Helen Roxburgh 6 Sep 2018 12:22pm

China's economic upgrade

In 20 years China has transformed itself from poverty stricken state to $13trn (£10.05trn) international economic giant

Caption: Illustration by Coen Pohl

Traditionally, it was a manufacturing hub for the world based on a low-wage, high-export model. Now the government is generating a complex economic evolution

China’s government has been really pushing forward to move from an investment and export-led economy to a consumption and service driven economy,” says Tianjie He, senior economist at Oxford Economics.

“If China wants to keep its growth at a sustainable level, it will need to push the consumer side, which is one of the major expenditure sides of the economy, and keep the services sector growing quite fast.” China’s GDP is forecast to reach $13.2trn this year, outpacing the $12.8trn combined total of the eurozone for the first time, according to Bloomberg. Chinese premier Xi Jinping has also set targets to double per capita GDP to $10,000 by 2021.

“The current Five Year Plan is transformative because it’s all about upscaling the economy to be more market orientated, more private sector orientated, and over time, shift to a more market led economy,” explains Andrew Weir, vice chairman
at KPMG China.

This repositioning is outlined in the Made in China 2025 programme, which aims to position China as a global leader in sectors including aerospace, biotechnology, green technology and advanced manufacturing, and encompassing artificial intelligence and robotics.

The government has been giving strong support to entrepreneurs, with a series of innovation funds, the creation of smart manufacturing centres, tax breaks and even homebuying help. A huge consumer market hungry for new technology has proved the perfect testing ground for these new companies, with low privacy expectations and high levels of smartphone penetration.

“The larger population enables more ideas to be experimented with in China, and Chinese consumers are always willing to try out new things – that provides a platform for a lot of entrepreneurs and start ups to thrive,” says Lawrence Jin, partner at Deloitte and ICAEW China president. “China has one of the strongest capital flows into the start-up sector and new economies.”

The China Securities Regulatory Commission has also set up a fast-track process for start-ups looking to list, while Shenzhen smartphone makers ZTE and Huawei are now the world’s top two inventors, together filing almost 8,000 patents last year

China also has more unicorns – a privately held start-up company valued at over $1bn – than anywhere in the world. The Ministry of Science and Technology says China now has 164 unicorns worth a combined $628.4bn, while Boston Consulting found it takes Chinese companies just four years to reach unicorn status, compared with seven in the US.

“The days of China being seen as a low cost provider to the world are over,” says Weir. “So the winners are going to be technology, new energy, fintech, consumption markets – and the old heavy industries will need to reform.”

Manufacturing labour costs have increased by 80% since 2010, and many factories have been relocating out of China and across south-east Asia in search of cheaper production as China loses its competitive advantage. In addition, restrictions on imported waste in China forced plastics recycling factories into other countries, while tens of thousands of Chinese factories were shut down under strict pollution regulations. While China, the US and

Germany are currently among the 15 most competitive manufacturing countries in the world, a report from Deloitte predicts that in the next five years, Malaysia, India, Thailand, Indonesia and Vietnam will enter the top 15, picking up factories that move from China.

In addition to new economic policies at home, China is also looking outwards. The One Belt One Road (OBOR) initiative is an enormous geopolitical project designed to recreate old Silk Road trading links.

The project involves $900bn of investments in 60 countries and will connect China across Asia, Africa and Europe. China’s east coast will link with ports C including Sri Lanka, Pakistan and Greece, while the overland ‘Belt’ will run through Europe to Moscow and central Asia. The landmark initiative is based around Chinese-led investment in infrastructure such as bridges, energy and ports, and forms the backbone of Xi’s economic and international agenda. “Traditionally, China’s economic ties for investment and trade were with the developed countries, Europe and the US in particular,” says Jin. “I think the leadership now sees the potential, politically and economically, of stronger ties with less developed countries.”

The Asian Development Bank estimates the annual infrastructure investment needed for the project is at least $1.7trn until 2030. The region covered by OBOR will account for 80% of global GDP by 2050. Critics have claimed that OBOR involves government spending and employing Chinese workers, while keeping China’s domestic market largely cut off to global investors. But while economists are divided about its benefits, there is a consensus on the shift it represents.

“OBOR is really an iconic initiative, showing that Chinese companies are looking outwards and they have a big motivation to invest outside China,” says He. “If well managed we believe that the initiative will support long-term growth and offer development in the economies involved. It will raise China’s international influence and also eventually help the internationalisation of the RMB. And because it’s really about construction, it will benefit Chinese construction firms with a new source of supply outside China.”

“China is strategic,” agrees Weir. “It’s trying to invest in industries it sees as relevant to the development of China, all for a greater purpose.”

