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China: Becoming the Next Economic Superpower

When federal Natural Resource Minster Herb Dhaliwal gave the keynote address at the 89th Annual Meeting luncheon last January, he strongly suggested that Canada look to markets other than the United States or Europe.

Look east, Dhaliwal said, notably to India and China — a consumer market that is potentially three times larger than the combined markets of Europe and North America. Since at least the early 1990s, Asia has been touted as the next region that will experience rapid (yet solid) economic growth. Where other nations have failed to meet western expectations, China has not. In the last five years, its economy grew at an annual average rate of 7%. (Growth is typically measured in gross domestic product, or GDP.) This year, China’s GDP growth is expected to hit 8%.

The country of 1.3 billion people has adopted a principle that it calls, One Country, Two Systems, which, by all accounts, is a gradual, calculated move away from a state-controlled socialist economy, marked by centralized planning and currency controls, to a free-market system of capitalism and consumerism, marked by foreign competition and political reforms.

Its promises of political and economic reform have fallen on receptive ears. After 15 years of assiduously trying, it became a member of the World Trade Organization (WTO) in December 2001, and a couple of weeks later, gained Permanent Normal Trade Relations with the United States, giving it preferential treatment on tariffs. No doubt, the last few years have been heady ones for China.

“China has certainly exceeded all expectations,” said Allan Seychuk, an international economist with Royal Bank of Canada in Toronto. “There is a rapidly growing willingness to slowly open its economy to western ways of doing business.”

There’s more. Chinese leaders have put forward some ambitious economic plans. “It has set an official target of annual GDP growth of 7% for the next 20 years,” Seychuk said. “And they certainly have some momentum in achieving that target.”

China’s growth stands in sharp contrast to other nations, including Canada, the leader among G7 industrialized nations. In Canada, the economy grew at an impressive 3.3% in 2002, and it is expected to achieve similar growth in 2003. (In contrast, the United States posted GDP growth of 2.5% in 2002.)

To be sure, the quick economic growth that China is currently undergoing is common in small developing nations. But when it takes place in an economy the size of China, Seychuk said, “it has a worldwide economic impact. And we are starting to see the result of that impact with each passing year.”

Buying wood pulp

To be sure, there’s a good reason to keep an eye on economic indicators like GDP, said Donald J. White, president of St. Anne-Nackawic Pulp Co. Ltd. in Nackawic, NB. “Paper consumption tends to follow GDP growth. For example, when in South Korea, the economy grew at an average rate of 5.6% a year, per capita paper consumption grew at the same rate — 5.6%. That’s a substantial increase.”

In South Korea, per capita paper consumption stands at about 168 kilograms. In China, it is about 10 kilograms, slightly less than 6% of Korea’s paper consumption. As White noted: “If you double China’s consumption to 20 kilograms per person, that’s another 10 million tonnes of pulp. The market potential is huge.”

Although China officially has more than 5,000 pulp and paper mills, most are tiny non-wood fibre mills. For a number of reasons, notably environmental and economic, these small Mom-and-Pop-type mills are facing shutdown. “The Chinese are getting into world-class paper mills,” White pointed out. “When you move to these types of operations, you need wood fibre to run it.” (See sidebar: Running on wood pulp.)

White worked for a pulp mill in Prince Albert, SK, when China bought 30,000 tonnes of pulp in the late 1980s. “That was the first time that we had any indication they were getting into the purchasing of softwood pulp,” he said. Chinese firms typically make block purchases, and not sign long-term contracts. “I suspect that half of the pulp going into China are spot purchases,” he said.

Although China is buying pulp from Canada, as well as Brazil and Indonesia, it imports most of it from Russia, which has easy access to the Chinese market, geographically and economically, if not politically as a former Communist nation. That benefits Canadian producers, because as White explained, “It removes Russia and Indonesia from our traditional market of Europe.”

Removing trade barriers

Still, some inequality exists. When exporting pulp, Russia pays 8.5% value-added tax, or VAT, whereas Canada pays double that amount, or 17%. “That’s a huge discriminatory measure,” said Avrim Lazar, president of Ottawa-based Forest Products Association of Canada, a government lobby group.

