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Dance with the dragon

China’s emergence as the most favoured destination for offshore manufacturing is beginning to show some cracks, writes Curtis Andressen.

india Updated: Jun 14, 2007 03:20 IST

China’s emergence as the most favoured destination for offshore manufacturing is beginning to show some cracks. India could now take advantage of the weaknesses.

Everyone knows that China’s economy is booming. In the past 10 years, China’s total trade has grown from $ 150 billion to nearly $ 1.8 trillion last year. It is fast becoming Asia’s workshop — a point that has strong implications for India.

China’s growth is based on its comparative advantage. It successfully produces goods at a relatively low cost while maintaining quality, a stable trading environment, relatively good legal protection and so on. The conditions were good enough that China was allowed into the WTO in 2001. Most of China’s trade, with the exception of the US, takes place within the region. While the US is China’s number one trading partner, Japan is second, Hong Kong third, South Korea is in fourth place and Taiwan comes fifth. Total trade with these five places totals nearly $ 900 billion — half of China’s trade.

But, most of this growth has been based on the foreign direct investment (FDI) that has flowed into the country in the last 20 years, especially the last decade. In this respect, China’s gain is India’s loss. China is now the world’s largest recipient of FDI, having recently overtaken the US. As China’s economy grows, however, some of its comparative advantage — especially its low cost labour — is being reduced. Wages in China are going up, and this is particularly true in coastal China, and especially in jobs that involve advanced industrial production.

What this means is that potential investors are now considering alternative destinations where costs are even lower. Here, India is a winner from China’s growth. But it will have to compete with countries like Vietnam and Indonesia, and countries further afield such as those in Africa. It is no accident that China is moving closer to Africa, both in terms of access to natural resources but also future sources of cheap labour for offshore manufacturing.

At the same time technology is increasingly impacting manufacturing processes. Wages are becoming less of an issue in terms of production costs as technology is used more and more. This is precisely why many high technology products are not made in China. Progressively, the days of wage cost advantage will pass away, and China will have to find other ways to ensure its comparative advantage.

Of course, the picture is not as simple as this. China is rapidly learning about production systems, business support, and quality control from foreigners investing in the country. These lessons, along with the nation’s anticipated capacity to innovate, means that Chinese companies should be able to produce more sophisticated products in the coming years. Indeed, FDI is finding its way into China’s hi-tech sector. This will offset the loss of comparative advantage on product pricing.

Balancing this positive development is the fear of an over-reliance on China. This fear is beginning to be felt among China’s investors. It is not a good idea to have all of one’s manufacturing eggs in the Chinese basket. This is not just an issue of comparative advantage but one of security. Hence Japan, for example, is implementing a strategy of China Plus One, the Plus One meaning an alternative source of investment/manufacturing. At present Vietnam is emerging as a favourite of Japanese companies in this respect.

Chinese companies are also learning from foreign corporations in terms of investing offshore to reduce their operating costs. Hence, China is looking to regional economies in the same way as Japanese or South Korean companies. In this respect, India may gain from China’s growth, though there is some reluctance in India to accept Chinese investment in sensitive areas.
Still, some argue that India gains from its difficulty in attracting foreign investment in that it forces Indian companies to develop using their own resources. In the long-term, this means that independent innovation takes place and, at the end of the day, India (like Japan), owns most of its own economy.

Curtis Andressen teaches Asia-Pacific Political Economy at Flinders University in Adelaide, Australia

First Published: Jun 14, 2007 02:40 IST