China’s manufacturing sector at a crossroads

Chris Devonshire-Ellis, Founder of Dezan Shira & Associates, a pan-Asia-Pacific accounting and management consulting firm serving foreign companies operating. Or seeking to operate within the region — convened an informal conversation over dinner in Hong Kong last week to discuss business trends in the region impacting foreign investors.  Joining the conversation were Meredith McBride, Researcher & Journalist International Tax Review, Renaud Anjoran, Consultant with China Manufacturing Consultants and myself.

The conversation ranged from a discussion about what opportunities and challenges exist for foreign companies doing business. In the region, to what impact ASEAN integration is likely to have on the business climate, to implications for US investors seeking to do business in Hong Kong in the wake of the implementation of the US Foreign Account Tax Compliance Act (FACTA)

The current state of China’s manufacturing sector

Another of the highlights of the conversation was a discussion of the current competitive state of the Chinese manufacturing sector.  As the South China Post outlined this week, China’s manufacturing sector “has long [been] the driving force of China’s economic miracle.”  However last year, as the report continues, citing a recent study by KPMG, “foreign investment in manufacturing ‘fell 12.3 per cent to US$39.9 billion and accounted for 33.4 per cent of total inflows.’”  In contrast, the report outlined. “The services sector drew inflows of US$66.2 billion, up 7.8 per cent from the previous year.”

With this precipitous decline in manufacturing-focused investment, Renaud Anjoran explained. How China’s manufacturing sector appears to be facing several challenges all at once.  They are:

• An inability of many manufacturing firms to emerge from low-end manufacturing
• Technological advances not yet able to compete with low wages (eg robots too expensive for cash-strapped factories and requiring difficult-to-find maintenance skills), leaving large parts of China’s manufacturing industry reliant on a wage-based, less expensive focus
• China lacks skilled workers in industrial engineering and preventive maintenance, and in middle-management
• Very few Chinese manuafacturers are looking at more advanced production techniques (does Japan really want to share them?)
• Near Sourcing for shorter lead times (eg Mexico manufacturing for the US market) is in ascendance and China will suffer from this trend
• Continuing quality problems – focus of factory owners is on cost containment and a 3% defect rate is often considered good
• Too many middlemen
• Lower wage competition in Vietnam and India are eating into Chinese margins. The ability to upgrade, especially in the apparel and footwear industry.

China also faces regional competition

Devonshire-Ellis suggested that the upcoming ASEAN AEC compliance at the end of this year would impact making Vietnamese manufacturing more competitive to China-based production. Wages alone were not the only factor driving some manufacturing away. Demographics were also playing a part and China was now beginning to lose its workforce as well as see its age. This was in stark contrast to India. Where a far younger workforce was now coming into the age worker group and would continue to do so for the next decade. India’s workforce would match the size of China’s by 2025. At far lower rates, suggesting that India, as well as Vietnam, would emerge as major competitors to China over the next ten years.

He also pointed out that an increasingly closed China in terms of internet access would hinder academic development. And that China had largely failed to produce executives that were familiar with operating. In the more transparent commercial systems engaged by most of the world. This hindered Chinese executives. He suggested by keeping them too constrained by ‘the Chinese system’ would also inhibit Chinese entrepreneurs from developing their businesses as global competitors. India, he said, was creating better quality entrepreneurs and this was now being shown. In the rise of Indian MNCs outstripping in numbers their Chinese counterparts.

Will China reclaim its position as the world’s manufacturing centre?

Last year, China overtook the United States as the world’s largest recipient of foreign direct investment.  But the focus of that investment is now on sectors including services.  China’s government does appear determined to utilize a combination of regulatory and restructuring initiatives with an aim to reclaim its position as the world’s manufacturing centre.  But as Anjoran and  Devonshire-Ellis outlined, China’s manufacturers are in need of more than just a few reforms. If the country is to assume a truly globally competitive posture deserving of a renewed focus by foreign investors.