Canadian newsprint currently producers pay a VAT of 8.5%, which is supposed to gradually decrease to 5% in 2006 — and eventually decrease to zero. Still, China has applied anti-dumping duties against South Korea, U.S. and Canada with rates ranging from 57% to 78%. “We expect the newsprint anti-dumping levies to expire in July,” Lazar said, “and hopefully they won’t renew it.” (China’s membership in WTO should offer some persuasion.)

The Chinese government is keeping high tariff barriers in place to give its home-grown industry enough time to compete. For example, it started up Shanghai Hanosl Potential mill in 1998, a PanAsian venture.

Even though no Canadian company has invested in any paper mill in China, Scandinavian producers like Stora Enso and UPM Kymmene have made significant investments in China, initially through joint-venture arrangements with Chinese firms. A joint-venture approach is often the best way to get a foothold in China. “If you are looking for a joint-venture partner in China, it has to make political, cultural and business sense,” said Nelson Guerra, a partner with Guerra International, a Montreal-based management consulting firm that helps Canadian businesses network in China. (See sidebar: Chinese etiquette: have patience.)

For example, the Scandinavians have built three large paper mills near Shanghai, arguably the commercial capital of China: Stora Enso Suzhou Paper, a 150,000-tonne/year (t/y) mill; UPM Kymmene-Changsu, a 200,000-t/y mill; and APP Dagong, a 900,000-t/y mill. Equally important, suppliers like Metso, Eka Chemicals, Johnson Corp. and Imerys have set up shop in China, some dating to the early 1990s.

Although China has taken a gradualist approach to economic (and political) reform, trying to avoid the mistakes of neighbouring nations like Indonesia and South Korea, which precipitated the Asian Crisis of the early 1990s, it has to move fast enough to ensure that domestic demands are met.

Simply out, China has little choice but to move to a market-based economy. Communism and its economic system have been a colossal failure, collapsing under its own weight. Here are some sobering facts:

About 415 million people are employed in a country home to 1.3 billion people.

Each year, 10 million people enter the workforce.

Each year, 10 million people are laid off from money-losing state-run enterprises.

About 150 million Chinese from rural areas, many underemployed, are looking for work in such major urban centers as Beijing and Shanghai.

China’s official unemployment rate is 3.8%, but many economists say it is much higher. China has to generate annual GDP growth of between 7% and 8% to keep the unemployment rate stable.

That partly explains China’s push for GDP growth, if only to meet the needs of the domestic market and quell any potential social unrest resulting from reforms that put millions of people on the streets out of work. High unemployment and a dissatisfied public sow the seeds of dissension, something that the Chinese government is sure to keep under check.

Observing human rights

Which raises the ugly issue of human rights and trade. Not everyone is sanguine about trading with China. Chinese dissidents, for one, have voiced grave concerns about human rights
abuses in their native land. Their comments have been well-noted in the Western press. “As a westerner, what I saw in China was world’s apart from what the western media often reports,” Guerra said.

“The speed of China’s political reforms are fast enough for western businesses,” Seychuk of the Royal Bank said. “They may not, however, be fast enough for western governments.”

Perhaps so. Yet, May Zhang, who was born and educated as an engineer in China and is also a partner with Guerra International, said that the changes taking place in China have caught the interest of many foreigners. “There are so many foreigners today in China, many looking for business opportunities.”

And although China is slowly privatizing state-owned businesses, China is not for sale to the West, Guerra noted. “The state is taking a very deliberate, calculated, structured and business-like approach to privatize the economy. China is open to the West, but it will safeguard its interests,” he added.

Under WTO guidelines, China has five years to gradually open its markets to foreign competition. In short, by December 2006, China has to allow foreign companies entry to 49% of its markets. Two of the sectors that Canada is earnestly seeking out are banking and telecommunications, the backbone of the economy. “Banks are currently state-owned,” Zhang said. “No private banks exist. And it’s pretty much a cash society.”

