A Welcome to Wal-Mart; the Retail Giant Has Revolutionized the U.S. Economy, Raising Productivity and Slowing Inflation. Now Free to Expand at Will in China, Wal-Mart Could Create an Economic Monster

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Byline: Sarah Schafer (With Wang Zhenru in Beijing)

The world's hottest economy has just thrown open its doors to its most dynamic company. Whatever happens next is likely to be explosive. The country is China, and the company is Wal-Mart. While nations like Germany have worked hard to keep the American juggernaut out, the Chinese are saying, in effect, yes, please set up in our backyard. In recent years Beijing had allowed foreign retailers to open stores in China, but only for chains with sales of more than $2 billion. That rarefied global group included only Wal-Mart, Carrefour of France (which Wal-Mart is rumored to be interested in buying) and the Metro Group of Germany. Last week Beijing opened the door to smaller players, and lifted rules that had confined the three giants to a limited number of cities and forced them to work with Chinese partners.

Letting Wal-Mart loose in China is a bold and risky move even for Beijing, which has earned a reputation for sweeping reform and smart economic management. The alliance of these two cost-cutting giants is already reshaping the global economy, restraining wage and price levels on both sides of the Pacific. Wal-Mart buys so many Chinese-made products that if it were a country, it would be China's sixth largest export market (after Germany) and its eighth largest trade partner. The company's iron-fisted price and performance demands on suppliers are changing the way China does business, and now that Wal-Mart is free to expand inside China, that impact will grow exponentially. Under the restrictions that just expired, Wal-Mart managed to open 42 stores in 20 Chinese cities, occupying less than 1 percent of a $550 billion retail market. Top executives now talk privately of opening "thousands" of stores in China over the next 20 years, as the market grows to estimated highs of as much as $2.4 trillion.

One indicator of the impact to come lies in the United States, where economists argue over the controversial "Wal-Mart effect": rising labor productivity and lower inflation. Studies have shown that the main driver of America's "miracle economy" of the late 1990s, when productivity growth accelerated by 4 percentage points, was rising efficiency in the retail sector, led by Wal-Mart. Improving productivity allowed America to produce more with fewer workers, restraining wage increases and allowing fast economic growth without inflation. Now consider China: it has been growing fast by throwing more workers into manufacturing, which is driving up wages and inflation at an annual rate now of about 6 percent--above the level Beijing considers safe. The Wal-Mart effect may be just what the Chinese economy needs.

Notwithstanding Beijing's reputation for economic savvy, it's not at all clear that officials deliberately opened the door to Wal-Mart for its impact on productivity and prices. What is obvious is that China, more than most nations, welcomes the disruptive impact of Wal-Mart's business model, built on the scale of its stores and innovative use of information technology to keep track of what sells and what doesn't. Chinese suppliers say Wal-Mart is already having a transformative effect on everything from supply chains, to distribution networks, to customer service. The company has a network of 10,000 suppliers for its China operation, most of which are small and not part of its global supply chain. Thus, the spread of Wal-Mart stores is raising efficiency standards for a growing number of Chinese suppliers, which is likely to make the nation an even tougher competitor in the international arena as well. Government officials see Wal-Mart as a good way to accelerate China's transition from state planning to free markets and to "bring the country's economy into the 21st century," says Li Fei, a retail-marketing professor at Tsinghua University.

At the same time, the hurdles to operating a national retail network in China, from bad roads to provincial bureaucrats, has so far prevented Wal-Mart from undercutting all rivals inside China on price. …