Economic Insight
Greater China
Quarterly briefing Q2 2014
Emerging markets hesitate as advanced
economies accelerate
Welcome to ICAEW’s Economic Insight: Greater
China, a quarterly forecast for the region prepared
specifically for the finance profession. Produced by
Cebr, ICAEW’s partner and acknowledged experts
in global economic forecasting, it provides a unique
perspective on the prospects for China over the
coming years. In addition to mainland China, we
also focus on the Hong Kong and Macau Special
Administrative Regions (SARs).
Economic fortunes are changing, more than
five years after the financial crisis hit. Growth
is accelerating in advanced economies, as the
eurozone creeps out of recession and the US hits
its stride. Emerging markets, however, are slowing.
The world’s largest emerging economies – including
India, Russia, Brazil, South Africa and Turkey, as
well as China – all face challenges of their own this
year. While plentiful liquidity, driven by low interest
rates in advanced nations, has helped to boost their
economies, as this begins to dry up they must face
their vulnerabilities.
China’s economy expected to enter a
phase of consolidation
Slower economic growth in mainland China has
long been forecast, however signs suggest that
2014 may be the year when this actually occurs.
The first defaults of corporate bonds have hinted at
overheating in capital markets, while the outcomes
of the Third Plenum suggest that bold steps will
be taken towards reform, rebalancing away from
a reliance on investment towards household
consumption. It seems most likely that the relative
decline of investment will be gradual and wellmanaged; data suggesting a sharper slowdown
was met, in March, by the acceleration of a small
government stimulus programme. While this may
be the year that GDP growth misses its target, it is
unlikely to do so by a significant amount.
In this issue of Economic Insight: Greater China, we
look beyond the inevitable bumps of the reform
process to the longer-term prospects for mainland
China and its SARs. Over the last two decades,
mainland China has benefited enormously from
opening its markets to the global economy, and
reaping the rewards of international trade. Its
plentiful labour force allowed it to compete in a wide
range of markets for labour-intensive manufactured
goods. Mainland China’s development has, in turn,
provided momentum for the economies of Hong
Kong and Macau, gateways to the mainland.
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As the working-age population of China begins to fall,
however, and wages rise, the economy must seek new
sources of growth, particularly new high-value export
industries. By competing with advanced economies in
the manufacturing of mechanical and technical goods,
China will be able to boost wages and create a new swell
of consumer-led growth.
Chinese manufacturers excel at making
high-tech components
Mainland China has already, to an extent, moved on
from the export of labour-intensive manufactured goods
such as textiles, as illustrated by Figure 1. In 2012, highskill and high-technology goods accounted for 40.8% of
the country’s manufactured goods exports – higher than
the eurozone (38.3%). Hong Kong and Macau, both
re-export centres for the mainland (they import goods
from China, and without further processing, export
them to other countries), have also benefited from the
increase in these higher-value exports. Nearly two-thirds
of manufactured goods exported from Hong Kong in
2012 (64.9%) were high-skill and technology intensive,
as were nearly half of all manufactured goods exported
from Macau (48.3%).
Figure 1: Mainland China and its SARs have
successfully developed high-skill and technologyintensive manufactured exports, but also rely on
labour- and resource-intensive exports more than
advanced economies
%
100
90
80
for Chinese producers. Chinese companies continue
to derive value from this expertise as wages rise, by
exporting their knowledge and setting up factories in
countries with lower labour costs, such as Vietnam.
China succeeds in the assembly of high‑tech
consumer goods but sophisticated
engineering continues to pose challenges
Medium-skill and technology-intensive goods (eg,
specialist parts for industrial machinery or cars) account
for a relatively small proportion of all manufactured
goods exported from mainland China – just a quarter
(24.5%). However, in Germany – famous for its
Mittelstand of small- and medium-sized exporters –
nearly half (49.9%) of all manufactured exports are of
this type. These companies produce goods including
machinery, car parts and chemicals, which require
a higher level of skill than labour-intensive exports,
pushing the German economy up the value chain.
With wages rising quickly in mainland China as the
working-age population shrinks, the economy needs
to produce fewer labour-intensive exports, and begin
to develop Mittelstand-like companies – specialists in
producing components for high-tech manufacturing
of goods such as cars. While the ability to create the
parts for high-tech electronic equipment is a good start,
mainland China must now develop the industries that
make use of these parts. With a supply of components
close at hand, China is already beginning to compete
with advanced economies such as Germany in the
production of goods like construction vehicles, and
could rapidly expand into other markets.
