them all into one development strategy. It is the way ahead, and with slow growth expected elsewhere China and Asia combined will be the trend for FDI during 2012.

Chris Devonshire-Ellis is the principal and founding partner of Dezan Shira & Associates. The practice specializes in providing foreign direct investment law, tax planning and investment advice throughout Asia, and has some 20 offices throughout the region. Please contact the practice at asia@dezshira.com, download the firm’s brochure here or visit www.dezshira.com for further advice or assistance.

Related Reading

Part one of this two-part article, detailing budgeting issues for China businesses in 2012, can be viewed here.

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5 Responses

  • Anjit says:

    Many thanks this useful observations. I am thinking we all too often too much Chinacentric and I enjoy your wider sense of Asian perspectives. Just wanted to say this as appreciations you doing this writings for us.

  • Chris Devonshire-Ellis says:

    @Anjit – thanks for your kind words. Just some pointers as to how we are organizing our business, maybe useful for other CEOs with investments in China. Best wishes – Chris

  • Chris Devonshire-Ellis says:

    I’ve seen the doom & gloom over the end of 10 per cent GDP growth every year but as I pointed out thats hardly unexpected and an expected rate of 7-8% is still pretty good. While US FDI apparently dropped 10%, in 2011 to be frank all the larger firms I know in China including ourselves were very busy with US inbound investment to China last year; I don’t expect that to change. – Chris

  • cliknget says:

    nice article…..
    knows lot of by this site about china….

  • Many thanks cliknget, we work very hard on this website. Cheers – Chris

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