November 2011 Archives
In terms of labour costs, cost to company per employee is increasing across China due to uneven supply, high demand, inflationary pressure, organised labour demands, and growing social spending requirements. But Western China still offers large pockets of very reasonable wages for skilled and semi-skilled labour, and foreign and local manufacturers in China are increasingly taking advantage of this. While it is true that wages are rising quickly in coastal regions, labour productivity gains due to investment and technical upgrades, especially in the machinery industry, have kept pace with the rise in labour costs (see chart above, left).
Chinese exporters of manufactured goods are also taking advantage of the massive local market. The demand for new plants, equipment, infrastructure – often one third to half of world demand – has created significant economies of scale and of scope for most of China's manufacturing sub-industries. The competitiveness and innovation in the construction machinery sector, for example, have primarily been driven by the country’s infrastructure build-up over the past 15-20 years. The same effect has benefited the producers of steel commodities and structural steel, construction materials, trucks, barges, electrical equipment, power generation equipment, etc. The infrastructure build-up and procurement demand, initially fuelled by foreign-invested companies and with some assistance from government procurement policies, government-approved projects, and the availability and low cost of land and capital, have generated a highly competitive and increasingly sophisticated plethora of local producers that are now dominating the Chinese market and aiming for global expansion.
The size and growth of China’s manufactured goods market is in effect supporting a self-sustaining cycle of cut-throat competition that features innovation, capacity expansion and upgrading, and ‘learning by doing’. Suppliers and clusters of suppliers compete with each other but an engineering talent pool and the related innovation usually travels freely and contributes to China’s overall manufacturing competitiveness. They take advantage of the more than 600,000 students who graduate with engineering degrees every year, excellent transport infrastructure, especially in coastal regions, and generally supportive government policies favouring Chinese high value added manufacturing. As industries across China consolidate and manufacturers grow and become more assertive in their quest for value-added production and profitability at home and abroad, firms sourcing from China must address the following question: How can we protect and consolidate our savings in sourcing capital goods from China through the establishment of a China procurement operation? At the same time, how can we move to the next level and take full advantage of an increasingly sophisticated manufacturing base?
The structural changes in China’s competitiveness across the sourcing spectrum will require procurement managers to shift some of their commodity spending from China to other LCCs, while increasing their orders of machinery, complex parts and high-value added consumables in China. In our view, the key to taking full advantage of a broader spectrum of cost and feature innovation present in the Chinese market is to move from a customer-supplier model of price-based sourcing with strictly dictated specifications and standards to a partnership-based approach where the supplier takes an active part in the overall project and in specifications design. This would entail a structured and patient exchange of ideas, a deeper understanding of Chinese manufacturing practices and standards, and above all, an open mind from both the customer and the supplier. Commercial practices would also require modifications. Contract management with Chinese suppliers generally relies less on contract enforcement and more on relationship management, so many of the standard contractual clauses traditionally used by international procurement teams are either not applicable or not enforceable in China, and thus create unnecessary burdens on suppliers and ultimately increase the total costs of the contract.
Ultimately, a sophisticated foreign buyer of Chinese capital equipment will probably need to adopt a number of Chinese standards, practices and approaches – all without compromising quality, environmental and labour protection standards, or good governance.
Two weeks ago I had the honor of attending, “The 10th Anniversary of China’s Accession to the WTO: China’s Learning Curve,” conference jointly held by the Research Center for Chinese Politics and Business at Indiana University and the China Institute for WTO Studies of the University of International Business and Economics. Sun Zhenyu, China’s former Ambassador to the WTO, was among the over 40 speakers from the WTO, Chinese and foreign governments, law firms, and leading universities scheduled to share their insights and thoughts nearly 10 years since China became a WTO member, including how China and the WTO itself has changed in the time since.
During the second panel of day one titled, “The Effect of WTO Entry on China’s Economic Reforms and Economy,” Mr. Christian Murck, President of the American Chamber of Commerce in China and Dirk Moens, the Secretary General of the European Union Chamber of Commerce in China, shared their insights on China’s current status as it moves towards a complete market economy. While both concluded that foreign companies have undoubtedly benefited greatly from China’s accession and economic progression, they both conceded there is still a lot of room for improvement. To start, SOEs continue to enjoy too much preferential treatment (easy access to low interest rates), stifling competition and some would argue, stifling innovation. Simply put, more reform is needed for China to declare itself as a true market economy. Other common problems/concerns shared by American and European businesses alike is the high degree of discretion local governments in China have when issuing and implementing laws, which makes it difficult for businesses with a nationwide presence to develop a unified China strategy. In the coming years as China’s working age population peaks, and labour shortages become more widespread, China’s hukou system must be reformed so that workers can move more freely between cities and companies can hire the necessary personnel. In fact, it can be easily argues that addressing these issues is in China’s best interest, as Chinese companies also face the same problems.
