As we enter 2017, China’s economy continues to evolve beyond exports of cheap manufactured goods and government infrastructure spending. Given China’s economic outlook including the risks involved with this transformation, we remain bullish on the opportunities in China for the world’s suppliers of products and services that support the new economy of higher-quality manufacturing and service businesses.

Update on China’s Economy
Once again the sense of doom over the China economy and its diminishing role in supporting world growth has been shown to be an exaggeration. China’s growth at 6.8% in the fourth quarter means that 2016 was close to its 6.7% plan. As we have said many times, there is considerable room for error in Chinese growth data, given China’s status as a very large, very diverse economy, and still a low-income, developing country across much of its geography.

As China shifts its growth model toward more services and more local consumer product sales, measurement becomes more complicated. We, in the United States, have trouble tracking services, and China’s developing country status makes it much harder.

Contributing to the skepticism regarding the quality of China’s growth reports, Liaoning Province recently admitted that local leaders were over-reporting growth from 2011 to 2014. Leaders in China are appointed and, for these individuals, doing a good job measured by GDP growth leads to better future assignments—for example, in new, larger cities or regions. So, it’s not a shock that local leaders would err on the side of overly rosy reports.

At the same time, the Liaoning example highlights how difficult it is to hide consistent misreporting extending over time. Eventually, the reported expansion no longer concords with observation and is uncovered. We believe that China’s slower, but still high, growth presents a fairly accurate picture of the opportunities in China. There’s politically-driven overreporting without question; however, there’s undoubtedly considerable underreporting as well, due to the hard-to-measure takeoff in services, eCommerce, and development in remote areas that is obvious when visiting these locations.

While growth is largely on track, the path of change is a difficult one. The government has stepped in with spending to jump start growth during slower times. It doesn’t represent lack of resolve, but rather pragmatism in supporting stability while the source of growth in the economy shifts.

Risks
We have discussed at length the risks inherent in China’s transformation to a modern economy from one driven by government, while keeping growth on track. Having lost its ability to be the lowest-cost producer of simple products due to dramatic increases in wages, China has no choice but to replace those low-value product sales with higher-end, innovative, and/or complex products.

The United States election added a new worry. President Donald Trump has accused China of unfair trade practices and manipulating its currency. The former is a long-standing irritant and the debate will go on, even as China moves up-market in terms of its exports. The Chinese leadership has positioned itself as pro-free-trade and is leading the effort to promote free trade across Asia. In mid-January, President Xi Jinping became the first Chinese leader to appear at the annual gathering of the World Economic Forum in Davos, and there he delivered a keynote speech that defended global trade and criticized protectionism.

The belief that China managed its currency to promote competitiveness was true in the past, but at present is misguided. Most economists agree that the renminbi is overvalued, having followed the dollar higher. Nonetheless, the potential for economic disruption caused by trade friction must be factored into planning, though we are optimistic that cooler heads will prevail after a period of public posturing and negotiation plays out.

Opportunities in Industrial Transformation
The continuing restructuring of the Chinese economy is a long-term process that the Chinese ideally will manage toward gradual but steady progress. The government’s goals will stay firm because they are driven by basic economics: the Chinese economy no longer is viable as a low-wage economy that can produce commodity products. The Chinese recognized that reality a couple of 5-year plans ago and its companies have been trying to move upmarket in their production and export structure.

It is difficult to get fast results from government-led innovation, but government-supported investment in manufacturing technology is more viable and what we see happening. Being a successful manufacturer means that China must produce better outputs and produce them with less labor.

A manufacturing sector with investment driven to overcome one of the fastest wage increases in history should be a call to action for the world’s suppliers of manufacturing equipment, factory and process automation systems, and solutions. Indeed, the market is growing very fast, supplied by both foreign and Chinese companies, each sharing about half of the market today. This market has also changed from the “old days” when Chinese suppliers of equipment, systems, and solutions were not credible and all but the extremely price-sensitive customers bought from foreign suppliers.

In automation, local Chinese suppliers, many of whom began as channel partners representing the United States or European companies, have grown to be serious competitors. In many cases, we have seen a progression from dealer of spare parts to systems integrator with technical skills and industry knowledge to manufacturers with a fully-integrated Chinese channel to market. So, in many cases, competition is intense.

Chinese local competitors are expected to keep increasing their market shares at the expense of foreign companies as the market continues to grow rapidly. So, for the world’s suppliers, a deliberate strategy is needed to focus on the best opportunities:

• Focus on growing end markets. Though there are some signs of recovery, sectors like mining, oil and gas, etc. continue to be depressed. Low-end manufacturing may try to automate before they disappear, but their business is not sustainable. So, one aspect of focus is to look for healthy, growing markets.
• Focus on demanding end markets. Customers in markets with global standards and/or having global ambitions are the best target. World-class solutions will be sought after by Chinese companies producing complex products who want to penetrate global markets. In the past, manufacturers meeting that description were themselves foreign, in global industries like autos. More and more of the market is local Chinese companies, but more are also seeking to compete on level playing fields in global markets.
• Benchmark your value against local competition. The local competition may have less experience and less of a track record, so buying from them to run a factory may mean taking a risk. Sophisticated customers in the Western world won’t accept risk of downtime and they also seek flexibility so that they can manage and update as their needs change. Chinese companies tend to focus much more on getting the job done and they tend to favor simpler over more flexible. In automation, “Set it and forget it” is favored over “Can do anything with the right operator.” Experienced employees are still difficult to find and train, so solutions that need less management are favored. What provides value in other markets might be a disadvantage in China, so it’s important to be both flexible and realistic.
• Align with the right partners. In China’s market, it’s essential to work with well-connected business partners. Since business is based on relationships, the partner who is effective for doing business with government organizations is probably not the best partner for selling to Chinese private companies. The best partner in one geography is probably not the best partner for every geography within China. Also, well-connected partners are not necessarily skilled in the technical aspects. Finding the right partner with the capabilities to drive business without outstanding supplier support may be very difficult.

With a national focus on manufacturing to produce better quality and innovative products, market opportunities will be good for many. At the same time, the local competition is very good and getting better, so the competitive landscape is more intense and complex than it once was.