Internet vital to China's economic transformation

Illustration: Chen Xia/GT

Businesses, policymakers should look to technology for efficiency gains

With some 632 million Internet users, China is now in the midst of a digital revolution. Last year alone saw the country's number of active smart devices grow from 380 million to 700 million, according to a report from Umeng, an app analytics firm. Meanwhile, its e-tail market stood at 1.84 trillion yuan ($295 billion) in annual sales in 2013, surpassing the size of the US market and becoming the largest in the world, data from iResearch show.

Until now, China's Internet economy, which is already 4.4 percent of GDP, has been largely consumer-focused, while many Chinese businesses have been slower to go digital. Across most sectors of China's economy, the Internet holds the promise of large improvements in labor productivity. As companies embrace Web technologies, their operations become more efficient, translating into productivity gains.

According to a McKinsey Global Institute (MGI) report, the Internet could fuel some 7 to 22 percent of the incremental GDP growth through 2025, depending on the speed and extent of Internet adoption by Chinese enterprises. By that point, it could generate 4 to 14 trillion yuan in annual GDP. Some 10 trillion yuan will be at stake in annual GDP by 2025, so capturing this potential will be critical for China's future competitiveness, particularly as the country's labor costs increase and its demographic dividend diminishes.

Perhaps even more important, the next wave of Internet development will help China shift toward an economic model driven by productivity, innovation and consumption. The heavy capital investment and labor force expansion that fueled China's rise over the past two decades cannot be sustained indefinitely. The Internet, by contrast, is facilitating the ongoing process of moving China's industry from less productive to more innovative and technologically advanced business models.

Much of the Internet's impact will likely come in the form of productivity gains. China has posted high rates of labor productivity growth in recent years, but its progress began from a very low base, so the productivity remains well below the levels in advanced economies. Meanwhile, China's labor force is projected to begin shrinking by 2015. To avoid a slowdown and continue to improve living standards, China will have to make its existing labor and capital stock more efficient, and wider technology adoption will be central to this effort. As Chinese companies digitize their operations on a wider scale, they will gain the ability to streamline operations, open new sales channels, accelerate the research and development process, and become leaner.

Take small and medium-sized enterprises (SMEs) as an example. Going digital can neutralize some of the disadvantages faced by Chinese SMEs today. The Internet provides a platform for entrepreneurs with new ideas to scale up rapidly and at low costs. It once took years to establish a huge sales force and wide distribution network, but e-commerce marketplaces grant SMEs instant and direct access to consumers, along with associated support services, such as payment and logistics.

Moreover, limited access to capital is a common challenge for SMEs. Yet, this picture is about to change. Big data to manage credit risks and online channels to reduce transaction costs provide financial institutions with greater capabilities to increase lending to SMEs. Private banks and Internet finance providers are injecting new competition into the financial services sector. Alibaba, for instance, provides micro-loans to its e-merchants. In addition, the Internet can also boost the export capabilities of SMEs, turning them into "micro-multinationals." They can reach overseas consumers directly by listing on foreign B2C and C2C platforms. In fact, 3,835 Chinese sellers were already on eBay with more than $100,000 in sales as of November 2012.

When SMEs have a platform for growth, collaboration and experimentation, the overall economy benefits. The rate of innovation increases, as new ideas and offerings can now be tested and rolled out quickly, easily and cheaply, introducing more competition and thus raising productivity in various industries.

The growth of SMEs in China could also create a disproportionate number of jobs. Helping SMEs flourish could mitigate job losses that could occur as labor productivity improves in the rest of the economy. China's ability to realize these benefits will depend on whether SMEs recognize the advantages the Internet can provide and are willing to adopt it in large numbers.

Facilitating more widespread Internet adoption is nothing simple; the Internet can also be a disruptive force. So the government is expected to face multiple policy challenges in harnessing the Internet for economic growth. First, a balanced set of regulations enhancing privacy protection and data sharing could remove constraints on big data adoption. Second, liberalize markets to encourage new innovations, allow robust competition and accelerate productivity. Third, the government can ensure that training programs are available to help workers continually refresh their skills. Fourth, building out networks is crucial to bringing more of the population online and facilitating industry adoption.