Future of China's services sector

David L. Cunningham, Jr., President, FedEx Asia Pacific, Jakarta

After 15 years of debate and negotiation, the People's Republic of China was officially inducted into the World Trade Organization as a full trading partner.

With so much hype around the accession of China to the WTO, what are the facts and what are the expectations that are central to this momentous event for the services sector, in particular for distribution and logistics? The opening of China's economy will have profound impact across many business sectors, but especially those in the services categories, such as investments/banking, telecommunications, and transportation and distribution.

China is Asia's second largest economy after Japan in terms of gross domestic product. Recent estimates by the World Bank and International Monetary Fund, using purchasing power parity, put China as the second largest economy in the world after the U.S.

In terms of foreign direct investment (FDI), the Economist Intelligence Unit predicts that China's total FDI will increase from $30 billion to $70 billion within five years of its WTO entry, creating a cycle of new wealth that will further increase demand for a broader range of goods and services. Recently, Goldman Sachs estimated that by 2005, external trade will double to $600 billion and direct investments will top $100 billion.

China's entry into WTO comes at a time when three major trends are driving business: globalization; creation of high value and high-tech products; and fast-cycle manufacturing.

To be competitive, China will have to build tightly focused, efficient supply chains in order to prevent obsolescence or inventory carrying costs. Speed and efficiency within the chain shaves costs and satisfies customers. The lack of it destroys profits and drives customers away.

Given the reliability and availability of express services, industries worldwide are able to adopt Just-in-time inventory systems as part of their strategic plans for growth. Though express services represent less than five percent of total ton- miles moved in international transportation today, it constitutes 37 percent of the value of goods.

Currently, there is little integration in freight-forwarding and logistics services in China. Inland transportation is handled by Chinese freight forwarding companies. In many cases, these are single truck operations subcontracted by international freight forwarders to move goods and materials from warehouses to seaports or airports. At present, there are about 1,500 licensed international freight-forwarding operators in China. Of these, 450 are Sino-foreign joint ventures, primarily involved in the management of freight at the international level.

If China is to keep pace with the rest of the logistics industry it will need to carefully reconsider its current laws regulating the role of foreign companies in the distribution services sector.

Phenomenal changes will take place over the next decade, driven by the commitments made in WTO. Foreign firms will be allowed to distribute imported products, besides those made in China. In addition, China has agreed to phase out all restrictions on distribution services within three years of its WTO accession. In the most sensitive and protected sectors, such as chemicals, fertilizer, crude oil and processed petroleum products, China has agreed to provide distributions rights to foreign companies within five years of accession.

Restrictions on all services auxiliary to distribution will be phased out in three to four years. These include express delivery services, vehicle rental and leasing, freight forwarding, storage and warehousing. Foreign companies engaged in these businesses will be able to set up wholly owned subsidiaries in China.

Investment options will also change dramatically. As rules and regulations relax, and greater transparency is guaranteed, companies will be more willing to make more significant investments in China.

A fast-growing services sector is pivotal to the long-term health of China's economy. According to a Morgan Stanley Dean Witter report, China's infrastructure and services sector investments have risen about 10 to 15 percent year-to-date. For the first seven months this year, the government reported a 24 percent increase in the services sector, which now accounts for less than one-third of China's GDP. The China Reform and Development Institute estimates that, for every one percent of growth in this sector, about 1.3 million new jobs will be generated.

For the air cargo industry and air express transportation these projected changes will have a substantial effect on growth and sustainability. Currently a small consuming market, the projected growth rate of China's exports will have huge implications for air cargo.

As trade liberalizes, China should become one of the dominant players in every manufacturing segment, from the high-end, high quality to the medium level and to the low-end. Given the scale of its economy, and a potentially significant domestic market to underpin economic growth and development, China will simply skip over some of the traditional stages of manufacturing. It will not migrate from low-end, low value products to the high-end. It will just establish itself in all market segments, enabling it to compete effectively and in some cases, leapfrog its ASEAN neighbors.

Without a doubt WTO accession will make the economic landscape more predictable. But it will take time. WTO accession will not see vast changes ushered in overnight. Instead, the types of sweeping changes that entry into the WTO will afford to China will take decades to fully develop. To expect that these changes will all be perfectly smooth and wonderfully executed is unrealistic.

Over time, increased foreign investment and greater access overseas for Chinese exports will create jobs and prosperity. But, in the short term, there will be employment pressures, job losses, especially among family run farms and state-owned firms as they try to meet global competition. The challenge for China will be to create enough jobs in other sectors, such as the services section, to offset losses in its traditional economy.

China is growing and constantly changing. WTO will have implications that are going to require massive changes in infrastructure and in fundamental business practices. All of us will do well to remember that the road will be bumpy, but the direction is positive the prospects are good for China to continue its long march toward economic strength and prosperity.