Saturday, November 26, 2005

Chinese Manufacturing

As a presenter at PEIE's forthcoming Smart Manufacturing Conference (23 - 25 January 2006, Muscat Inter-Continental Hotel) PEIE Mirror sat down with Nottingham Business School's Professor Kulwant Pawar (pictured) to talk manufacturing and China.

China is the fourth largest country in terms of size and the largest in terms of population. Driven by domestic demand and supported by World Trade Organization accession, China's economy should continue to grow robustly over the next 2 years. The total value of goods and services has been growing at a double digit rate for over 20 years. Although growth figures are now in the single digits (about 7.3 %), this is a large market that cannot be ignored. The World Bank estimates by the year 2025 China's economy will account for 25% of the total world economy.

PM: In reading about industrial development in China, one often encounters the terms – Economic and Technological Development Zones (ETDZs), High-tech Industrial Development Zones (HIDZs), Free Trade Zones (FTZs) and Export Processing Zones (EPZs). To the new China-hand, this “alphabet soup” may seem daunting and confusing. Can you explain what each of these terms signify and how they differ and can affect a company’s selection of a location?

Economic and Technological Development Zone (ETDZ) has a more general function, whilst High-tech Industrial Development Zone (HIDZ) focuses on high-tech industry. But in reality, the distinction between the two is not clear and often they are differentiated only by name. To date, there are 54 national-level ETDZ, among which, eastern coastal regions 34, Middle West regions 21. The ETDZs have been quite successful in attracting foreign investment and have made significant contribution to export.

On the other hand Free Trade Zone (FTZ) and Export Processing Zone (EPZ) are kinds of special zones, whose main function is for international trading, exhibition and export-oriented manufacturing. Therefore, goods imported to these zones enjoy zero custom duties.

PM: Today over two-thirds of foreign manufacturing in China is for the domestic market. The second wave of FDI is characterized by a two-fold shift: from low knowledge base industries to medium and highly knowledge-intensive industries and geographically from the coastal and southern areas of the country inward. This seems to indicate a less coastal bound stage of development and a more domestic as opposed to export oriented economy than most other observers have reported. Are these trends clear at this time and how certain is this change in economic development?

The publicly available statistics are patchy and present a fragmented and fuzzy picture. It is always important to develop a holistic and complete picture as more and more statistics emerge, otherwise there is danger of presenting an incomplete and contradictory viewpoint.

Much of the current production in China has been organised by foreign companies themselves, and they dominate the industry and overseas companies accounted for 87% of China’s 2004 exports. The next 5-10 years will be critical as many foreign companies will cut their expatriate staff to reduce costs and many companies will also lose their special tax status over this period. Currently, state-owned Chinese companies have access to 300,000 engineers who graduate from universities every year, however, foreign companies tend to attract the best talent. Many state owned Chinese companies are initially likely to rely on a fast-growing domestic market before venturing into high technology export markets.

PM: The non-state sector, which consists of private companies, self-employed businesses, shareholding corporations, joint ventures with foreign investment and community-owned rural industries, a great part of which are actually private undertakings, now contributes 74% of industrial output, 62.2% of GDP and more than 100% of the increase in employment. These and other statistics seem to indicate an economy that has already transitioned much more to a private business model than most people outside of China realize. Is this change as deep as the above statistics suggest and in terms of state control of business how different is China today than many European countries in terms of state control and state intervention in the economy?

The emergence of the non-state sector is a phenomenon that has been mentioned by a number of analysts and observers. For instance, recently the Party Congress in Beijing has allowed members of the private sector to come into the Standing Committee. This is a positive step forward, and does indicate a trend towards a more open, diverse economy. While it is too early to say, it is possible to imagine a situation in which the Chinese economy is as diverse as and possibly more flexible than some of those in Europe today. On the other hand, China is already a much more open market than Japan or South Korea were when they started to become global industrial powers. China’s barriers to entry are still falling as it attempts to comply with its promises in 2001 to the WTO. In contrast, the pace at which China is opening sectors gives local companies very limited time to develop their R&D competences and hence innovative products which can compete with western companies.

PM: If you were to give five reasons for a company to consider establishing a factory or a business office in China, what would those reasons be?

1. Low labour costs but committed workforce.
2. Chinese culture is similar to Japanese and Korean and shares similar work ethics.
3. Huge potential for local markets as well as opportunities for export to neighbouring Asian countries and indeed to the West.
4. Relatively well developed infrastructure when compared to its competitors such as India, Indonesia etc.
5. Increasingly educated workforce. For example, in 2004, Chinese universities produced more than 200,000 graduates in computing and information systems and the government estimates that between 1978 - 2003, 700,000 Chinese studied abroad.

PM: How important is an understanding of the regions and provinces of China to a company’s plans in China and how best would you recommend for a company to acquire and build such knowledge into its planning?

Location is always one of the most important decisions which a company has to make as it has significant impact on the returns on investment. It needs to be considered that the development in China are highly divided, some regions are more prosperous when compared to others. In Shanghai more than 50% of the students have finished higher education. However, the level of progression of a region, including economic development, infrastructure, convenience of transportation, can often translate into investment costs and returns. Additionally, the level of development in one region often has high correlations to the culture, educational attainment, attitude and the policies of the local government.

PM: For years, China has been the cheap assembly shop for the world’s shoes, clothes and microwave ovens. Now, it’s laying the groundwork to become a global power in more sophisticated, technology-intensive industries that demand considerable capital. Billions of dollars are flowing into autos, steel, chemical and high tech electronics plants. How will this affect manufacturing in Europe and North America?

The advances in Chinese manufacturing present two challenges for producers in developed countries. First, more companies and industries will face new competition from low cost Chinese manufacturers. Second, as China becomes more self-sufficient, it may limit the opportunities for these same companies and industries to sell product into the Chinese market. In contrast, China’s success has two shortcomings:

1). Despite great effort to climb up the value ladder, the vast bulk of Chinese electronics manufacturing is focused on relatively low-value parts production or assembly.
2). The biggest beneficiaries so far have been overseas ventures.

Furthermore, it has been argued that if a multi-national company can come and take advantage of lowers costs, what can a Chinese company do that is different or better? It is felt that a large proportion of the Chinese educated labour force lacks creativity due to heavy reliance on rote learning and memorisation and students are not encouraged to ask questions. The system is heavily examination oriented even at the top universities.

I feel that the Chinese have not figured out how to capitalise on their culture in terms of economic wealth generation, once this happens then the West should be concerned. Similarly, Chinese industry still lacks technical know-how and competence to compete with the best in the world.

PM: Chinese manufacturing will drag down the profitability of global industries – do you agree with this statement?

As China moves into more sophisticated industrial sectors, Western companies are likely to face new challenges. They will have to move into even higher-tech, higher-value added materials and products - or buy them from China!