Manufacturing Drives China's Economic Growth
By Ben Vickery
When the future of manufacturing in the U.S. is considered, the current and future states of manufacturing in the People's Republic of China merit consideration as well. While the growth of China's economy opens new markets for U.S.-manufactured goods, it also poses new challenges to U.S. manufacturing. Therefore, it is useful to understand the factors that drive China's economic growth, including:
· Foreign Direct Investment - As a result of the Chinese government's economic reform efforts, particularly in Eastern China, the nation has enjoyed an explosion of foreign direct investment (FDI).
· International Trade Policy - China's economic development is being accelerated by international trade policy, especially as a result of entry into the World Trade Organization (WTO).
· Labor Supply - China's almost inexhaustible native labor supply, with over 1.3 billion inhabitants, has helped keep labor costs low, particularly as rural Western Chinese seek jobs in the industrialized East.
· Currency Policy - China's continued under valuation of its currency has kept the cost of Chinese labor and goods extremely low.
· Markets and Exports - China's economic development is also being driven by the promise of a growing Chinese market for goods and services. As multinational corporations that have located manufacturing facilities in China wait for the internal market to mature, they focus largely on goods for export to the U.S. and other established markets, thereby impacting international trade balances.
· Capital Accumulation - Sales to overseas markets and foreign direct investment have become the primary mechanisms to generate capital in China. Thus, China has managed to fuel a significant percentage of its economic growth with a large increase in investment from the global money markets.
· Education & Recruitment - The Chinese state is committed to building a strong educational system, and China has undertaken a strategy to bring back expatriate Chinese scientists and engineers that have been educated in the U.S.
· Transition From Low-Tech to High-Tech Production - Over the last decade, China has shifted from traditional, low-tech production and processes toward higher-tech, higher-wage manufactured products and processes.
· Formal and Informal Intellectual Property Policy - China has also undertaken a strategy to greatly enhance its intellectual property, both by requiring that foreign manufacturers train their local partners in the technologies associated with their products and by illegally acquiring intellectual property.
Manufacturing has driven the rapid growth of China's production and economy. Further, the factors above are negatively impacting the U.S. economy and will continue to do so. China's growth poses a unique challenge to our economy unlike challenges of the past, such as those posed by Japan in the 1980s. China has demonstrated the ability to successfully utilize its capacities, and as its growth continues, China may well challenge U.S. economic primacy during the twenty-first century.
Economic Reform Brings Foreign Direct Investment
Economic reform in the People's Republic of China has now been underway since the late 1970's. Under Deng Xiao Ping, the successor to Mao Ze Dong, China began gradually introducing market-based reforms and decentralized economic decision-making into its socialist system. This period has been defined by three stages:
· China as a socialist planned economy, 1979-1984: In 1979, the Chinese government established four Special Enterprise Zones (SEZs) in Shenzhen, Zhuhai and Santou (in Guangdong Province) and Exiamen (in Fujian Province). During this period, however, there was little clear government policy addressing the creation of new financial tools and markets, and new practices often preceded policy change.
· China as a socialist commodity economy, 1984-1994: In 1984, spurred by the initial success of the SEZs, China opened 14 cities along its East Coast to foreign investment and foreign trade. It was also during this period that China's first money market emerged, a secondary market for securities trading was established, and financial institutions were first allowed to issue financial bonds.
· China as a socialist market economy, 1994-present: In 1994, the State Council of China issued "Guidelines of National Industrial Policies," laying out rules for creating and implementing industrial policies. In 1995, China's Insurance Law was passed, designed to regulate insurance activities and protect the legitimate rights and interests of the parties involved. Also in 1995, China instituted its Banking Law, which codified the role of the four national banks, created specialized financial institutions - such as the Import-Export Bank - and established rules allowing operation of regional and city banks.
China is now committed to continual economic reform. In his first public comments after becoming China's President, Hu Jintao stated, "China's development is at a new historical starting point." In concert with this commitment to economic reform, there has been a dramatic increase in foreign direct investment, or FDI. As a result, FDI has increased from $1.26 billion in 1984 to $52.7 billion in 2002.
The U.S. Bureau of Economic Analysis defines foreign direct investment (in the U.S.) as "the ownership or control, directly or indirectly, by one foreign person of 10 percent or more of the voting securities of an incorporated U.S. business enterprise or the equivalent interest in an unincorporated U.S. business enterprise." A simpler definition of FDI is that it represents the total actual purchases of domestic assets or claims by any foreign interest. From 1979 to 2000, $346.2 billion of actual FDI flowed into China. The last decade, as the state has worked to implement an economy in which market forces begin driving the distribution of resources, has been marked by an increased acceleration of FDI inflow. Between 1992-2000, China received $282.6 billion in FDI, or 93 percent of the total between 1979-2000.
