Current structural changes in China’s economy will have significant implications for Africa’s developmental ambitions. This is not the first time decisions in China have been felt in Africa: for the past 15 years, the rapid and pervasive entry of Chinese capital and companies into Africa have had a big impact on the continent.

The rapidity and scale of these changes over the past decade and a half – through multi-billion dollar transactions and political summits – has resulted in an African incline towards China’s commercial sphere of influence. This trend has been accelerated by the (Western) financial and economic crisis, with African economies reorienting towards the emerging rather than the developed world.

But as China’s strategy towards Africa matures, so too must Africa’s strategy towards China. Beijing is no longer just an actor in Africa’s resources sector but is broadening the scope of its commercial foray into the continent. African governments need to respond accordingly and be more agile in their policy-making vis-à-vis China’s engagement.

Chinese-African relations: all change

The African continent continues to struggle to develop its domestic economies through beneficiation and, by and large, sub-Saharan African countries remain dependent on raw material extractive industries, often being single-commodity dependent. Ironically, the China-driven commodities “super cycle” over the past decade or so may have reinforced the resource dependence of African states.

Despite this, China’s resource-intensive growth model has helped African growth – underpinning the “Africa rising” narrative that has emerged in recent years.

Furthermore, in 2008 Beijing’s financial authorities used a sizeable stimulus of approximately $570 billion to pump-prime economic growth. This was in response to rapidly slowing global growth following the financial crisis, and it had a very positive knock-on effect on Africa’s growth trajectory. Ironically, China’s actions reinforced Africa’s commodity dependence, with strong commodity prices providing a deterrent – or at the very least a distraction – for African policy-makers to accelerate their efforts towards diversification.

But changes now impacting the Chinese domestic economy hold out a new promise for aspirational African economies. The rising cost pressures on China’s light industrial manufacturing sector will increasingly lead to manufacturing capacity to relocate to lower-cost foreign economies over the long term. This trend of Chinese “hollowing out” of low-end manufacturing and offshoring to Africa is likely to be the next driving force of the relationship. This forms part of what is often referred to as China’s “economic rebalancing”. If this opportunity is seized by progressively reformist African states, they could well be on the cusp of a 19th-century style industrial revolution – generating jobs and creating new industries.

But viewing the relationship through the statist lens from Beijing, it can be argued that China’s Africa policy has become increasingly fused with that of the management of its own economy. China’s resource-intensive growth model – propelled by heavy infrastructure spending and its manufacturing machine – requires a large amount of commodity inputs. Underpinning Beijing’s engagement of Africa has been a desire to secure a number of strategic commodity supplies, in particular oil, iron ore and copper. In the mindset of the (very strategic) Chinese government, its own growth model may be at risk from restricted resource supply. China’s ability to guarantee the supply of key resources from resource-endowed African states is strategically important for Beijing.

Thus, a politically welcoming environment among African governments is of paramount importance for Chinese capital. In Europe, the United States and recently Australia, there have been government attempts to block Chinese investors from acquiring local assets – in telecoms, in computer hardware and in mining. In Africa there has yet to be an active political obstruction to Chinese investment.

However, recently, some senior government and political figures in Nigeria and Botswana have been critical of the often skewed nature of their countries’ relationships with China. China’s foreign policy towards the continent under President Xi Jinping will need to balance its growing commercial interests while having to accommodate a changing and more assertive Africa.

Beyond resources

It is a massive opportunity cost considering most resource-rich (solid minerals) African states did not adequately foresee and take full advantage of the so-called commodity super cycle driven by China’s insatiable demand for commodities. This is different to Australia, where, in spite of the economic crisis, GDP growth has remained strong on the back of enabling infrastructure and high demand from China. A number of oil-rich African economies – led by Angola – are the exception. Few African governments have been as proactive at linking Chinese investments in resources to mega infrastructure to build commitments in their economies. With a handful of notable exceptions, African economies could have been doing much more to hitch their resource-reliant economies to the Chinese stimulus-powered growth train.

