Tuesday, January 02, 2007

A Japanese View of China

Don't Confuse "Made in China" with "Made by China"
April 26, 2002
by Chi Hung KWAN
[Japan's] Research Institute of Economy, Trade and Industry (RIETI)

Recently, Japanese imports of manufactured goods from China have surged and the reputation of Chinese products has improved substantially, giving rise to concern that China will soon replace Japan as the "factory of the world." An objective evaluation of China's industrial strength, however, suggests that there is still a long way to go before it will become a truly advanced industrial country on par with Japan.

First of all, the high proportion of labor-intensive products in China's exports means that its trade structure is typical of a newly industrializing economy (NIE). This is different from that of developed countries, where the major export items, such as machinery, are technology-intensive. Although China is increasing its share of the global market for manufactured goods, including some IT products that are classified as high-tech, Chinese exports are still highly concentrated in lower-end products. In the case of televisions, for instance, Japan specializes in high-definition and other higher-end models, while China produces standard models whose unit values are much lower.

Reflecting China's emphasis on processing trade, goods "made in China" contain large numbers of overseas components, some of which are made in Japan. According to official Chinese statistics, increasing exports by $1 million requires importing intermediate goods and components worth $500,000, which do not form part of China's GDP. Moreover, the proportion of this imported content is higher for high-tech than for low-tech products. A computer labeled "made in China" is likely to contain a large portion of imported contents including an Intel CPU, Microsoft Windows operating system, and a liquid crystal display made in Japan or South Korea.

In addition, approximately half of China's exports are produced by subsidiaries of foreign companies, to which dividends, interest charges, royalties and other fees must be paid. Even among Chinese companies with no capital relations with overseas companies, the majority of their exports are processed under OEM (original equipment manufacturing) contracts and sold with foreign brand names. Thus only a very small percentage of the value-added of products labeled "made in China" is actually "made by China." The latter corresponds to the concept of China's gross national product (GNP), and excludes import charges on intermediate goods and investment income paid to overseas countries.

China is so heavily dependent on foreign partners that it has yet to develop its own edge-cutting technology and internationally recognized brand names. On the top of this, Chinese companies are inferior to their overseas counterparts in virtually every aspect, be it capital, human resources, or business management. As a result, China has no option but to look to cheap labor for its export competitiveness. Indeed, the majority of China's contribution to the value-added of its exports lies with the cost of labor, and the very low wages in China averaging less than $100 a month imply that this contribution must be very small.
As such, the common assumption that Chinese goods are competitive because the country's wage levels are low holds true for only labor-intensive products, and does not necessarily apply to industry as a whole. Instead, China's low wages should be interpreted as a reflection of the fact that its labor productivity is poor. It is when China's wage levels approach those of Japan, reflecting a rise in productivity, that China will really become a formidable competitor for Japan.

The Myth of Chinese Competitiveness - Are Low Wages China's Strength or Weakness ?
August 30, 2002
by Chi Hung KWAN
[Japan's] Research Institute of Economy, Trade and Industry (RIETI)

It is often said that since the wage levels in China are low relative to industrial countries, products made in China have strong international competitiveness. Among Japanese corporations too, a gloomy mood persists that it is impossible for them to beat their Chinese counterparts in international markets, given the very large wage gap between the two countries. It is certainly true that low wages have been a major factor contributing to China's strong competitiveness in labor-intensive products, but looking at Chinese industry as a whole, they rather reveal its lack of competitiveness. Taking into consideration the fact that Japan's strength lies in technology-intensive products, it is clear that China poses no threat to Japan because the two countries complement, rather than compete with, one another.

