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Hope is still alive for manufacturing

Hope is still alive for manufacturing Source:
Date: 13-02-2014
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Rising labor costs and the strengthening yuan are prompting overseas investors to seek alternatives to manufacturing in China. In China’s biggest export markets, the United States and the European Union, China’s market share began to fall for the first time in 2011. China has lost a little import market share in labor intensive manufactured goods, particularly textiles, fibers and clothing. However, a clear trend has yet to be formed. Meanwhile, China continues to move up the value-added chain. It’s not the end for Chinese manufacturing.
Are emerging markets in Asia gaining market share at China’s expense? For all their cost advantages, Bangladesh and Cambodia’s market shares in both the US in EU are very low and seemingly stagnant. It will likely take years before these countries can achieve the level of vertical integration that China has established over the past 20 years. As long as their supply chains are not fully developed, extra transport costs would be required to transport raw materials or semi-finished goods from China into these countries.
Moreover, there are serious concerns about these countries’ safety records and political stability. Global brands may reconsider expansion plans in these regions or even scale down existing operations, lest events tarnish their reputation. Claims that Bangladesh and Cambodia could replace China Ñ even if in low value-added manufacturing Ñ seem farfetched for now.
Vietnam may be a threat to China’s manufacturing as it is gaining market share in both the US and the EU. However, its import market share is still low. Unlike Cambodia and Bangladesh, which focus on low valued-added manufacturing, Vietnam is increasing its share of high-tech manufacturing as well.
Foreign investors are adopting a “China plus one” strategy to diversify their production bases as China’s labor costs rise. One example is Intel, which opened a US$1 billion chip and assembly facility in Vietnam in 2010, the biggest for the company at that time. Samsung, LG and Nokia have also been building manufacturing bases in Vietnam. In the textile and garment space, Japan’s UNIQLO has cut its share of production in China to 70 percent in 2012 from 90 percent in 2008, with the ultimate aim of having one-third of its production outside China. It also has production facilities in Vietnam.
Further, Vietnam is one of the 12 countries undergoing US-led TPP (Trans-Pacific Partnership) negotiations. Should a deal be settled, the TPP would benefit Vietnam greatly in terms of tariff concessions and favorable treatment by partnership members. Presently, typical tariffs on apparel from Vietnam to the US are 5-20 percent, but could drop to 0 percent under TPP. Some manufacturers in China have already moved or will consider moving to Vietnam to capture potential opportunities there. China, for now, remains outside the TPP.
If China only had low value-added manufacturing, the threat from other countries would be much greater. But China’s manufacturing is no longer confined to low value-added goods. Tougher conditions for manufacturers have induced positive shifts while the yuan’s appreciation and wage increase have deterred entrants into labor intensive segments.
Meanwhile, improvements in innovation, education and higher margins have attracted entrants into more capital intensive industries. China is gaining US market share in higher-skilled manufactures and medium-skilled manufactures of electronics and parts. Machinery and equipment is now the biggest category of China’s manufactured goods shipped to the US (53 percent in 2012). The ratio was only 45 percent when the yuan started to appreciate against the US dollar in 2005; and 35 percent when China entered into the WTO in 2001.
Such developments are consistent with the progression of an economy as entrepreneurs realign strategies in light of changing comparative advantages. Factory relocation so far has not caused severe unemployment. On the contrary, labor shortages are more prevalent than ever before. In 2013, China’s working-age population declined by 2.44 million.
The prospects for manufacturing still look good. While China lost market share in the US and EU in the past two years it has not lost any market share globally. The share of world exports has increased in all categories by level of capital intensity and technological sophistication. Looking forward, we are encouraged by the fact that China has moved up the value-added chain well before neighboring countries forced their way into low value-added segments. Finally, manufacturing is not just about exports. It is also about producing for locals, and China is a huge market in itself. While export growth of garment and clothing accessories averaged 9 percent in the past five years, retail sales of garment products in China grew 21 percent. Manufacturing will remain a key part of China’s economy for years to come.
High value-added
Rising wages and the yuan’s appreciation have pressured manufacturers of low value-added goods to abandon existing area of expertise and venture into higher value-added production. That said, profit margins may not be substantially higher. It is a strategic shift if the transition is well planned with corresponding soft and hard infrastructure in place. However, if the decision to transform is made out of desperation driven by herd mentality, entrepreneurs may eventually find themselves trapped in a position without any comparative advantages due to the lack of experience and customer networks.
The crux of the issue is that low value-added manufacturers do not know how to move up the value chain within their own area of expertise. A good example is the shoe manufacturing industry. Italian and French made shoes are often sold for more than 2,000 euros (US$2,720) per pair, whereas Chinese made shoes are often priced between 50 and 100 euros. Such huge discrepancies are attributed to factors such as culture, protection of intellectual property, branding strategy, perseverance of traditional craftsmanship skills and even education and vocational training policies.
The gradual decline of low value-added manufacturing is the natural result of evolving comparative advantages and the consolidation process will continue for quite a while. Threats from emerging rivals exist but are generally exaggerated. Nothing suggests an imminent demise of China’s manufacturing sector.
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