But this new outward facing economy could be placed in jeopardy by an emerging trade war between China and the US. Last year, president Donald Trump launched an investigation into China’s treatment of US companies, which concluded that China forces foreign companies to partner with Chinese companies to do business in the country, then requires them to hand over intellectual property. This investigation was the start of rising tensions, political posturing, and an emerging trade war. The US slapped billions of dollars of tariffs on Chinese imports, and Beijing responded in kind.

This spat over market restrictions, intellectual property rights and the US deficit could seriously damage economic growth, and diplomatic relations between the two global powers. Tech companies are on the front lines of this contest for world supremacy, which is nothing new, as China’s ‘Great Wall’ of censorship has long been a sore point for US tech giants.

Oxford Economics has estimated the impact of the two-way tariff, plus an additional anticipated $16bn in tariffs from both sides, will reduce GDP growth in both China and the US by about 0.1% in 2019. And it warns that in a “full-blown trade war” scenario, China’s GDP growth could be reduced by 0.7% in 2019. “China will need to double down on becoming technologically independent in the future,” says He. “China has a very big trade deficit with the US, so it knows it’s more vulnerable.”

“My sense is it’s a short term distraction that has highlighted a particular issue, and in particular the fundamental disconnect between what China has and what China needs,” says Jon Geldart, executive director for markets development, Greater China, at Grant Thornton.

And Beijing has become increasingly nervous of high levels of capital going overseas. Regulators clamped down on outbound deals in 2017 following an unprecedented flood of offshore acquisitions that drained China’s foreign exchange reserves. Now a new state framework encourages deals that fit China’s “strategic priorities” including avoiding the entertainment, sports and real estate sectors. Controls were further tightened in November by requiring central regulatory approval for large outbound deals. China’s outbound investment fell by 40.9% in 2017, according to official figures.

“The government has been tightening up capital controls, especially in particular industries,” says Jin. “In the second half of 2017, there was definitely a correction and a fairly sharp fall in outbound investment, both in terms of value and volume. But in terms of overall trends, I’m pretty confident [outward investment] is going to be a macro economic shift for many years to come.”

Domestic problems also threaten China’s growth, including falls in the property market, shadow banking, the need to cut pollution levels, high corporate debt, and an ageing population. The UN projects that a quarter of China’s residents will be over 60 by 2030, leaving the country with a shrinking labour force.

“You can’t lie about demographics,” says Geldart. “If you talk to people on the street, people in their 50s, even in their 30s, they are genuinely worried; will there be enough money left in the system to pay me even a meagre pension? And the answer is, possibly not.”

Despite storms on the horizon, China is still expected to see GDP growth of at least 6% annually for the rest of this decade, and to account for 30-40% of global GDP growth over the next few decades.

“The challenge will be how to handle the demographics, and the social aspects, and the more Western style mature economic challenge,” says Weir. “These will now come to face China. In 15 years time, will China be a very vibrant, modern economy? Yes. Will it have a challenge on demographics, on inequality, on the funding of healthcare? Certainly. And these are all things that they are going to have to face up to.”

Accountancy and ICAEW in China

Accountants in mainland China must be qualified by the Chinese Institute of Certified Public Accountants (CIPCA) or Hong Kong Institute of Certified Public Accountants (HKICPA) for the Hong Kong Administrative Region. ICAEW has been in mainland China for 11 years, and in Hong Kong the ACA is fully reciprocal with the HKICPA.

“We were invited by the Ministry of Finance to come to China and help build Chinese accountancy standards, jointly develop talent, to build convergence, and to help Chinese businesses go international,” says Andie Wang, ICAEW regional director for Greater China. “We worked closely with the national bodies, CIPCA and HKICPA, and we are the only international body given mutual exemption in China.”

In Greater China, ICAEW has 3,300 members, of which around 3,100 are in Hong Kong. A particular focus is on developing talent across the country, including launching the Women in Finance Network in Beijing in June, as well as a Leadership in Accountancy executive training programme.

Research is also key, and ICAEW established the Big Data and Accounting Research Centre with the Shanghai National Accounting Institute and Inspur, China’s leading multinational IT company.

As China’s business world matures and internationalises, there is an ever greater need for highly qualified accountants. According to the CIPCA, in 2017 there were 8,605 accounting firms in China and 105,570 certified public accountants, although Grant Thornton’s Jon Geldart estimates the country needs tens of thousands more.

“You’re never going to get rich working as an accountant in China, but you are going to make a difference,” he says. “China needs surety; the surety that is going to support the capital requirements, and the banking confidence that will allow them to grow and expand. The role the accountant can play in a well-managed Chinese business is enormous.”

The Big Four are prominent in China, with PwC the biggest in the country, but there are also large local firms claiming market share, such as Ruihua. “My view is that there is so much potential in terms of how this profession is developing, and so much hunger by the young people in China to get the right qualification and better themselves,” concludes Lawrence Jin.

“So I think there’s really a lot to play for, and there’s a lot of things we can do at the Institute to help our brand, help the Chinese government and the local institute, and really to invest in young people.”