Unplugged and unproductive

AT FIRST glance it would appear that China has gone online, and gone digital, with great gusto. The spectacular rise of internet stars such as Alibaba, Tencent and JD would certainly suggest so. The country now has more smartphone users and households with internet access than any other. Its e-commerce industry, which turned over $300 billion last year, is the world’s biggest. The forthcoming stockmarket flotation of Alibaba may be the largest yet seen.

So it is perhaps surprising to hear it argued that much of Chinese business has still not plugged in to the internet and to related trends such as cloud computing and “big data” analysis; and therefore that these technologies’ biggest impact on the country’s economy is still to come. That is the conclusion of a report published on July 24th by the McKinsey Global Institute (MGI), a think-tank run by the eponymous consulting firm. It finds that only one-fifth of Chinese firms are using cloud-based data storage and processing power, for example, compared with three-fifths of American ones. Chinese businesses spend only 2% of their revenues on information technology, half the global average. Even the biggest, most prestigious state enterprises, such as Sinopec and PetroChina, two oil giants, are skimping on IT. Much of the benefit that the internet can bring in such areas as marketing, managing supply chains and collaborative research is passing such firms by, the people from McKinsey conclude.

The country’s labour productivity has increased by a quarter since 2010, but that was largely due to heavy capital spending that resulted from an unsustainable fiscal stimulus. In fact much of Chinese industry (save exporters, which by their nature must compete with efficient foreign rivals) is still inefficient, for a variety of reasons—not least bureaucracy, official meddling and the coddling of favoured firms with subsidies. The MGI report argues that a failure to get online and go digital is another big factor.

Although millions of Chinese businesses sell their products on Taobao, an online marketplace owned by Alibaba, vast numbers remain offline: only 20-25% of small firms in China are internet-connected, compared with 75% in America. This helps explain why the labour productivity of local small businesses is roughly two-thirds of the average for all firms in the country; the comparable figure in Britain is 90% and in Brazil it is 95%.

However, the upside to all this is that as Chinese firms of all sizes get themselves plugged in, as they are belatedly doing, there should be a burst of productivity gains, providing a sustained boost to GDP growth. The dwindling supply of cheap labour will be less of a worry for China, and its economy will be driven more by innovation and consumption. As the internet injects competition and price transparency, dominant firms will suffer an erosion of profit margins, forcing them to look to new technologies to restore their fortunes. In all, MGI predicts that “a great wave of disruption has just begun.”

In each part of Chinese industry there are marked differences between the most and least connected firms. Among carmakers, for example, some are using real-time data feeds to optimise their supply chains and transport, helping them turn over their stocks five times as quickly as the laggards. With 10m searches each day by potential car buyers on Baidu (a local equivalent to Google), there is much scope for cutting marketing and sales costs. Foreign carmakers such as Volkswagen are already selling cars directly to Chinese motorists on their websites and on Tmall, an e-commerce site. Building internet connectivity into the cars themselves, as GM has done with its OnStar service, means dealers can check faults remotely and send maintenance alerts to drivers, cutting costs and satisfying customers.

The digital revolution can help in several ways. Because publicly owned banks have directed credit to favoured state firms, bamboo capitalists have long been starved of capital. Now, though, Alibaba and Tencent are disrupting the market by offering microloans to businesses online. Their payment systems let even tiny firms become multinationals. Yougang Chen, one of the authors of the MGI report, predicts that the web will also help millions of small entrepreneurs across the country collaborate, producing a powerful network effect that boosts productivity.

The staid state

Could the internet also work wonders in the state-owned sector? China’s publicly owned businesses are typically its least efficient; the gap between their returns on assets and those of private firms has been widening. Recognising this, the government this month launched a modest reform effort, involving partial privatisation and minor corporate-governance reforms. CITIC, a rambling state conglomerate, recently injected the parent company’s Chinese businesses into a division listed in Hong Kong, hoping that by putting them under closer scrutiny by investors it will force them to shape up.

Such moves could prompt state firms to speed up their entry into the digital age. That said, many such half-hearted reforms have flopped over the past two decades, so scepticism is in order. And there is only so much that technology can do to enhance a firm’s efficiency if its management is dysfunctional. A study by EY, another consulting firm, asked managers in China what were the main obstacles to increasing productivity. The most common answers were not about a lack of technology, but were related to cultural barriers and incentives, such as “unclear accountability” and “overly centralised control from headquarters”. Nowhere are these problems more apparent than at publicly owned companies. For all Chinese business stands to gain from the internet, digitisation, cloud computing and big data, the state firms’ problems will not be fixed without bolder reforms.

^{Economist.com/blogs/schumpeter}