[SCMP Column] China’s astute decision to abandon export processing by upgrading manufacturing base

May 20, 2015

There are moments when the Chinese government’s big picture thinking comes into sharp focus, and the release by the State Council this week of its first blueprint to upgrade the manufacturing sector by 2025 provided just such a moment.

For a government and a party that is made up largely of engineers, this is bedrock stuff. I find it slightly surprising that we have not seen a blueprint on manufacturing development before.

The Action Plan shows clearly the abandonment of the export promotion strategy that has underpinned growth for the past three decades. Priority is to be given to high technology, robotics, aerospace engineering, naval architecture, ocean engineering, advanced transport, new energy vehicles, electronics, agricultural equipment, new materials, and pharmaceuticals and high end medical devices.

This is manufacturing focused on internal development, and the empowerment of the domestic economy. It embodies domestic infrastructure development, and the shift to building a new large middle class inside China that can drive domestic consumer spending in the decades to come.

This Plan has its roots in insights first gleaned a decade ago, perhaps when they were able for the first time to see the fundamental weaknesses of its export-focused model in Foxconn’s role in supplying the world with iPhones.

When the ADB Institute managed to open up the iPhone value chain a decade ago, China’s leaders quickly saw two things: first, that success sits not in controlling the assembly of a final product, but in capturing high value-added activities (mainly services) along long, complex, international supply chains.

And second, that in aiming to capture the final assembly stage they had been playing a mug’s game, capturing a low-wage, low-skill, low value added activity that locked its workers in low-wage penury.

You may recall that the ADB institute study showed that in an iPhone retailing in the US at US$500, China’s customs-measured export value was $180, but the domestic value added accruing to the Foxconn final assembly operations in Dongguan amounted to less than $7.

Statistically, and in terms of Customs measurements, China was exporting items at $180 – which greatly boosted apparent export earnings. But most of this export value was accounted for by the import of high value components and services that had earlier been imported from countries like the US, Germany, Korea and Japan.

Since this discovery, China’s leaders have steadily raised minimum wages in the coastal export zones to where they are more than double today what they were in 2000. This has forced manufacturers out of this immiserating part of the value chain. They have had to boost productivity, raise value added, and move into higher technology areas, or they have withered.

From this discovery forward, China’s leaders have recognized that providing rich consumers in the West with low-cost consumer goods may have been right for the emergent 1980s, but by locking their own work force in low-wage poverty, they were throttling the growth of their own domestic consumer market, and were also building social discontent problems for themselves in the future. Since the early 2000s, and in particular since the crash of the global financial markets in 2008, they have recognized the logic and urgency of building their own consumer middle classes.

Hence the priorities of the China manufacture 2025 Plan, and the recognition that development of their services economy (to drive efficiency and productivity in their supply chains) has to play an essential part in building a competitive future manufacturing economy. We saw this very clearly in APEC last year in China’s fierce advocacy of services development.

Some will no doubt see in the new manufacturing plan hints of efforts to build China’s defence industries – aerospace engineering and naval architecture, for example.

But the heart of this plan is to build infrastructure for a strong domestic economy – in advanced transport systems (high-speed rail, metro systems, efficient airports), in sustainable technologies (new energy cars, new materials), and in technologies that will decisively shift China’s manufacturers far up the value added end of the value chain (New IT, robots, electronics, high end medical devices).

For APEC member economies meeting this week in Boracay in the central Philippines, Trade Ministers would do well to learn important lessons from China’s plans: services liberalization is essential to enable cheaper and more competitively delivered services (which make up 60-70 per cent of the value of any manufactured good); stay open to trade – importing as well as exporting – so you can grab a piece of the global value chains that now account for about 70 per cent of all trade; and focus not on capturing the final assembly process, but on high-value-adding activities along the supply chain.

China’s lesson is clear: low-value-adding export processing is a mug’s game that locks your own work force in perpetual poverty; build your own wealthy middle class that can drive consumption inside your own economy; and keep your market open to imports, so that your domestic manufacturers are kept on their toes.

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