Wanted: A New Miracle

Huang Shaobi was just 7 years old, growing up dirt poor in southeast China, when the world she would inherit changed forever. It was 30 years ago–December 1978–when China’s leadership decided the time had come for their country to open up its economy and embrace something akin to capitalism. The monumental shift–China under Mao Zedong had been a centrally planned economic disaster–reflected the growing, behind-the-scenes influence of a man few in the West had then heard of: Vice Premier Deng Xiaoping. China, the ruling Communist Party decreed back then, “required great growth in the productive forces.” And Deng was smart enough to know that it would come in only one way. China would get on the road to capitalism.

Today, Huang, who has chosen a Western name, Colleen, works in a gleaming office tower in the manufacturing center of Guangzhou in southern China. At 37, she is the very image of a polished chief executive officer, right down to her Milano briefcase. Huang is the founder of an advertising agency that employs nearly 70 people in three Chinese cities and counts as customers major multinational companies, including Procter & Gamble and Sony Ericsson. Like so many of her generation, Huang never looked back after racing through the door that Deng’s economic reforms opened, and her accomplishments show how far the country has come. But just a few miles from Huang’s office, the evidence is everywhere to see that China’s capitalist road is leading toward a wall, that the first phase of its 30-year economic miracle has run its course.

Every day at the Guangzhou train station, hundreds of migrant workers wait to start the long journey back to their home provinces. They have been laid off from jobs at toy and textile factories and construction sites throughout what used to be a booming province. Among them is Zhang Dingli, 36, who worked at a toy factory for a decade. But in early November, the plant closed. He is a victim of an economic transition–a move away from the low-end, low-wage, export-oriented manufacturing on which much of China’s rapid growth was built–that has been made more urgent by the global economic crisis. As China’s double-digit growth rate plummets, thousands of factories are being shut down, and millions of workers are being thrown into the streets. They will need jobs in the years to come, and the Chinese government is scrambling for an answer to Zhang’s plaintive question as he prepares to return to his native Sichuan province: “What am I going to do after I get home?”

China needs a new economic miracle–and the trajectory of the global economy may depend on whether one can be conjured up. China, theoretically, should be one of the locomotives that will eventually help pull the world out of its slump. That won’t happen overnight; overhauling the world’s fourth largest economy is going to take some time. For the moment, to tread water, Beijing is slashing interest rates and frantically throwing money at infrastructure projects, much as U.S. President-elect Barack Obama promises to do in America. But ditch-digging on a national scale, Beijing knows, will not take China where it needs to go. Only if leaders execute a series of complex alterations to the foundations of China’s economic growth will the country maintain its momentum. “The [global slump] is absolutely accelerating the fundamental changes that were already taking place,” says Daniel Rosen, a former senior adviser in the Clinton Administration, now a principal at the Rhodium Group, a New York City–based economic-consulting firm. “The Chinese may have understandably felt entitled to relax a bit after 30 years of wrenching change. Unfortunately, they can’t.”

Turning Savers into Spenders

The goal for China’s transition sounds straightforward enough. “We’ve become a big economy,” says Wang Zhenzhong, an adviser to the Chinese government and director of the economic-research institute at the Chinese Academy of Social Sciences (CASS). “Now we need to become a strong economy.” In a nutshell, this means becoming a bit more like Japan by developing domestic, technologically formidable manufacturers, rather than just making a lot of inexpensive stuff for the rest of the world. It also means becoming a bit more like the U.S., where over the years, factory jobs have been supplanted by the growth of the service sector and knowledge-based companies. China’s need to emulate America may seem counterintuitive at the moment, given the parlous state of the U.S. economy. But it is precisely because tapped-out American consumers have stopped buying Chinese-made goods that this economic rebalancing act needs to proceed with haste. The country’s factories need new customers. Chinese consumers can fill that void by spending more and reducing their stratospherically high national household savings rate, which stands at more than 25%, compared with a savings rate in the U.S. that hovers near zero. China needs to start creating new jobs by boosting its underdeveloped service sector, which contributes just 40% to overall GDP, compared with 79% in the U.S. In that way, the country can reduce its dependence on exports and continue to grow, thereby increasing its role as an outlet for the goods and services produced by the rest of the world.

