Is China losing its competitiveness?
Given all the bad news being reported from China—a slowing economy, mounting debt, rising costs, an increasingly hostile environment for foreign companies, and a political clampdown—we have prepared this series of blogs with the intent of providing some perspective to the challenges facing China.
Is China losing its competitiveness?
Trade and manufacturing statistics do not indicate that Chinese manufacturing is undergoing a precipitous decline. Lower wages in inland China, productivity gains, moving up the value curve, and a lack of capacity among alternative countries has left Chinese manufacturing more competitive than some think, although a transition away from low value products and toward high value products is certainly underway.
An Appreciating Currency, Rising Wages, and Factory Closings
There are certainly strong indications that the manufacturing environment in China has changed
Over most of the past five years, China has had an appreciating currency, rising wages, and thousands of factory closings (no doubt due to the wages and currency). Meanwhile the US government has set a goal of growing manufacturing jobs in the US and the American press has given ample attention to the concept of “re-shoring,” i.e., bringing manufacturing jobs back to the US. Given the above, it would be natural for one to think that China’s status as “factory for the world” is a thing of the past. Yet, if you look closely at the situation, it would seem that the death of the “China factory” has been greatly exaggerated.
Numbers don’t lie
Trade and manufacturing statistics don’t indicate a dramatic shift in manufacturing
US Imports have rebounded since the economic crisis, moving north of pre-crisis levels. In some sectors, like household appliances and consumer electronics, China has been gaining market share over the last five years. In other sectors, like toys, shoes, and furniture, China has had slower growth or even negative growth, but not at a precipitous rate. In cases in which China has lost share, it is largely Vietnam that has benefitted, with Mexico showing limited to no benefit in most sectors. US manufacturing employment and output statistics, while up since the financial crisis, also don’t suggest a strong influx of products now being manufactured in the US. The above facts point to a few conclusions that seem reasonable. On-shoring is no doubt happening in select areas and by some companies. But there is certainly no tidal wave of manufacturing returning to the US, at least not substantive enough to impact imports and manufacturing levels. Secondly, at least from a macro point of view, China is maintaining its competitiveness in higher end sectors (appliances and electronics) while losing it in lower end sectors (toys and shoes). This is a sign that China is moving up the value chain—focusing on more value-added products and service—a positive and expected trend in a less developed but rapidly growing country. Below are few factors that help to explain why manufacturing is still relatively strong in China.
Outside of eastern China wages are lower which is why manufacturing is moving there
China’s development over the first three decades of liberalization was concentrated mostly along the east coast which resulted in the east coast having much higher wages than the rest of the country. Eastern China has also relied heavily upon migrant workers from other parts of China. Over the last few years there has been a trend in which migrant workers are choosing to stay close to home. Lastly, there is the deliberate policy on the part of the government to increase investment in Central and Western China. For these reasons manufacturing is moving out of Eastern China and into other parts of China where costs are low. This is one way China is staying competitive.
Lack of alternatives
While other countries can match China’s costs, isn’t easy for them to match China’s capabilities
As was mentioned above, the statistics don’t show that Mexican trade has benefitted greatly from any decrease in activity in China. It is also interesting to note that India, which is frequently mentioned as an alternative to China, hasn’t seen large gains in exports to the US in any major categories that China dominates. Capacity and infrastructure, among other reasons, are likely an issue for India. It seems clear that Vietnam is making strides in certain areas. But Vietnam has a population of 80 million, roughly one-sixteenth of China’s 1.3 billion. Plus Vietnam is at a much earlier stage of development. The point is not that there are no alternatives to China. The point is that it took China thirty years to build the manufacturing sector it has and it will take many years to build an alternative. So the transition of low cost manufacturing out of China will be a long-term process, not a quick reaction to changes in relative costs.
Better equipment and management techniques help counter rising costs
For years most Chinese manufacturers had little reason to focus on productivity. They made simple products. They competed on cost. Labor was abundant and cheap. If you needed to do more, just bring in more people. When wages and the exchange rate began to rise, all that changed. So entrepreneurs and managers began to consider productivity enhancements—both management techniques (like more advanced quality control processes which focus more on preventing mistakes and less on inspecting each product and are thus less labor intensive) and investment in capital equipment. Particularly because most manufacturers had excess employees, it wasn’t that difficult for manufacturers to increase production without adding people. This became perhaps the most important reason why Chinese manufacturers were able to stay competitive as some cost factors moved against them.
Moving up the value curve
Better equipment and management techniques help China make higher margin products
I know a Chinese foundry that, a few years ago, stopped making low-tech, “commodity” castings and instead only accepted parts that involved a fair amount of machining because the machining meant they could earn a higher margin to counter rising costs. I know a US specialty electronics firm that has increased its purchasing in China, despite rising costs, because Taiwanese suppliers of higher end products in their niche have moved their factories to China. These are two examples of a phenomenon that is happening throughout China—companies are moving up the value curve, making more high-end products that require more technical sophistication.
Serving the local market
Factories that used to export now serve China as well
Ten years ago most of the foreign company activity in China was for export. That has changed. China is now a market and many companies that were sourcing and/or manufacturing in China are now trying to sell there as well. Selling in China gives these companies another reason to continue sourcing or manufacturing there, which further supports manufacturing in China.
Transitioning, not falling off a cliff
China’s manufacturing capability is undergoing a transition, not collapsing
For the Chinese economy, the above means that China’s status as “factory to the world” is likely to undergo a gradual transition over time, not a precipitous decline. For companies sourcing in China, while higher costs might suggest that a change is necessary, it is also possible that China still presents the best alternative. That doesn’t mean companies should feel beholden to China forever. It simply means that, once all factors are considered, China might remain more competitive than you think.