Agreement on Government Procurement
The Agreement on Government Procurement (GPA) is a legally binding and plurilateral agreement in the World Trade Organization (WTO) focusing on the subject of government and local government agencies procurement (the only one of its kind to date). The procurement in the Agreement includes a variety of goods, ranging from commodities to high technology equipment, and services. The GPA was established to eliminate discriminative laws and practices against foreign supplies and suppliers in government procurement among member countries. For member countries, the market opportunity is significant as the government procurement of goods and services typically accounts for 10-15% of GDP for developed countries, and up to as much as 20% of GDP for developing countries. Subsequently, the GPA is currently being reviewed among the 42 members, so that it “reflects the realities of government procurement in the 21st century,” according to senior Swiss trade diplomat Nicholas Niggli, who chairs the government procurement committee. An updated version will expand the coverage (range of government procurements) in terms of the entities or sectors covered, which, according to the International Centre for Trade and Sustainable Development (ICTSD), would liberalise access to billions of dollars worth of public procurement contracts.
According to a recently released working paper from the WTO’s Economic Research and Statistics Division, the total value of additional market access commitments that could result from GPA accession by 42 WTO members is in the range of USD 380-970 billion annually. The accession of the five BRICS countries – Brazil, China, India, Russia (not yet WTO member, see below) and South Africa – would, by itself, add in the range of USD 233-596 billion annually to that value. Currently, Albania, China, Georgia, Jordan, Kyrgyz Republic, Moldova, Oman, Panama and Ukraine are negotiating accession.
On 28 December 2007, China delivered its application and initial (largely ceremonial) offer for acceding to the GPA to the WTO Secretariat. Subsequently, on 9 July 2010, China submitted a revised and improved coverage offer. Although China has 15 years of WTO negotiations experience, it is taking a different approach this time around as shown in the first three years of negotiations. According to a working paper presented at the conference, China, lacking a formal political process of interest, is utilising its political leadership, organizational arrangements, academia and public opinion to help guide its negotiations. China has pledged to submit a “robust improved offer” before the end of the year, to be reviewed at the WTO's ministerial gathering on 15-17 December. According to ICTSD, the offer would outline China’s proposal for which Chinese government agencies would be covered under the agreement, what thresholds would apply, and other coverage-related details. While it is expected to well received by existing GPA members China’s accession is not expected to be concluded by the end of the year.
Russia’s Impending Accession
After 18 years of negotiations, Russia and its USD 1.9 trillion economy is on the verge of joining the WTO after recently accepting a trade deal in early November with Georgia, the former Soviet republic with which it fought a short war in 2008. The compromise deal on monitoring mutual trade was the last major hurdle that will secure Russia’s integration into the global economy and arguably the biggest step in world trade liberalization since China joined the WTO. President Dmitry Medvedev is hopeful that Russia will formally join the 153-member club by the end of the year. On November 10, Russia won approval from the WTO’s Working Party, which will draw up a final document for approval by WTO trade ministers in Geneva on December 15; Moscow will then have until mid-June to ratify its membership, which will become effective 30 days later.
Accession is expected to stimulate Russian economic growth, boost gross domestic product by an extra 11% in the next 10 years and help encourage global companies, especially those based in the European invest in Russia. The biggest beneficiaries of the WTO deal are global companies based in the European Union, by far Russia's biggest trading partner, the U.S. and other countries. According to Andrew Somers, head of the American Chamber of Commerce in Russia, "The benefits for Russia are basically long term. It's going to normalize Russia as an investment destination market. Over time, Russian companies will be forced to be more efficient and competitive." While Russian companies and exporters such as Russian steelmakers are set to benefit tremendously through more favorable treatment in tariff negotiations abroad (the average maximum Russian import tariff is set to fall to 7.8% from 10%), some domestic manufacturing industries which have been largely shielded from global competition such as food processing, textiles and construction materials, will most likely suffer. Looking ten years into the future, if Russia does indeed join the WTO, it will be interesting to see how much the business landscape in China has changed, and if China is any indication, Russia will be remarkably different.