China and the world: Inside the dynamics of a changing relationship
The relationship between China and the world now is changing. Accompanying this shifting exposure are the signs of stresses in the relationship. Trade disputes are making daily headlines, new rules are emerging to evaluate technology flows, protectionism is on the rise, and geopolitical tensions are becoming more heated. The way ahead is uncertain. Could we be at peak integration between China and the world after the years of deepening ties? Conversely, what opportunities could more engagement offer? What value could be at stake for all players?
China became the world’s largest economy in purchasing-power-parity terms in 2014. In nominal terms, China’s GDP was 66 % that of the United States in 2018, making it the second largest economy in the world. On the MGI Connectedness Index that ranks participation by flows of goods, services, finance, people, and data, China was the ninth most connected country in the world in 2017. In 2018, China accounted for 16 % of world GDP. However, China’s journey to global prominence has been uneven. To gauge the extent of China’s integration with the world, we look at eight dimensions of China’s global scale and integration.
Focusing on three of the eight dimensions, MGI has analyzed the mutual exposure of China and the rest of the world on trade, technology, and capital. From 2000 to 2017, the world’s exposure to China has increased on all three, while China’s has fallen (Exhibit 2). MGI’s new China-World Exposure Index measures the relative importance of these economic flows for the Chinese and global economies compared with other large economies. The rest of the world’s aggregate index rose from 0.4 in 2000 to 1.2 in 2017, while China’s exposure to the world peaked at 0.9 in 2007, and has declined to 0.6 in 2017.
China’s declining exposure partly reflects its rebalancing of the economy toward domestic consumption. In 11 of the 16 quarters since 2015, domestic consumption contributed more than 60 % of total GDP growth. In 2017 to 2018, about 76 % of GDP growth came from domestic consumption, while net trade made a negative contribution to GDP growth. As recently as 2008, China’s net trade surplus amounted to 8 % of GDP; by 2018, that figure was estimated to be only 1.3 %—less than either Germany or South Korea, where net trade surpluses amount to between 5 and 8 % of GDP. Rising demand and the development of domestic value chains in China also partly explain the recent decline in trade intensity at the global level. China is consuming a larger share of output produced. These are significant changes that alter China’s priorities and shift the dynamics of its relationship with the world.
The increasing exposure of the rest of the world to China reflects China’s increasing importance as a market, a supplier, and a provider of capital. China accounts for 35 % of global manufacturing output. Although it only accounts for 10 % of global household consumption, China was the source of 38 % of global household consumption growth from 2010 to 2016, according to World Bank data. Moreover, in some categories including automobiles and mobile phones, China’s share of global consumption is 30 % or more. It is, as we have noted the world’s second largest source of FDI and its second largest recipient between 2015 and 2017. However, the exposure to China varies among sectors and countries, according to our analysis of 73 economies and 20 sectors.
China’s rapidly expanding consumer market confident, gradually richer, increasingly sophisticated, and willing to experiment offers a strong link between China and the world. It is not only the prime engine for economic growth but is a huge opportunity for international businesses. By 2030, 58 % of Chinese households are likely to be in the mass-affluent category or above (defined as household disposable income being 18,000 renminbi or more a month), surpassing today’s South Korean share of 55 %. The spending profile of urban Chinese consumers is converging with that of their counterparts in cities around the world.
China’s consumer markets are already heavily integrated with the world and penetration by multinational corporations is considerable. Across the ten large consumer categories, their average penetration was 40 % in 2017, compared with just 26 % in the United States. In some categories, penetration is even higher; for instance, in beauty and personal care, multinationals’ penetration is as high as 73 % .
Given the uncertainty and potential risk of the changing relationship between China and the world, businesses may need to adjust their approach. There are four areas for consideration:
Assess short- and long-term exposure to the China-world relationship. To understand the likely impact of changing relations between China and the world, companies should first assess their level of exposure to China-world relationship. Exposure can take many forms. Across the eight dimensions of Chinese scale and integration, there are specific metrics that businesses could examine and track. Depending on their exposure, companies can assess risks and benefits to the business depending on different engagement scenarios. Even in the face of short-term volatility and uncertainty, companies should also incorporate a view on China’s long-term fundamentals. What long-term trends including rising incomes, technology flows, and intensifying local competition may have an impact on the business?
Determine investment and value chain posture. Given the scenarios and value at stake for every company, executives should determine their China strategy in terms of investment commitment compared with other countries, and the role that China should play in the company’s global value chains. They should define and be clear about their aspirations for China—do they want to make China their key growth engine, or do they want to play only in niche areas, for instance? They could for example, optimize investment as part of a long-term strategy, potentially investing more and doubling down on core value creation activities by, for instance, driving innovation and R&D, if China remains an important source of growth and innovation. If not, shifting business activities and investment to other geographies could also be considered.
Develop operational excellence needed to manage risks and uncertainty. Given increased regulatory and economic uncertainty, companies need to be much more agile in delivering their value proposition. Governments around the world are playing an increasingly important role in cross-border investment, M&A, and flows of technology and people. Businesses need to pay attention to the local context in which they are operating as it can change quickly, sensitivities can grow, and operational mistakes can be made that in the past could be fixed easily and contained, but may, in this new era, quickly escalate, drawing the attention of stakeholders. They may think about adjusting their operational footprint, and need to be agile when making shifts, and they need to devote more resources to risk management.
Adopt and maintain a survivor’s mind-set. Companies that have thrived despite recession and crises in the past have tended to maintain a healthy balance sheet, take care to ensure access to finance, and have a broad range of businesses to insulate them from downturns in particular sectors. However, crises and uncertainty also bring opportunity; the pressure they bring can be a catalyst to reorganization that improves the long-term health of a company, and they can bring new opportunities to expand footprint or market position through business development and inorganic growth.