China has now become a global leader in foreign direct investment inflow. As recently as 2000, the U.S. received roughly seven times as much FDI as China, yet 2002 marked the first point at which China surpassed the U.S. ($30.0 billion) to become the leading global FDI recipient. China expects this trend to continue; for example, preliminary first quarter 2003 FDI figures were up 56.7 percent from a year earlier. China's Development Research Centre under the State Council notes that - as a result of recent economic growth, entry into the World Trade Organization and the selection of Beijing for the 2008 Summer Olympic Games - FDI growth is expected to "make big breakthroughs in the next five years" and that FDI is projected to surpass $100 billion annually between 2006-2010.
FDI growth during the 1990s was largely driven by multinational corporations (MNCs) who moved their manufacturing operations from the U.S. and other Western nations to China. For instance, during a seven-month span between October 2000 and May 2001, more than eighty corporations announced their intention to shift production from the U.S. to China, with roughly 35,000 U.S. manufacturing jobs lost as a direct result. This drive among U.S. manufacturers to move offshore has been and continues to be primarily motivated by lower production costs.
Labor Supply
While economic growth in developing nations often results in rising wages, China's labor supply represents a special case. According to most estimates, the average Chinese factory wage is roughly 40 cents per hour, about one-sixth that of Mexico and one-fortieth of the U.S. rate. China, with a population of nearly 1.3 billion offers a huge supply of labor. Of those, nearly 700 million live in rural Western China and earn an average of $285 per year. Despite a working environment that - by Western standards - features long hours and dormitory-style living conditions as well as a lack of benefits, pensions, and occupational safety, it becomes understandable as to why rural Western Chinese peasants are moving Eastward in search of pay that seems quite meager by our standards. This is a primary factor allowing China to maintain a competitive advantage of low labor costs in high skill sectors - including science and technology-based industries - as well as their more traditional low skill counterparts. This contrasts with the economic challenge posed by Japan during the 1980s, since Japan's total population has remained relatively steady since 1985, and is currently about one-tenth that of China.
Currency Policy
Another factor that allows China to maintain a competitive production advantage is its maintenance of a stable currency. The Chinese state has pursued an aggressive policy of tightly maintaining its currency, and while other Asian currencies have fluctuated greatly, the Renminbi (RMB) has remained consistently low. China's currency policy has led to regular intervention on the part of the Chinese government. As a result, the RMB has remained in an extremely tight trading band, between 8.276 and 8.280 to the dollar, varying by only 0.02 percent since April 2000. In turn, this currency policy has kept Chinese export prices low in the world market.
However, China's policies of keeping its currency artificially low have allowed the nation to accumulate $280 billion of currency reserves, including $75 billion alone in 2002. While Chinese officials have assured the U.S. government that it will eventually allow the RMB to move more freely, recent reports suggest the Chinese Central Bank's new governor, Zhou Xiachuan, will allow no such action in the near-term.
Conversely, if the RMB grows stronger, Chinese firms will gain more affordable access to imported manufacturing equipment, raw materials and energy to grow infrastructure. Given that China is dealing with increasing energy supply shortfalls, is following an overseas energy development strategy, and is poised to become one of the world's two largest oil consumers - along with the U.S. - by 2010, energy needs may indeed force the RMB upward over the coming decade.
Chinese Markets, Exports and Capital Accumulation
China's economic development also is being driven by the promise of a growing Chinese market for goods and services. As multinational corporations that have located manufacturing facilities in China wait for the internal market to mature, they have instead focused largely on goods for export to the U.S. and other established markets, thereby impacting international trade balances.
Growth of the Chinese market has been hampered by concerns about and unfamiliarity with market-based institutions, which has led to high precautionary savings among Chinese citizens, thereby depressing domestic demand. China has more than $1 trillion in household savings, most of which lies fallow in state-run banks, with only $16 billion invested in mutual funds. This large pool of savings stored in state-owned banks results in excess levels of credit for state-owned enterprises, in turn creating excess capacity - sustaining domestic deflation - and keeping capital from the private sector. Thus, sales to overseas markets and FDI have become the primary mechanisms to generate capital.
At the same time, the Chinese have managed to decrease the price of many manufactured products, which has effectively reduced pricing of such goods - from telephones to DVD players - to the realm of commodities. In fact, Chinese export prices have dropped by 15 percent since 1996, contributing to deflationary concerns among the U.S. and other overseas economies.
