The China Sourcing Blog

Textile and Apparel Sourcing: The Rise of South East Asia

2012-01-30T09:55:04Z

Global textile and apparel sourcing is currently in a state of change. In China, the textile industry is not a major focus for industrial development, and lower value added manufacturing is progressively moving into South East Asian countries. For this reason, textile and apparel sourcing has to become more diversified. Yet this does not mean that China is no longer one of the leading players in this field, but emerging countries in South East Asia are increasingly challenging China's dominance.

China still has a lot going for it. It has well-established supply chains, as well as good infrastructure and expertise in making apparel and textile products; no single emerging country in South East Asia can yet hope to match China in all of these capabilities. Hence China will likely remain the leading textile and apparel sourcing country in the region over the near to medium-term. But the basic point here is that sourcing can (and should) now utilise the increased number of sourcing options in the region, and not focus solely on China.

Old and emerging players: The global landscape

The World Bank has identified four basic types of apparel exporting countries in the world, with the largest share of production occurring in Asia:

Steady Growth Suppliers: China, Bangladesh, India, Vietnam, and Cambodia (Pakistan and Egypt can also be included on this list, but with smaller market shares)
Split Market Suppliers: Indonesia (which is increasing its market share in the US and Japan, and decreasing its share in the EU), Sri Lanka (which is increasing its market share in the EU and decreasing in the US)
MFA-era Suppliers*: Canada, Mexico, the Central America Free Trade Agreement, (commonly known as DR-CAFTA, a free trade agreement including the US and the Central American countries of Costa Rica, El Salvador, Guatemala, Honduras, Dominican Republic and Nicaragua), EU-12, Tunisia, Morocco and Thailand (all of which have all registered sharp declines in textile and apparel exports after the MFA quotas were abolished in 2005)
Past-prime Suppliers: Hong Kong, South Korea, Malaysia and other countries with decreasing market shares since the 1990s such as the Philippines and Singapore

The map below illustrates the new challengers to China's dominance for textile and apparel sourcing, highlighting the emerging sourcing potential of South and South East Asia:

New opportunities in the Asian landscape

China is no longer the only option for textile and apparel sourcing, and it certainly is no longer the cheapest option. So taking advantage of this new landscape means being able to exercise a range of sourcing options focusing on a number of emerging Asian countries. Some of these opportunities are outlined very briefly below:

With low cost domestic supply of cotton and low labour costs, Pakistan has a good track record for pure cotton apparel production for items such as male T-shirts and cotton jerseys
Bangladesh still has an underdeveloped apparel and fabric manufacturing industry, although it also has very low labour costs and cotton prices. Thus Bangladesh can be targeted for sourcing of cotton garments of basic design and standard quality
Sri Lanka has similar cost advantages as Pakistan and Bangladesh (although the cotton price and labour costs are slightly higher), but operating and capital costs are higher, and a lot more machinery needs to be imported. As a result, Sri Lanka could potentially only be a sourcing target for certain niche products such as women's underwear
Cambodia's textile industry is still highly underdeveloped, but low costs and government support for the industry makes it attractive likewise for niche products such as basic design T-shirts
Indonesia's cotton price is the lowest in the region, but operating costs are higher than most countries in the region and much of the machinery in the industry is largely outdated. Indonesia does, however, have substantial installed capacity across a range of textile segments, and hence can be targeted for a number of products such as synthetic fabrics, synthetic apparel, and high-end cotton shirts
Vietnam has a lower cost base than China and India, although higher than Bangladesh and Pakistan. The textiles and apparel industry is actively supported by the government, and relatively significant currency depreciation makes the country's exports competitive. The local workforce is still largely of a low-end skill base, however, meaning that Vietnam's best sourcing opportunities are still in basic designs and standard types such as woven garments and children's products
India has a diverse and integrated fabric and apparel industry, and it now has lower labour costs and cheaper cotton prices than China. These and other trends mean that India will likely gain a comprehensive competitive edge over China in the future. India can be targeted for sourcing fabrics and textiles across virtually all product categories

This very brief outline illustrates that China is no longer the only game in town for textile and apparel sourcing. It is still the dominant player, and will likely still account for the largest share of global textile and apparel sourcing for some time to come, but other countries in South and South East Asia are now attractive for specific products, and China's position will be further assailed in the years to come by these emerging Asian countries. The trick is to exercise the right sourcing options.

* The Multi Fiber Arrangement (MFB), implemented as a short term measure to allow developed countries to adjust to imports from the developing world, governed world trade in textiles from 1974 to 2004 and imposed quotas on exports from developing countries to developed ones.

Also see this report on the CEIBS website: China's Role in the Global Textile Industry.

Happy Holidays from The China Sourcing Blog

2011-12-14T08:51:17Z

To all our readers who are taking some time off after a long year, we wish you a pleasant and relaxing time, hope we'll catch you again soon.