It goes without saying that wages alone do not decide the competitiveness of a country's industries. If the simple logic that "low wages equals high competitiveness" were actually true, countries such as Bangladesh and Somalia, with wage levels even lower than those of China, should be competitive. It would also be expected that in China too, foreign investment would be focused on the inland regions of the country where development is lagging behind that of the coastal regions. In reality, however, these trends have not materialized. Accordingly, when making judgments concerning competitiveness it is vital to take labor productivity into consideration. In other words, in countries where wages are cheap relative to productivity, competitiveness should be strong, but in low-wage countries where productivity is even lower, competitiveness should actually be weak.
As an indicator of competitiveness, it would therefore be better to use unit labor cost, which takes into consideration both wages and labor productivity. For example, although the average wage rate in China is only 2.1% that of the United States, productivity is also at only 2.7% that of the U.S., so that its unit labor cost (2.1/2.7 = 76.9%) is not so much different from that of the U.S. If other factors such as China's high capital costs, poor infrastructure and weak legal system, are taken into consideration, its advantage in international competitiveness is further diluted. [...]

The large gap in productivity between China and the developed countries means that, when China participates in the global markets, it can do so only by specializing in labor-intensive products (or labor-intensive processes for technology intensive products) in accordance with its comparative advantage based on low wages. Since China has an enormous surplus of labor in its rural areas, further increase in the demand for labor in manufacturing areas would not result in upward pressure on wage levels. Thus, for the time being, China should have no problem sustaining its competitiveness in labor-intensive products. In these circumstances, however, since for Chinese corporations the optimal strategy is to expand labor input rather than improve productivity, low wages could actually be a factor retarding the advancement of industries.

So long as China depends on low wage levels to compete in international markets, it can at best be a "factory of the world," rather than an "industrial power" that would rule over such high value-added areas as product standards, brand names, and core technologies. Since low wages also imply a low standard of living, no doubt they should be understood as a sign of China's weakness rather than its strength.


Blogger Harry Eagar said...

You'll never find me underestimating the problems that China faces, but this particular area is one where things can change very quickly.

About 30 years ago, I attended a Deming conference where one of the speakers was the chief of TV manufacturing for RCA, at that time the last US maker.

He held up a tiny part, which he said cost about a tenth of a cent to make, and said his job was to get the cost of making that part even lower, in order to match -- the Japanese.

This is largely a matter of human engineering. At the same time, many wannabe countries (eg, Indonesia) had local-content requirements that forced auto manufacturers (eg, Toyota) to do from some to a lot of assembly in the countries where the cars were to be sold.

Toyota (unlike Detroit) participated in these assembly schemes, exporting millions of "knock-down kits" to Africa, Asia and Latin America.

The intent to use auto assembly to kick-start a local manufacturing sector failed, and most (perhaps all) of these schemes were withdrawn. Toyota immediately withdrew all assembly from backward countries to Toyota City, which is one reason it is the world's largest manufacturer now.

If you want labor productivity, you have to invest in labor, not machinery, first.

China is doing this, and I am willing to bet that, until its imminent political collapse, it is going to be competing more closely with Japan.

January 03, 2007 10:20 AM  
Blogger Oroborous said...

Yes, I agree that China is taking rational and necessary steps towards becoming a mature economy, and a nation that matters on the world stage.

My prediction about China's future is that they will be increasingly successful at becoming a global economic and military power, especially when measured in relation to the continued decline in Europe's economic and military power.

It's just that I don't see them becoming the "U.S.-beater" that some other people predict. (At least, not during the 21st century).

Japan, however, isn't competing directly with China to export manufactured goods; instead, they're using China in much the same way that America uses Mexico. They have their own maquilas in coastal China.

January 04, 2007 6:54 AM  
Blogger Harry Eagar said...

True, but that's not new. That's how Japan used Singapore in the '20s. Japan's field of operations has gotten a lot bigger.

January 04, 2007 8:07 AM  
Blogger M Ali said...

Yeah, China's got a long way to go before they achieve the management and infrastructure depth of the First World. Lenovo hasn't done much of note since it took over the IBM PC business.

Still it is having a major effect regionally thanks to all the investment it's making in energy and natural resource production. The interactions between it, Central Asia, Pakistan and India will become a lot more developed in years to come.

January 05, 2007 2:06 PM  
Blogger Oroborous said...

Right, China is a major player now in global energy markets.

January 06, 2007 5:14 AM  

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