But the nature of the relationship is now potentially changing. While resources have underpinned China’s foray into Africa throughout the first decade of its “new” foreign commercial relationship with the continent, a shift is taking place. instead of being initiated on a political level in Beijing, the shift is increasingly being shaped by market forces.

In tune with China’s own domestic reforms, China’s relations with Africa under Xi will become less state-driven and more characterized by the market – in essence, more private sector-driven. This is a result of China’s own evolving economy as well as the gradual declining support by Beijing for its state-owned enterprises (SOE) in Africa, particulary the construction sector, which has gained a dominant presence in Africa largely due to Chinese state support.

Less state influence

The 2012 Forum on China-Africa Cooperation (FOCAC) ministerial meeting – a vehicle for Chinese-African political dialogue that meets every three years – once again upped the ante of China’s pervasive engagement of the continent. African policy-makers were intent on winning Chinese “pledges” in the form of foreign investment, concessionary loans, grants and aid – i.e. Chinese “state capital”. This is a wise strategy. A politically welcoming environment among African governments is of paramount importance for Chinese capital. But despite the Chinese government pledging a further sizeable sum of $20 billion in investment in Africa over a three year period, it can be argued that China’s state-directed capital towards the continent will play less of a role in the growing trend of Chinese market-driven outbound investment.

This assertion is made for the following three reasons:

First, the industrial manufacturing component of the Chinese economy is passing through the “Lewis Turning Point”, as the cost of production is now surpassing gains in productivity. This portends the start of a long-term trend of offshoring of China’s low-end labour-intensive manufacturing sector. While China will remain a very competitive manufacturing economy, at least over the medium term, rising production costs in manufacturing-heavy south-eastern coastal provinces will result in Chinese firms relocating their operations both inland and abroad. A part of this offshoring could find its way to Africa.

Secondly, the so-called rebalancing of China’s economy with the gradual shift away from extremely high rates of fixed asset investment – sometimes over 50% of GDP – will result in a less resource-intensive growth model in China. The imperative – or perhaps strategic desire – for resource security by the policy-planning bodies in Beijing will as a result lessen over time. This will feed into policy-making and could well temper SOE’s appetite for large transaction assets in Africa and elsewhere.

Thirdly, the peak of SOE dominance in the Chinese economy was arguably reached at the end of the Hu Jintao administration and magnified by the significant fiscal stimulus spend from the first quarter of 2009, which was largely spent by 2012 – the bulk of which found its way into the coffers of SOEs. The government’s ability to direct the commercial interests of Chinese SOEs in the global economy has probably never been greater. It can also be argued that China’s slowing economy will encourage the process of internationalization of Chinese enterprises, be it either state-owned or private business.

Recent reform measures and questioning of existing state-led developmental models under the Xi government may also result in a review of China’s SOE-led outbound investment forays. This will particularly be the case with China’s policy banks and their financing of SOEs abroad. This could well have a knock-on effect on Chinese state-driven investment in Africa.

Chinese government expenditure, 2004-2014 (% of GDP):

china1

china2

Source: IMF World Economic Outlook, 2014, and the World Bank, 2014

National interest

Despite the slowdown of China’s economic growth rate, its outbound investment continues to increase rapidly. In 2012, China’s outbound direct investment (ODI) was recorded at $84.2 billion, representing a year-on-year increase of more than 10%. The main thrust of the ODI came from China’s SOEs receiving both encouragement from China’s Ministry of Commerce, and capital from the policy banks to do so. This allowed them to pursue “strategic national interest” in international markets, most often resource-focused.

The main target sector of China’s ODI is mining, which received over 29% of investment according to 2009 data. While the Ministry of Commerce of the government haven’t released sectoral data on outbound FDI since then, manufacturing has, as an outbound investment destination, probably significantly increased its worth from the 22% reflected in 2009.

