China’s economy is now taking its next great leap forward: Parts of its manufacturing sector are moving up the value-added chain and out of the country. The China challenge is now a global one.
The reasons for this are not difficult to fathom. Production costs (wages, rent, land, capital etc) in China’s coastal provinces — where most of the country’s manufacturing and service production, as well as foreign direct investment (FDI), are located — have been rising fast. Since last year alone, minimum wages in nine of 12 coastal provinces, including Beijing, rose by an average of more than 21 percent.
At the same time, the yuan is appreciating, making domestic production of export-oriented goods and services even more expensive. This is important, especially for labor-intensive activities, whether by affiliates of foreign multinational enterprises (which account for more than half of China’s exports) or by local firms, which are losing competitiveness in international markets.
To maintain its export-oriented production base, output must move up the value-added chain toward more sophisticated products. Multinational enterprises can do that within their integrated global production networks, which allow them to organize an international intra-firm division of labor. Any part of these production chains can be located wherever it best suits the firms’ international competitiveness. And such firms have the experience to scout the globe for the right investment locations.
Domestic Chinese firms also need to respond to these pressures. They are helped in this effort by the rapid deepening of China’s skills and technology base. This partly reflects training in foreign affiliates, but the main reason has been the Chinese government’s sustained effort to foster education and training, encourage technology transfers from foreign to domestic firms and, in particular, to build up research and development capabilities.
In short, producers of more sophisticated goods and services in developed and emerging-market countries need to be prepared for growing competition from China.
At the same time, China’s labor-intensive production will increasingly move to countries with lower labor costs — including Bangladesh, India, Indonesia and Vietnam (where Chinese firms have already established about 1,000 affiliates), as well as various African countries. This process has already begun and has been supported since the beginning of the last decade by the government’s “Going Global” policy, through which it encourages outward FDI from China.
The data bear this out: FDI outflows more than doubled in 2008 to US$52 billion, from US$23 billion in 2007, and rose even further in 2009 — when global FDI flows collapsed by about 50 percent because of the Western financial and economic crisis — before reaching US$68 billion last year. Not counting Hong Kong, this made China the world’s fifth-largest outward investor that year.
This development creates new opportunities for other developing countries to reap the trade benefits of inserting themselves into the international division of labor. These countries’ investment-promotion agencies — indeed, those of all countries, including developed ones — should increasingly target firms in China to lure them to their shores. In so doing, they should aim not only for big state-owned companies, but also for the rising number of vibrant, private small and medium-sized enterprises in China that can be found in all sectors of the economy.