Can technocrats in Beijing pull this off? The country has an advantage: it has not yet leveraged its enormous domestic market. The service sector has huge potential. Consider entrepreneurs like Colleen Huang. Instead of employing low-wage metal benders, her ad agency, Rayken, provides jobs for young, middle-class professionals: graphic designers, art directors, a couple of account executives and several copywriters.

This is unremarkable, of course. It’s what advertising agencies do. What is remarkable is how few Chinese companies like Rayken exist. China’s service industry is shockingly underdeveloped for an economy that will likely be the world’s largest by 2050. In a country of 1.3 billion people, only about 5 million work in health care, just 2 million in jobs related to the environment and conservation, and only 4 million in banking and insurance.

This needs to change–and it has started to. Beijing plans to increase the service sector’s overall contribution to the economy by three percentage points by 2010–to 43% of GDP–and by 10 points a decade from now. Earlier this year, the government ordered state-owned banks to step up lending to service-sector companies. Beijing has also begun to break down barriers that have prevented foreign companies from investing in highly regulated areas of the economy. Health care, which should generate an enormous number of jobs as China’s population ages rapidly, is one example. Taiwanese companies have already invested in 14 hospitals across the country–and see that as only the beginning. Says Michael Tseng, an executive at Taiwan’s BenQ Corp., which runs a hospital in Nanjing: “China was the world’s factory, but manufacturing is yesterday’s story now.”

How quickly a new story can be written may depend largely upon the Chinese becoming a whole lot better at consuming more and saving less. But while the authoritarian government continues to pull the strings in many parts of society, Beijing cannot simply order citizens to buy Gucci for the good of the country and the world. The Chinese save much of what they earn because the government has yet to provide the web of social services available in other countries. China’s national social-security system and government health-insurance schemes are drastically underfunded; moreover, they don’t cover the millions of migrant workers who helped power the country to high growth but are now being laid off.

The lack of safety nets demands frugality, as does Chinese cultural tradition that all but dictates that working children care for their parents as they age. Even ad-agency chief Huang takes care of her parents. This requires the Chinese to accumulate very large nest eggs, particularly because China’s long-standing one-child policy means there is often just one offspring caring for two parents.

The government is committed to freeing up discretionary spending. Earlier this year, Beijing vowed to double the size of the national social-security fund, to $147 billion by 2010, and to steadily increase it thereafter. “This,” says CASS economist Wang, “is like turning around an ocean liner. But at least we’ve started to turn.”

A High-Tech Solution

To economic policymakers, the real meaning of becoming a strong economy lies beyond getting citizens to spend more and expanding the service industry. The next Chinese miracle, at root, will mean becoming a first-rate technological power. China’s road ahead was on display in Shanghai in early December, when a San Francisco–based company called the Cleantech Group hosted a venture-capital forum aimed at driving investment dollars toward alternative-energy entrepreneurs on the mainland. Opportunities appear to be plentiful, despite the dim economic environment. Forum attendee Patrick Tam, CEO and general partner of Beijing Tsing Capital, says he is investing heavily in Chinese clean-tech companies–most recently in a Beijing firm called NetPower Technologies, which makes a battery that helps power-hungry businesses reduce their electricity consumption. “The government is just letting the venture-capital market rip in this field,” says Tam. “It’s exactly what needs to happen to develop new technologies and new jobs in China. I think in a lot of ways this is our future.”

It’s a compelling vision: China as a high-tech powerhouse. But making it come true will take years, and there are major obstacles. Idea theft is the biggest. Though the country has made progress in strengthening intellectual-property rights over the past several years, rampant piracy of software, music and other intellectual properties remains a huge issue. “People with the ideas have to be protected,” says consultant Rosen. “They’ve moved on this because they know without it, a high-tech China remains a dream.”

The next miracle, in other words, will be harder to pull off than the last one. That doesn’t mean it won’t happen. Consider what in 1978 constituted a “rich” eligible bachelor in urban China: he had to own a radio; he had to be able to buy his bride a fashionable wristwatch made by a state-owned company no one would ever confuse with Rolex; and he had to commute on the coolest set of wheels available–a bicycle called the Phoenix.

In just three decades, China has remade its world. For all the challenges the country now faces, is it wise to bet against it happening again?