Insight April 13, 2010, 10:30AM EST

Three Growth Megatrends in China

Chinese consumers are spending more, smaller cities are drawing more workers, and local factories are upgrading. Multinationals are adapting

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As fears of a double-dip recession fade, companies are looking once more to invest in potential growth areas. Foreign direct investment into China and emerging markets such as Brazil and India is on the rise again. FDI has climbed for seven straight quarters since August 2009, rising nearly 5% more in January and February than it did in those months during 2009, according to China's Ministry of Commerce. However, executives need to realize that major changes took place in China during the financial crisis. They should rid themselves of commonly held misconceptions about China's economy, then reconsider how the middle kingdom should fit into their business plans.

China is no longer just the world's workshop. Driven by rising incomes, for instance, China bought more from the rest of the world in March than the rest of the world bought from China, with a trading deficit of $7.24 billion. The country has become the largest auto market in the world, with over 13.6 million vehicles sold in 2009, vs. just over 10 million in the U.S. It is also now the second-largest market for luxury products, with Chinese consumers buying nearly $7.5 billion of them annually.

Aside from increasing domestic consumption, there are two further megatrends developing in China over the next five years that senior executives need to keep in mind. One involves Chinese labor: Instead of moving to find work in manufacturing centers in southern China or such first-tier cities as Shanghai and Beijing, more young people are moving to second- and third-tier cities such as Wuhan, Hefei, and Shenyang, where they can find good white-collar jobs closer to home.

Much of China's rapid growth over the last three decades was made possible by hundreds of millions of low-skilled Chinese laborers willing to leave their homes for months at a time to work in factories in southern China, making cheap products for such companies as Nike (NKE) and Apple (AAPL) for low pay. This is changing fast. There is a major labor shortage in Guangdong province right now. Younger Chinese are no longer willing to work in factories far from home with no opportunity for career advancement. With the number of university graduates having increased from 1 million to 6 million per year in the last decade, it is only going to grow more difficult to find young people willing to labor in factories for little pay, far from their families.

multinationals: following the workers

At the same time, prohibitively high housing costs in Beijing and Shanghai are driving younger white-collar workers to second-tier magnet cities such as Hangzhou or Nanjing, where the quality of life is high and entrepreneurship is thriving, especially in the high-tech sector. Too much of the local economies in Shanghai and Beijing is increasingly accounted for by the reemergence of large state-run enterprises, real-estate developers, and multinationals that offer little career potential to young Chinese who wish to make it big.

Many companies are migrating to where the costs of doing business are cheaper and where the workers are, bringing plum, high-skilled jobs with them. Applied Materials (AMAT) in October 2009 opened the world's largest commercial solar research and development center in Xian, for instance, and Intel (INTC) has relocated many China operations away from Shanghai to such cities as Chengdu and Dalian, It is in these regional hubs, as well as in third- and fourth-tier cities in their orbits, that incomes are growing fastest and where new opportunities are opening up for companies looking to expand their market presence. (See my column "Beyond Beijing: Selling Across China.")