China's Economy at an Inflection Point

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Fourth, China is making a concerted drive to transform itself from an economy propelled by low-cost manufacturing to an economy whose comparative advantage will also derive from innovation. The State Council has identified boosting indigenous innovation as one of the most important goals for the country. China's expenditure on research and development grew from 1.1 percent of GDP in 2002 to 1.4 percent in 2010 and is targeted to reach 2.5 percent of GDP by 2020. The nearly 20 percent annual growth in R&D expenditures is accompanied by an explicit (albeit controversial) program to encourage and induce leading multinational companies to transfer technology to China in return for market access. Evidence of progress is already evident in such areas as telecommunications and aerospace technologies.

Coming Rollups

Fifth, Chinese policy makers are systematically engineering a consolidation of many capital intensive industries—such as steel, cement, autos, and earth moving equipment—which are far more fragmented in China than in almost any other country. Consolidation is seen as yielding many benefits—economies of scale, more energy efficient and environment-friendly production, more professional management, and a greater likelihood of emerging as a global champion. The consolidation process has already started and is likely to pick up steam during the next five years. Ironically, a by-product of this consolidation process is likely to be a further increase in the role of state-owned enterprises in these commanding heights of the economy.

Sixth, the Chinese government is pulling all available levers to boost outbound foreign direct investment. Several objectives are driving this push: to diversify the investment of China's vast foreign exchange reserves away from primary reliance on U.S. treasuries; to acquire guaranteed access to raw materials such as iron ore, copper, and oil; and to create Chinese global champions that can compete worldwide with such companies as Toyota (TM), Caterpillar (CAT), and Cisco (CSCO). According to a World Bank report, China moved up from the world's 21st-largest source of FDI in 2006 to the 13th-largest in 2010. Given the country's abundance of capital and a determined policy push, we anticipate that China is likely to move into the ranks of the top five by 2015.

For multinationals, the shift from exports to domestic consumption will increase the importance of treating China as a core market. Companies will find it beneficial to align their China strategies with the government's policy agenda. While market opportunities are likely to be abundant in most industries, we anticipate that some sectors, such as health care, financial services, and travel and tourism, are likely to grow at a much faster rate than the GDP.

Anil K. Gupta (anil.gupta@insead.edu ) is the Insead Chaired Professor of Strategy at Insead. Haiyan Wang (hwang@chinaindiainstitute.com) is managing partner of the China India Institute and an Adjunct Professor of Strategy at Insead. They are the coauthors of Getting China and India Right (Wiley, 2009) and The Quest for Global Dominance (Wiley, 2008).