Composition of outward Chinese FDI stock in Africa (2009):

china3

 

Source: Chinese Ministry of Commerce, National Bureau of Statistics, State Administration of Foreign Exchange, 2010

From state capitalism to the market

Chinese private companies will be chasing Beijing-influenced SOE investment into Africa. China’s recent commercial activity on the continent could be divided into two simple categories – large SOE investment alongside Chinese micro-enterprises owned by entrepreneurial migrants either trading or selling. A new type of Chinese firm will be coming to the continent over the medium term – growing private firms that best represent the real competitiveness emanating from the Chinese economy.

In previous high-level Chinese and African government interactions, there has been little focus placed on the macro forces that are impacting the Chinese domestic economy and how African policy-makers should be planning to adjust their own growth strategies in line with changes in China’s own domestic economy. Considering that the China-driven commodity super cycle is now rapidly cooling, and in light of the commodity-dependent nature of a large number of African economies, this omission has become all too apparent.

China’s and Africa’s growth trajectories, % (2004 – 2013):

china4

Source: African Development Bank, 2014, International Monetary Fund, 2014

While resources have underpinned China’s foray into Africa, a shift is beginning to occur – no longer planned by the government in Beijing but shaped by the market. The potential move of manufacturing out of China to Africa is the next thrust.

According to Justin Lin, former chief economist of the World Bank and now at Peking University, China is forecast to possibly lose up to 85m labor-intensive manufacturing jobs within the next decade. In the same way that Japan lost 9.7m in the 1960s and Korea almost 2.5m in the 1980s due to rising wages and production costs, the Chinese economy will undergo a similar (but far greater in number) process (Lin, 2012). Wages for unskilled workers in China are set to increase four-fold in ten years. According to China’s National Statistics Bureau, the average monthly worker’s wage now stands at US$325.24 (National Bureau of Statistics, Xinhua, 27 April 2012) with an annual increase last year that topped 20%. Wage inflation and rising production costs will over time force China’s manufacturers to focus on higher-value outputs, not dissimilar to previous trends in other Asian economies from Japan, Korea, Singapore, and Taiwan amongst others.

The Chinese economy has reached the so-called “Lewis Turning Point” – named after the Nobel Prize-winning economist W. Arthur Lewis. This refers to the gradual shift of a manufacturing sector toward higher-value output that is affected by the cost of production surpassing gains in productivity. The long-term trend of offshoring China’s low-end labor-intensive manufacturing sector is thus now starting to emerge. Whilst China will remain a very competitive manufacturing economy at least over the medium term, rising production costs will encourage and force Chinese firms to relocate their operations abroad. A part of this offshoring could find its way to Africa (Davies, M. Edinger, H, Draper, P. Changing China, Changing Africa, Asia Economic Policy Review, May 2014).

It has been a very disruptive period over the last decade or so for foreign manufacturers that have battled to compete with the Chinese manufacturing machine. South Africa’s own textile and garments industry along with other sectors have undoubtedly felt the pain. Others have benefitted from attracting low value chain manufacturing of textiles. Neighboring Lesotho for example has built provided a lower cost and lesser unionized workforce to capture this sunset sector from South Africa. This has been supported by the the African Growth and Opportunity Act (AGOA), signed by the US Congress in 2000, serving to boost the small country’s exports to the US market.

China’s labour intensive manufacturing competitiveness is, however, now on the wane. The inevitable result will be the relocation of Chinese low-end manufacturing to lesser-cost developing economy destinations. This can create enormous employment generating opportunities for low-income economies with nascent manufacturing sectors. Lin supports this argument by citing the figure of China’s apparel exports amounting to US$107bn in 2009, compared to sub-Saharan Africa’s total apparel exports of just US$2bn. The opportunity for Africa to capture a share of this revenue from relocated Chinese factories is indeed enormous.

Manufacturing’s share of GDP in sub-Saharan Africa has held steady at 10-14% in recent years. Industrial output in what is now the world’s fastest-growing continent is expanding as quickly as the rest of the economy (Economist, 8th February, 2014).

