Thomas White Global Investing
China
China stamp
April 12, 2013
A Postcard from the Asia Pacific
China: Imitation to innovation?

Chinese lanterns

The notion of ‘cheap China’ appears to be fading now and the “Made in China” tag is no longer only about inexpensive and inferior-quality toys, shoes, and apparels. Slowly but surely, China has been increasing its export of higher-end goods.

These days, from dusk to predawn, a symphony of lights is played on San Francisco’s Bay Bridge to commemorate the structure’s 75th Anniversary. Choreographed by computer algorithms, 25,000 white LED lights glow on and off in tandem in a scintillating dance of ever-changing, abstract patterns. Since its opening in early March, “Bay Lights” has not just dazzled its audience, but also thrown light on a significant phenomenon — that China’s all-important export sector has been surely and steadily undergoing a paradigm shift, for the good.

After all, the Shanghai-based Inventronics, Inc., which has manufactured the sophisticated power devices for the Bay Lights project, is a symbol of China’s long-standing endeavor to export more higher-end goods. Indeed, the notion of ‘cheap China’ appears to be fading now and the “Made in China” tag is no longer only about inexpensive and inferior quality toys, shoes, and apparels. According to The Wall Street Journal (WSJ), China’s exports of high-tech auto parts, electronics, and optical devices to the U.S. have jumped 24% over the past two years while its shipments of clothes and footwear have grown just 5%. Similarly, Businessweek has reported that the share of heavy industry in Chinese exports has grown from 29% in 2001 to 39% in 2011.

The continuing change in the composition of Chinese exports has far-reaching implications for not just China but also the global economy. The Asian emerging giant, often called the world’s factory, now accounts for a fifth of global manufacturing. Thanks to its export prowess, China has been clocking the fastest rate of growth among major economies over the past two decades. The Economist magazine says that Chinese factories have produced so much, so cheaply, and for such a long time that they have curbed inflation in some of their export markets. But on the flip side, the cost of manufacturing has been rising rapidly in the country. Establishment costs have gone up, the Chinese currency has appreciated, and, more importantly, wages have escalated at an average of 15% a year since 2005.

Consequently, China’s low-cost manufacturing model is under pressure. Several of the electronic assembly units as well as apparel and shoe factories that have been at the core of the country’s growth and urbanization have shifted to cheaper locations like Mexico, Cambodia, Vietnam, and Bangladesh. Crucially, China now faces the prospect of stagnant growth economists describe as the “Middle Income Trap.” By creating lots of jobs in labor-intensive industries like apparels and electronics, China was able to lift a large section of its population from poverty and become a middle-income nation. But now that wages have swelled, these basic industries have become less competitive in the global export market. Therefore, to raise incomes further to the levels of advanced countries, China needs to compete with developed nations in high-technology industries.

Fortunately, for several years now, China has been working on acquiring the know-how, technology, and skill levels to compete with developed countries. The country’s R&D expenditure moved up from 1.1% of GDP in 2002 to 1.5% of GDP in 2010. In fact, China’s share of the global R&D expenditure increased from 5% in 2002 to 12.3% in 2010. On their part, Chinese businesses have been trying to get into sectors where margins are higher. A Businessweek article says that in 2011, Chinese-built ships accounted for 41% of the global market and China’s share of the global output of railway locomotives and wagons, industrial boilers, and machinery improved notably.

Another example is Talaris, a maker of sophisticated cash-sorting machines used by banks, which shifted its production facility from Sweden to China in 2012. Significantly, Talaris decided against shifting to other manufacturing hubs like Taiwan and South Korea, favoring China due to its superior supply chain or large network of parts suppliers, which has a reputation for keeping costs at the lowest-possible levels and preventing supply disruptions.

Nevertheless, these developments notwithstanding, there are still a number of areas in which China could improve while making the shift to higher-end exports. For instance, many commentators contend that China has so far developed strength only in second-generation innovation or in areas where tiny improvements need to be done to existing designs. Further, the nation doesn’t have a good track record in filing patents that are recognized outside its borders. According to the WSJ, the country also needs to do a lot more to change the focus of its education system from largely rote learning to creative problem solving.

Be that as it may, the Chinese manufacturing export sector has only just started climbing up the value chain. And, if its current success in some high-technology areas like telecommunications and biotechnology is any indication, the sector can be expected to scale new heights. Chinese manufacturing is undoubtedly changing and, like the light sequences on Bay Bridge, the pattern is continuously changing, hopefully for the better.

 

Image Credit: Dainis Matisons’ photostream on Flickr under a Creative Commons License

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