Heavy Industry: China's New Level of Competitiveness

2011-11-30T10:37:13Z

Heavy equipment manufacturing is an interesting measure of the maturity of China's economy. Its one thing to build a bulldozer, but its quite another to build a bulldozer that can compete with the best in the business. And right now, China is aspiring to achieve just that. But is it there yet? Not quite.

Measuring progress

China's progress in heavy industry exports during the last decade, however, is very impressive. The chart below illustrates just how well China performed in terms of total heavy industry exports in 2010 (y axis), and CAGR from 2000 to 2010 (x axis). It now stands just behind the US, Germany and Japan, but its growing much faster than those.

As the note explains, 'heavy industry' here refers to a bundle of exports of 10 trade items, in all of which China has immensely increased its share of world exports. To illustrate this further, the following chart shows these items individually, and contrasts where China stood in 2000 vs. 2010. Its quite a change, as you can see.

Competitive champions

So the statistics illustrate a clear picture of China's emergence in heavy industry. Yet when it comes to actually competing with the best, does China's best efforts measure up? I want to take one example to discuss this: construction equipment. The 'Bulldozers, etc.' and 'Derricks and Cranes' categories in the chart above refer to such construction equipment for which China has registered rapid progress in the last decade. And if China has become competitive it means that its leading construction machinery manufacturers have done so as well.

Its no surprise then to discover that China now has three companies in the top ten of construction equipment manufacturers globally; only six years ago, the highest ranked Chinese company was in 33d place. The ranking I am referring to here, which used sales revenue for the 2010 calendar year, is the Yellow Table published in the magazine International Construction (downloadable with registration), which lists the top 50 global construction manufacturers (Im referring to the April 2011 edition of the magazine).

Its very interesting how the Yellow Table ranking corresponds with the first bubble chart above: the US, Germany and Japan lead, followed by a few other countries and China. In the 2010 Yellow Table, Caterpillar (US) is at the top, followed by Komatsu and Hitachi (Japan), Volvo (Sweden), Liebherr (Germany) and Doosan (S. Korea). Then, in 7th, 9th, and 10th place follows the Chinese competitors Sany, Zoomlion and XCMG. Other Chinese companies in the top 25 are Liugong (20) and Shantui (22).

Being competitive vs. matching the best

But how competitive are the likes of Sany, Zoomlion, XCMG and Sany really? Can they really compete with Caterpillar and Komatsu? The short answer to this question is no, or at least not yet. The longer answer is more complex, and needs to be looked at in terms of the situation in a specific market. I am going to briefly refer to the South African market for this purpose.

Buying a bulldozer or a wheel loader is not just a case of buying a bulldozer or a wheel loader. Construction companies and mines will want to be absolutely sure that the machine they buy will work as long as its supposed to. And they will want to know that if a part is needed, it can be provided without delay. For every hour that the machine does not work on a mine, the mine loses a stack of cash. Reliability and longevity is everything. Price is not unimportant obviously, but quality is more important.

So consider the disadvantage that new Chinese competitors in South Africa face against long established players like Cat and Komatsu. While you will pay more for a Caterpillar machine, you know when you buy it that the after sales services coming with that machine will be top notch. If it breaks, Caterpillar will supply a new part within 24 hours. As new entrants in the South African market, the Chinese competitors cannot yet match this service offering. Their machines cannot yet match the performance of a Caterpillar or a Komatsu, even though they have come a long way in the last few years.

A different future

And thats just the rub: Chinese manufacturers have come this far, its very unlikely that they will not become serious competitors to the best in the business sometime in the future. The Chinese are learning the ropes fast, they know that you need to put down deep roots in a country to be able to supply the kind of after sales services necessary to compete with the best, in addition to building quality machines. They are not quite there yet, but they are getting there.

Some of them even seem poised to step up to another level of competitiveness right now. One example is the Chinese producer Shantui, whose main product is a bulldozer. Shantui hails from China's Shandong province, where Shantui had originally set up a factory based on Japanese technology. Shantui has now been in South Africa for a few years, and just a few weeks ago it launched a whole new facility in Johannesburg, which I attended.

Shantui has run an advertising campaign in South Africa proclaiming itself as the world's #1 bulldozer manufacturer, and seem to have placed great emphasis on the right kind of after sales services. Shantui was also able to present feedback from some of the users of its machines which glowed with appreciation of the quality of the machines, and it also announced that its sales in South Africa in the last few months have gone through the roof.

So time will tell if this is really the beginning of big things for Shantui. But I can picture a time when a Shantui bulldozer or a Sany wheel loader will be among the best brands in their classes. Its happening, but give it some more time.