China has managed to fuel a significant percentage of its economic growth with a large increase of investment from the global money markets. This strategy represents a departure from other recent cases of economic growth, such as Japan during the 1980s, which predominately leveraged internal capital to fund economic expansion. Unlike China today, Japan actively restricted investment by foreign corporations. The willingness of multinational corporations and other global investors to invest in China, taken with the Chinese government's willingness to accept investment, sets a new precedent for planned economic growth on a massive national scale.
International Trade Policy
A major milestone in China's economic evolution was reached with its entry into the World Trade Organization (WTO) in December 2001. As a result, China has committed to a series of reforms over a five-year period. By the time of their full accession in 2006, average tariffs on all products are expected to drop below 10 percent (compared with an average 44 percent in 1991), and nontariff barriers such as quotas and licensing requirements also will loosen. Perhaps most important will be the removal of China's "safety net" of state-owned banks to cover firm losses, which should - in turn - create opportunities for U.S. and other Western financial institutions. The restructuring of the Chinese banking and finance system does represent one of the most critical risks involved with WTO entry. However, China's re-acquisition of Hong Kong in 1997 is expected to provide a means of financial expertise and skill to assist the restructuring of China's banking system. Hong Kong already possesses a strong base of international banking. Seventy-five of the world's largest 100 banks have a presence there, and Hong Kong is the world's seventh largest foreign exchange center.
China expects WTO entry will result in the following impacts:
· Increasing numbers of state enterprises are expected to sell their assets to private firms and become mixed companies that are jointly owned by entrepreneurs and the state. Jointly-owned enterprises accounted for 9 percent of all businesses in 1990, currently account for 40 percent, and could increase to 60 percent over the next five years.
· Reforms of state-run monopolies are expected to accelerate in the next three years. New antimonopoly laws are expected to help drive massive restructuring in China's service industries, perhaps particularly so in the telecommunications industry. For instance, China Telecom has already been broken up, and multinational corporations such as Motorola (who lead all such MNCs in FDI investment into China) are eager to acquire the maximum-allowed 49 percent stake in joint telecommunications ventures.
· Chinese deregulation also should be enhanced by streamlining regulations and simplifying administrative procedures. Currently, 60 ministries and departments are entitled to issue roughly 4000 types of permits and authorizations, of which 789 are to be eliminated by the end of 2003.
· China's government will be required to redirect its efforts to focus on current and growing social issues. As China's economy grows, so too will the desire for (and unrest by lack of) the pensions, unemployment and health benefits, and occupational safety and health measures that exist in other nations. Additionally, the anticipated acceleration of the growth of Eastern industrialized China and its middle class will create greater socio-economic stratification between China's East and West. In an effort to stave off unrest among its population, China has begun applying more focus toward addressing these social issues.
Already, the impacts of China's WTO entry have been profound. In the first three quarters after their entry, exports increased by 19.4 percent and total trade volume with the U.S. increased 18.3 percent, while the average import tariff rate was cut from 15.6 percent to 12 percent. Meanwhile, China's improved trade environment has been cited as a new factor that has already impacted FDI growth and related growth of the private sector.
Entry into the WTO is also increasing the role of standards in China. The Standardization Administration of China (SAC) was established in 2001, and is undertaking an "International Standards Adoption Plan 2002-2005" with the intent to gradually adopt more sophisticated international standards. China has also recently enacted the China Compulsory Certification (CCC) mark, which is required for a wide range of manufactured products exported to or sold in China.
Knowledge Recruitment and Retention
The Chinese state is committed to building a strong educational system, and China has undertaken a strategy to bring back U.S.-educated expatriate Chinese scientists and engineers. Since 1979, more than 400,000 mainland Chinese students have traveled abroad for graduate study, with only 10-25% estimated returning to China. However, that number is growing. In 2002, more than 18,000 overseas students returned to China, double the number from 2000. More than 30,000 Chinese returnees are in Shanghai alone working or starting businesses, and 90 percent of those hold graduate degrees from overseas. Further, the ranks of those returnees in Shanghai are expected to swell to more than 120,000 by 2010. Potential China returnees include green card holders, H1B visa holders (for skilled high-tech workers), and naturalized American citizens (including many granted blanket asylum after the 1989 Tiananmen Square incident).
Chinese firms now offer salary and benefits to scientists and engineers roughly equivalent in purchasing power to those in the U.S. The Chinese Government sponsors all-expenses-paid visits to China for potential engineering recruits and holds recruiting fairs in Silicon Valley. With the ascension of Hu Jintao as China's President, the recruiting push is expected to accelerate. Jintao is himself a graduate of the Qinghua University engineering school.