Building long-lasting links

“In the long run, the Asian market will be serviced by Asian facilities,” Lazar pointed out. Still, there are a lot of good reasons for Canadian companies to get involved, to some degree, with China. Take your pick: a fast-growing economy, a large consumer market, a highly skilled, educated, and low-wage workforce, and political and economic reforms that promise to gradually open the market to foreign competition.

To be sure, to prosper in that market requires some important ingredients. “You have to be big to get in and succeed, requiring staying power, size and capital,” said Craig Campbell, partner, Global Forest & Paper Practice for Vancouver-based PricewaterhouseCoopers, a consulting firm. “For a paper company, it depends on how much risk it wants to take on, with the potential for a lot of rewards.”

That’s says volumes. Most Canadian producers tend to be, by nature, highly risk-averse, tending to leave risk-taking to the Americans and Scandinavians. Canadian companies like St. Anne-Nackawic considered opening a mill in China, but decided that the risks for doing so were too great. “It wasn’t the right time,” company president White pointed out.

Still, Canadian companies do not risk losing out if they wait a few years, at least until China develops a better banking system and a legal and regulatory framework that is fair and transparent. ” The market is so big that there is enough room for everyone,” Campbell said.

RUNNING ON WOOD PULP

China has made great strides in reforestation, planting some 35 billion trees since 1981, when it started a serious reforestation program. Its forested area now covers 1.4-million square kilometers — equating to almost one-sixth of its landmass of 9.3-million square kilometres. (As a comparison, although Canada’s landmass is similar to China’s, Canada benefits from having more than 50% of its land richly covered with forests and woodlands.)

Each year, loggers in China harvest 240 million cubic metres of wood. The pulp industry, however, consumes a small fraction of that total, about two million cubic metres. Historically, China has used non-wood sources like bamboo, bagasse and wheat straw to make paper. But to run modern paper machines, it needs wood pulp.

Accordingly, it has almost doubled its imports of pulp from 2.7 million tones to 4.7 million tonnnes in the last two years. “And they forecast to increase its imports of wood pulp to 6.7 million tones within the next four years,” said Donald J. White, president of St. Anne-Nackawic Pulp Co. Ltd. in Nackawic, NB.

BUILDING A CASE FOR MORE WOOD

The use of wood products is expected to increase in China, as it builds a large, consumer-driven middle-class. When that takes hold, sectors such as furniture-making and housing will likely see an increased use of lumber products.

For one, the Chinese government plans to create 5,000 satellite cities, which will boost demand for housing solutions, said Avrim Lazar, president and chief executive officer of FPAC. “For residential housing, they are expected to reduce the use of brick, and use more concrete and wood.”

The housing code will have to be updated to incorporate the use of wood products, notably two by fours. “We are working closely with the Chinese government to help them update their housing codes and standards to use more wood,” said Herb Dhaliwal, federal minister of natural resources.

Toward that goal, Canada has set up a Wood Office in Shanghai. Part of its mandate is to teach the Chinese construction industry how to effectively use wood as a residential building material. Equally important, it has to change the view that the Chinese hold of wood. “There is a perception among the Chinese that wood is not a reliable building material,” said May Zhang, a Chinese native and partner with Guerra International, a Montreal-based consulting firm. “In China, the prevailing view is that a concrete structure is more solid, a place where you can live for the rest of your life.”- PJG

CHINESE ETIQUETTE: HAVE PATIENCE

China is a huge populated country, where 51 ethnic minorities reside, each having some differences (often minor) in customs and ways of doing business. Such variations make it almost impossible to establish the Five Easy Rules of Business. Common rules, however, do exist.

For example, business is carried out round the clock. “The Chinese are a very commercially driven people,” said Nelson Guerra, partner with Guerra International Management, a Montreal-based consulting firm that helps Western companies enter the market in China. “That’s evident in the 24-hour business cycle in metropolitan areas like Beijing and Shanghai, which never sleep.”

As well, don’t look for the quick deal. “If you want to do business in China, you have to think long-term and build relationships,” said May Zhang, also a partner with Guerra International and a native-born Chinese. “Once you’re there, you must have patience, patience, and more patience.”

Perry J. Greenbaum is an award-winning business and technology writer.#text2#