The most notable example of this trend is in Ethiopia. The sovereign wealth funded China Africa Development Fund CADFUND) is financing a special economic zone industrial park to the value of US$2bn over the next decade to create a light manufacturing zone on the outskirts of the capital city Addis Ababa. The focus is footwear and clothing. The eventual outcome of this could be the creation of 200,000 jobs (Economist, 8th February, 2014).

From Asian to African geese?

East Asia’s growth model has been characterized by US academic Daniel Okimoto as a V-shaped flying geese pattern, with Japan as the leading regional economy. By the 1970s, Japan was followed by the Tiger Economies of Hong Kong, Singapore, South Korea and Taiwan. The third tier of Asian geese includes Malaysia, Thailand and most recently Vietnam. But the lead goose is undoubtedly China. Its economy is not so much a flying goose in formation as it is a Boeing roaring past – such has been its disruptive impact on sector dislocation and job destruction in competing economies. On the other hand, its positive contribution to lower inflation through the export trade of low-cost products must also be recognized.

If we apply this model to Africa, can we begin to identify the economies that might become the leading geese on the continent? Nigeria is the largest African economy, following the rebasing of its GDP in April 2014. But South Africa is undoubtedly the most industrialized country in Africa, with the most internationally competitive business sector. However, even with rising production and wage costs, we have not seen South African manufacturing shift to lesser-cost African economies, except perhaps textile and garment production, which has moved to Lesotho. It is unfortunate that regional economies in the Southern African Development Community – a region with a combined population of 285 million – have not done enough to make themselves attractive to South African manufacturing in the way that Asian economies did to attract Japanese manufacturing in the early 1990s.

As there are few states in sub-Saharan Africa that are effectively differentiating themselves from their neighbours – Ethiopia, Ghana and Rwanda stand out as possible exceptions – perhaps the African geese will fall into formation with the Asian model. A key question to consider is which African states will proactively build the required institutions and enabling environments to attract manufacturers into their economies and step up on the bottom rung of the industrial value chain?

Minimum wages or average wages in Ethiopia, Ghana, Rwanda, Indonesia, the Philippines and Vietnam:

chinaSources: US Department of State Country Reports, Wage Indicator and various websites, including from different departments of labour, the International Labour Organization and the Ghana Investment Promotion Centre

Where will Chinese industry – which now accounts for over 20% of global manufacturing – begin to move to? The emerging competitors to Africa’s manufacturing aspirations are all Asian: Indonesia, the Philippines, Thailand and Vietnam all stand out. Their labour costs are becoming relatively cheaper as China’s increase.

According to the Bank of America, these Asian economies are “poised to accelerate, propelling the area’s currencies and fuelling consumer and property booms”. Supported by young populations – the so-called demographic dividend – and high literacy rates, these Asian countries are well-positioned to benefit from the relocation of China’s low-end manufacturing.

Africa did not lay the same foundations for industrialization that its Asian counterparts did in the 1970s and 1980s. The “latecomer challenge” now lies in building the necessary infrastructure, institutions and skills base to attract the investment.  African states did not foresee the China-driven commodity super cycle of the past decade and thus did not fully leverage the opportunity it presented for its resource sectors. It is imperative that we now recognize the upcoming shift driven by market forces in China’s manufacturing sector to give impetus to African industrialization and beneficiation ambitions.

Africa’s relationship with China is no longer just about attracting state capital but also about private investment. This key point should increasingly inform the policy of those African states that seek to move beyond resources and diversify their economies by building nascent industries and manufacturing sectors. Structural changes in China thus now hold out enormous development potential for Africa.

Author: Martyn Davies is Chief Executive Officer at Frontier Advisory and a Young Global Leader.

Image: An engineer guides a train driver at Sudan Railway maintenance complex in Khartoum February 14, 2013. REUTERS/Mohamed Nureldin Abdallah