Meanwhile, Chinese-born Americans are returning to China for the opportunity to apply entrepreneurial principles to homeland startups. A recent OECD paper suggests half of the emerging firms from Chinese Taipaei's largest science park, Hsinchu, were founded by returnees from the U.S., and the Chinese Ministry of Science and Technology estimates that returning overseas students are responsible for most of China's Internet-based ventures.
Low-Tech to High-Tech
The notion that China is purely a source of low-quality goods produced with low-tech manufacturing operations and processes is now inaccurate. Over the last decade, China has shifted from traditional, low-tech production and processes toward higher-tech, higher-wage manufactured products and processes. For instance, in 1989, only 30 percent of imports from China competed against goods produced by high-wage industries. By 1999, that percentage had risen to 50 percent. Further, a recent study of production shifts out of the U.S. between October 2000 and May 2001 concluded the electronics and electrical equipment industry and chemicals and petroleum products industry have the two highest concentrations of production shifts to China. The same study found that, in 1999, the electronics and electrical equipment industry accounted for a $17 billion U.S.-China trade deficit, leading all industries, and represented the largest share of FDI inflow into China from the U.S. Correspondingly, the U.S. is increasingly experiencing accelerated losses of higher-tech, higher-wage manufacturing jobs and related capacity to China as well. For instance, a recent U.S.-China Security Review Commission report projects that China's computer production appears poised to surpass Japan in 2003 and could surpass the U.S. in 2005 or 2006.
This transition from production of low-tech to high-tech goods has affected the U.S-China trade deficit. In 1990, the U.S. had an overall trade deficit with China of $10.4 billion, but also a surplus of over $1 billion in bilateral trade of advanced technology products. However, while the value of U.S. exports of advanced technology products to China grew by 483 percent between 1990-2001, the value of such exports from China to the U.S. grew by 8126 percent.
Legal and Illegal Intellectual Property Acquisition
China's shift to high-tech, value-added production has taken place in concert with China's strategy to greatly enhance its intellectual property, both through legal and illegal means. China requires that all foreign manufacturers engaged in multinational ventures must train their local partners in the technologies associated with their products and openly share intellectual property. As a result, many Chinese manufacturers have greatly improved product quality and incorporated international innovations through these joint ventures. By applying lessons learned from such ventures, they have been able to develop competing products and introduce them into global markets. These products compete in the global marketplace as a result of their low-cost competitive advantages. In some cases, such as with Sony's camcorder and digital camera production, this has led foreign partners to shift production out of and away from China. In other words, China is benefiting from a "fast-follower" advantage; that is, rather than focusing on being the first to market with a given product, China has successfully leveraged the strategy of being first to put together a combination of features, value, and sound business economics to unlock a profitable new market. In other instances, investors in Chinese joint ventures have experienced the loss of their intellectual capital more rapidly than expected. This is a result of the actions of Chinese executives that have been hired into such joint ventures and who have secretly created their own companies which end up competing with the original joint venture between partner and investor.
Chinese intellectual property acquisition is particularly rampant in the electronics and software industries. The director of the U.S. Patent and Trademark Office testified in 2002 that Chinese intellectual property piracy represents one of the greatest areas of U.S. concern, and that while accession into the WTO had helped, "despite WTO commitments, there is little evidence of any prosecutions of Chinese citizens for criminal copyright theft". A recent study found that, in 2001, software piracy rates in China resulted in $1.6 billion lost in retail software revenue and that China was surpassed only by Vietnam for having the world's highest rate of software piracy, though it should be noted that China led all nations in software piracy in 2000.
Chinese Trends Will Impact the U.S.
Manufacturing has driven the rapid growth of China's production and economy. During the 1990s, the U.S. began losing an increasing number of lower-tech, lower-wage manufacturing jobs to China; however, we are increasingly experiencing accelerated losses of higher-tech, higher-wage manufacturing jobs and related capacity to China as well. This loss of capacity to manufacture high-tech, innovative products may have an effect on the ability to maintain our national security. Furthermore, the factors, as described in this article, are negatively impacting the U.S. economy and will continue to do so. China's growth poses a unique challenge to our economy unlike challenges of the past. China has demonstrated the ability to successfully utilize its capacities, and as its growth continues, China may well challenge U.S. economic primacy during the twenty-first century.
Ben Vickery is senior analyst/Manufacturing Futures Group at the National Institute of Standards & Technologies, Manufacturing Extension Partnership. For a complete listing of the resources used in this article, contact him at (301) 975-2954 or ben.vickery@nist.gov.