High-value export industries set to benefit
from improvements in education
Labour-intensive and resource-intensive manufactures
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9
8
7
6
5
4
3
2
1
Indonesia
India
Turkey
0
US
Differences remain in the types of goods exported by
emerging markets such as China and India and advanced
economies such as the US, Korea and Germany. While
China has established high-tech and high-skill export
industries such as the production of computers and
mobile phones, labour- and resource-intensive export
industries (eg, textiles, paper and cement production)
also continue to play a significant role in the economy,
accounting for nearly a quarter (23.4%) of all Chinese
manufactured exports in 2012. While this proportion
has fallen over time, China’s profile in manufactured
exports remains closer to India than to the advanced
economies of Korea, Germany and the US, where labourand resource-intensive goods account for less than a
tenth of all manufactured goods exported. Macau and
Hong Kong also export a higher proportion of these
goods than most other economies at a similar level of
development, due to them being re-export centres
World Bank Knowledge Index
Source: United Nations Conference on Trade and Development, Cebr analysis
10
Vietnam
Low-skill and technology-intensive manufactures
Figure 2: Mainland China has room for improvement
in the factors expected to support the development
of competitive high-value export industries
Mainland China
Medium-skill and technology-intensive manufactures
Mexico
High-skill and technology-intensive manufactures
Thailand
Korea
US
UK
Germany
eurozone
Brazil
Hong Kong
Macau
Mainland
China
India
0
Brazil
10
Singapore
20
The success of the German Mittelstand is based on
the ability of small- and medium-sized companies to
specialise in the production of a particular component
and innovate to give themselves a competitive edge in
that market. This technique has provided hundreds of
German firms with the ability to expand across global
markets, making the country a highly effective exporter.
eurozone
30
UK
40
Hong Kong
50
Korea
60
Germany
70
Source: World Bank, Cebr analysis. No data is available for Macau
This sort of economic structure, however, requires
several underlying foundations – a culture that welcomes
innovation, educational institutions which provide a
wide range of specialist skills and access to information
and communications technology (ICT) equipment to
ECONOMIC INSIGHT – GRE ATER CHIN A
Q2 2 014
support modern manufacturing processes. The World
Bank’s Knowledge Index provides a snapshot into how
countries perform on these three factors, and so can be
seen as an indicator of their likely success in encouraging
the development of competitive exporters of high-value
manufactured goods. Statistical analysis suggests that
higher scores on this index are associated with higher
rates of future economic growth.1
Mainland China comes 59th out of 144 countries included
in the World Bank’s analysis – in the top half of the table,
but clearly not pole position. More worryingly, China is
not only being outpaced by more-developed economies
like the UK, US and eurozone, but it also scores lower than
more direct competitors, including Brazil, Mexico and
Thailand, as illustrated in Figure 2. Mainland China does,
however, out-rank several of its neighbours, including
India, Vietnam and Indonesia – now targets for Chinese
investment in labour-intensive export industries. This
shows how mainland China is beginning to move up the
value chain towards a greater focus on skill and innovative
products. While the production of labour- and resourceintensive goods such as textiles is increasingly being
outsourced to Vietnam and India, mainland China is not
about to lose its edge in the manufacture of high-tech
electronic components to these markets. Hong Kong,
in line with its higher level of economic development,
scores relatively well on this index, ranking 22nd – but is
outperformed by other offshore hubs including Taiwan
(3rd in the world), suggesting there is still scope for
improvement.
Mainland China will have to move up the international
Knowledge Index if it is to develop competitive players
in other manufacturing industries. It should, eventually,
be able to compete with the likes of Germany in the
production of machinery and industrial equipment.
Mainland China scores highly on innovation,
but further efforts in education and ICT
are needed to sustain this and propel the
development of high-tech manufacturing
Mainland China scores highly on the innovation
component of the World Bank Knowledge Index – which
measures patents filed and research articles published.
It ranks 6th in the world, just below the US, UK and
Germany, but above the eurozone average and other
advanced Asian economies including Singapore, Hong
Kong and Korea. Mainland China has led the world
over the past three years in the number of patents filed,
however the country’s businesses have struggled to
transform innovations into commercial products. While
Chinese businesses may secure some financial gains from
filing patents, they will not reap sizeable rewards until
they are able to practically implement innovations.
The development of original ideas may be hindered by
mainland China’s lower scores in ICT and education.
On the education component of the Knowledge Index,
China ranks 95th, below Mexico, Thailand and Turkey.
Although it has already considerably improved the
quality of education, evidence from a recent survey of
US companies in mainland China found that a lack of
suitably-qualified managers was the fastest growing risk
for these companies. These findings suggest that the
country still needs to do more to equip its workforce with
the skills needed to propel the economy forwards. Plans
recently announced to train all young migrant workers by
2020 and to introduce more vocational qualifications will
both help to upgrade the skills of China’s manufacturing
workforce, but a broader improvement in education will
be needed to ensure that all areas of the mainland prosper.
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The country also scores relatively poorly in the provision of
ICT, ranking 93rd out of 144 countries in this component
of the Knowledge Index, below Brazil, Mexico and
Thailand. While in mainland China’s urban centres access
to technology is relatively good, there is significant room
for improvement across the country’s vast rural expanses.
Hong Kong, by contrast, scores well on ICT, just inside
the global top 10, but falls behind on education, due to
a relatively low take-up of tertiary education and shorter
duration of secondary schooling. Changes to introduce
whole-day rather than half-day schooling across the SAR
may improve this, however further support for young
people wishing to obtain an undergraduate degree will
also be needed to ensure the labour force can compete in
international markets.
Hong Kong relies on re-exports of goods,
but services sector exports are of growing
importance
Re-exports of goods through Hong Kong were worth
$449.4bn in 2013, up 3.8% in nominal terms compared to
2012. Even as the Chinese economy slows, the SAR retains
its role as a gateway to the mainland’s markets. Service
sector exports from Hong Kong are also vitally important
to the region; they grew by 5.8% in 2013 and now
account for more than 90% of the domestic economy.
As financial and trade dealings between the mainland
and the rest of the world continue to grow, Hong Kong
should remain an important destination for international
services sector firms seeking to gain a foothold in the AsiaPacific region. A government survey in June 2013 found
that there were 3.835 regional headquarters and regional
offices in Hong Kong representing parent companies
located elsewhere – a 20% increase on the previous
decade.
This will be further enhanced by the recently-announced
plan to link the Hong Kong and Shanghai stock
exchanges. As well as making it easier for Chinese
companies to access foreign capital, this will reinforce
Hong Kong’s position as the financial gateway to the
mainland, securing its role as a global financial sector.
Productivity growth in mainland China
remains world class, but there is still a
long way to go to catch up with advanced
economies
Improvements in innovation and education would help
to boost the productivity of Chinese workers, helping
to increase the amount of output each employee can
produce. With wages rising due to the shrinking workingage population, productivity must rise if Chinese exports
are to remain price competitive in international markets.
This in turn will be an important determinant of GDP
growth and living standards.
Productivity growth in mainland China, measured as
GDP per worker, has risen rapidly over the past decade,
despite a slight slowdown in the years following the
financial crisis. At 10.4%, average annual productivity
growth between 2003 and 2012 was much stronger than
most other markets. This remarkable productivity growth
has allowed GDP per worker to more than double (an
increase of 167.8%) over the decade to 2012, as illustrated
in Figure 3. By contrast, productivity in India increased
by less than half as much – 73.7% over the same time
period. Other emerging markets, including Indonesia,
Vietnam, Turkey and Thailand, achieved growth of
between 30% and 50%. By contrast to the emerging
ECONOMIC INSIGHT – GRE ATER CHIN A
Q2 2 014
Figure 3: Despite remarkable growth in labour
productivity, mainland China still has a lot of catching
up to do
GPD per person employed, constant US$, thousands
0
10
20
30
40
50
60
70
Vietnam
India
Indonesia
Brazil
%
50
Forecast
40
30
20
10
0
Mainland China
US
Hong Kong
eurozone
2020
2018
2016
2014
2010
2012
2008
2006
2004
2002
2000
1998
1996
1994
1992
1990
1988
1984
1986
-10
1982
This very rapid increase in labour productivity, however,
cannot hide the fact that Chinese productivity remains
well below that in many other markets, as Figure 3 shows.
While mainland China’s rapid improvements over the
decade to 2012 mean it has nearly caught up with Thai
productivity, GDP per person employed continues to
lag behind Mexico and Turkey, and remains below the
world average. Chinese productivity is still less than a
quarter of that of the average worker in the US. Improving
productivity through education, ICT and fruitful
innovation is thus critical to the future prospects of the
Chinese economy.
Figure 4: Mainland China’s share of global FDI inflows
is set to rise, but the full extent will depend on
progress with other reforms
1980
markets, productivity in the US grew by just 13.2% over
the decade to 2012, while across the eurozone as a whole
it rose by just 6.4%. In these advanced economies, where
education is already high quality and nearly universal and
ICT provision generally strong, there are relatively fewer
productivity gains to be made.
Source: United Nations Conference on Trade and Development, Cebr analysis
The share of global FDI inflows to mainland China, by
contrast, is expected to rise gradually over the coming
years, from 9.0% in 2012 to 13.3% by 2020. This is due
to mainland China’s growing dominance of the global
economy, assuming that the mainland’s economy
continues to be gradually opened to foreign investors.
Hong Kong is also expected to account for a slightly
larger share of global FDI inflows in coming years, as it
continues to act as a gateway to the Asian-Pacific region
for multinational corporations. Increased liberalisation
of the mainland will limit this growth, however, by
allowing firms to establish bases in China itself rather
than expanding in Hong Kong. The SAR’s share of global
inwards FDI flows is expected to rise from 5.5% in 2012 to
6.0% by 2020.
Mainland China
Thailand
World
Mexico
Turkey
Germany
eurozone
UK
Hong Kong
US
2002
2012
Source: World Bank
Foreign investment in mainland China
expected to rise and bring additional
benefits in skills and know-how
In addition to the skills benefits Chinese firms can gain by
investing abroad (see the Q1 2014 version of this report),
investment by foreign companies in mainland China
(foreign direct investment, FDI) can provide a boost to
knowledge and know-how, raising labour productivity
through the transfer of skills and ideas. The size of
mainland China’s domestic market – the largest country
on the planet by population – means that it is inevitably
attractive for firms hoping to reach its consumers. Growth
in the eurozone is expected to remain relatively weak over
the next five years, so there is little prospect of this region
regaining the share of global FDI inflows it enjoyed in the
years immediately before and after its formation. Similarly,
while the US’s share of global FDI inflows should rise as
its economy accelerates it is unlikely to regain its past
peaks as other markets now offer much greater growth
prospects. Over the decade to 2012 the US accounted for
around 13% of global FDI inflows, which is expected to
rise to around 15% by 2020.
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Encouraging more FDI inflows to mainland
China could provide greater returns to the
domestic economy
Although mainland China’s size makes it an attractive
destination for FDI, other factors make it difficult for
foreign firms to invest. Moreover, with economic growth
slowing, China must increasingly compete with other
economies in South East Asia for foreign investment flows.
The Heritage Foundation’s Index of Economic Freedom,
illustrated in Figure 5, considers a range of variables which
influence a foreign company’s decision to invest overseas.
These include:
• rule of law – including property rights, corruption and
legal enforcement;
• freedom to invest – for example, limits on foreign
ownership of companies or access to foreign exchange;
• freedom to trade with other countries (including the
level of tariff barriers);
• freedom in business (management structure and
regulation); and
• freedom of labour, including regulation of working
hours, redundancy payments, barriers to hiring and
firing workers and minimum wage legislation.
Higher scores indicate greater freedoms. As Figure 5 shows,
mainland China scores relatively poorly on this index – it
ranks 137th out of 186 countries, below other emerging
markets including Brazil, Turkey, Thailand and India.
ECONOMIC INSIGHT – GRE ATER CHIN A
Q2 2 014
While the restrictions reflected in this index remain in
place, Hong Kong – the place in the world with the most
economic freedoms, according to the measure – will
continue to benefit, as firms seek an alternative location.
The SAR obtains a nearly perfect score for business
freedom, with an investment freedom score higher than
the US and equivalent to the UK.
100
80
60
40
US
Hong Kong
SAR
UK
Germany
Macau
Mexico
eurozone
Turkey
Thailand
Brazil
Indonesia
India
0
Vietnam
20
Mainland
China
Index of economic freedom, 2014
Figure 5: The size of mainland China’s market makes it
an attractive destination for FDI, but regulations make
life difficult for foreign investors
Source: Heritage Foundation, 2014
The reform plans already set out by the mainland
authorities should improve the economic freedom of
international firms to invest in China. While the planned
overhaul of the financial sector must be carried out
carefully to avoid unnecessary shocks to the economy,
pushing planned changes through and examining
other ways to transfer foreign skills and knowledge to
the Chinese economy (for example through Free Trade
Zones) should be prioritised to support GDP growth over
the next decade – a critical period for mainland China’s
economic future. Changes to FDI laws eg, removing
restrictions on the industries where foreign firms can
invest, would help to boost mainland China’s skills in
the services sector and the medium-skill and technology
manufactured goods, such as vehicles and specialised
parts for industrial machinery, where it currently lags
behind. Analysis by the United Nations Conference on
Trade and Development finds that mainland China is still
mainly engaging with the lower-end of global valueadded chains, while the world’s largest multinational
corporations control the parts of the global production
chain associated with the highest value-added. By
engaging more closely with these companies, particularly
in the high-skilled manufacturing and services sectors,
mainland China could boost its inwards FDI flows and
reap rewards.
China’s slowdown is expected to be well
managed, while Hong Kong and Macau will
continue to benefit from deeper integration
with the mainland
The path of reforms mainland China is following will
slow GDP growth over the coming years, as the economy
works through structural change. While the accumulation
of risk in the shadow banking sector would pose a risk to
the broader economic outlook if a disorderly default were
to occur, initial evidence suggests that action is being
taken to gradually deleverage the economy. Despite this,
mainland China’s growth is likely to be slightly under the
official target of 7.5% this year, at 7.3% – still presumably
within a range considered acceptable by the government.
The relatively steep quarter-on-quarter decline in
outlook from Q4 2013 suggests the economy has come
off the boil, and although retail sales remain relatively
strong, further deceleration in investment is expected
as the regime battles against surplus capacity. While
the response to slow trade data in March and slower
growth in Q1 2014 has included a slight acceleration
of planned infrastructure spending, there has been no
hint of a broader stimulus package, suggesting that
the government is happy for GDP growth to decelerate
slightly this year. This slowdown is expected to continue
over the coming years, with the pace of expansion falling
to 7.0% in 2015 and 6.8% in 2016, as the economy
gradually moves to a more sustainable growth path.
Hong Kong is expected to see GDP growth accelerate
in 2014, to 3.8% from 2.9% in 2013. It will benefit from
increased demand from advanced economies as the US
and eurozone both pick up pace. Additionally, although
Chinese demand growth is set to slow over the coming
years, demand for Hong Kong’s services exports is likely to
remain relatively robust. GDP growth is expected to rise
slightly to 3.9% in 2015, and to remain strong at 3.7% in
2016, dented only slightly by a fall in domestic property
prices.
Economic growth is expected to remain in double
digits in Macau over the forecast period, mainly due
to the peninsula’s casino clientele. Gambling revenues,
which account for nearly half of GDP, rose by 18.6% in
2013 and are expected to continue to rise at a similar
rate. Investment will also boost growth this year, as
development continues on the Cotai strip, pushing the
pace of economic expansion to 12.2%, up from 11.9%
in 2013. The completion of some of these investment
projects will reduce growth slightly in 2015, to 11.4%,
but it is expected to rebound to 11.8% in 2016 as these
developments begin to bring in revenue.
Figure 6: The economic outlook for mainland China,
Hong Kong and Macau over the next three years
14
% annual GDP growth
12
10
8
6
4
2
0
Mainland China
2014
Hong Kong
2015
Macau
2016
Source: Cebr analysis
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ECONOMIC INSIGHT – GRE ATER CHIN A
Q2 2 014
1 World Bank Institute, Measuring Knowledge in the World’s Economies: Knowledge Assessment Methodology and
Knowledge Economy Index, http://siteresources.worldbank.org/INTUNIKAM/Resources/KAMbooklet.pdf
2 Survey carried out by the American Chamber of Commerce
3 James Zhan, (2013) Director of Division on Investment and Enterprise of United Nations Conference on Trade and
Development (UNCTAD), Rise of the Service Economy and China’s Inward and Outward FDI Strategy.
For enquiries or additional information, please contact:
Vivian Yu
T +86 10 8518 8622
E vivan.yu@icaew.com
Cebr
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