A New Approach to China Procurement

2011-11-17T00:40:20Z

China's procurement environment is changing under the weight of both old and new trends, and procurement managers worldwide must adapt to a new opportunity landscape. A different approach is now required that takes advantage of China's more sophisticated manufacturing base.

For the past 10-15 years, China has been the undisputed darling of purchasing managers worldwide. The goods Chinese suppliers export to the EU and US range from apparel and electronics to heavy machinery, all of which have grown steadily in the past decades to place China in the number one spot for overall exports volume. Exports of machinery and equipment to developed countries have particularly enjoyed rapid growth over the past ten years (see chart below, right). But since 2006-07, new issues such as an appreciating currency and increasing labour costs have started to impact both the real and perceived competitiveness of China as a source of manufactured goods. How should a procurement manager re-assess China in the light of these and other changes? How can they assure that competitive advantage is gained by investing in a China sourcing operation? How to benefit from the long-term trends and evolving landscape of China’s manufacturing base?

Old news: Labour and currency issues

Labour cost increases and rapid rises in input prices, mostly for commodities and energy, were a significant problem for the Chinese manufacturing industry in the years preceding the global financial crisis. The crisis provided a brief respite, with declining exports and capacity utilisation releasing upward pressures on prices and wages. But since early 2010, the trend has resumed, with labour costs increasing by 14.3% in real terms in 2010, and PPI inflation reaching 5.5%. Not only is labour becoming more expensive, but there is also a shortage of experienced white collar workers, engineers and managers which are increasingly in high demand.

In addition, the Chinese government is allowing the gradual appreciation of the renminbi, with has risen by 21% against the US dollar over the past five years. With pressure from the US and other developed countries for China to further appreciate its currency, this trend is likely to continue for the foreseeable future. Other trends that are not new but continue to plague the Chinese manufacturing base are intellectual property protection; weakly defined and poorly implemented quality management processes; governance issues in supplier selection and management; and inconsistent product quality.

New trends

There are also more recent discernable trends which are negatively affecting the pricing and availability of Chinese exports. The government is increasingly implementing trade restrictions such as export bans or export quotas, and also reducing VAT export rebates and in some cases placing export duties on certain commodity-type products, especially energy-intensive goods or low-value-added processed raw materials. On the other hand, newly emerging or existing sources of manufactured goods, such as Vietnam, Thailand, Malaysia, Indonesia, and the Philippines, have started to look comparatively better from a labour cost perspective. Governments across the region have started implementing some of the policies that brought success to China’s leading export manufacturing industries, and are offering increasingly attractive investment incentives to manufacturers. Procurement managers across the globe are under pressure to evaluate these up and coming low-cost countries, and determine the best approach for avoiding increasing costs in China and taking advantage of these opportunities.

Estimating the extent of change

From our experience in China and our understanding of China’s manufacturing strengths and weaknesses, none of the trends described above are surprising. They all fit into the mould of the long term income rise of China’s population, as well as government policy goals of increasing the value added of local manufacturing, reducing the country’s energy and raw materials dependency, and shifting the growth engine of the economy away from export-oriented manufacturing towards a more balanced portfolio of investments, including boosting local consumption and the service exports are forecasted by MEPS to fall by 37% this year, while seamless tube exports will only see a modest 8% growth. To better understand how to take advantage of this shifting China procurement equation, we need to re-assess the key elements of China’s traditional manufacturing competitiveness. What began 30 years ago as a cheap labour outsourcing base for unsophisticated goods has changed dramatically to become a continent-scale country of widely varying costs, standards, capabilities and business environments.

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?

A new approach: Drawing in the supplier and sourcing goods of increasing complexity

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.

Note: This article originally appeared in the section China Sourcing Strategy of the September 2011 edition of The China Analyst.

China’s Accession to the WTO 10 Years On, Agreement on Government Procurement, Russia’s Pending Accession

2011-11-11T06:01:06Z

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.

Map: China's Top 100 Industrial Clusters

2011-11-04T00:00:23Z

The map below illustrates the concentration of industry in China, using cities to identify locations where resources and competencies have been concentrated to produce a competitive advantage in a specific industry.

Click on the map for a bigger view.

This map provides an interesting perspective on what is made where in China. Some of the cities listed on this map has become famous for their particular industrial cluster, just a few examples of which are bra's and ladies underwear in Shantou (Guangdong); electronic products in Dongguan (Guangdong); transport equipment in Shandong; and lighters in Wenzhou (Zhejiang). The clusters are predominantly still located in the eastern part of the country, but as the distribution of the dots on the map illustrates, there is a lot going over a many provinces, not only in the coastal areas.

New China Sourcing Fairs in Brazil in the Context of China-Brazil Trade

2011-10-31T02:30:15Z

A new channel for Brazilian sourcing from China will be opened next year when Hong Kong-based Global Sources will extend their China Sourcing Fairs to Brazil. Global Sources will team up with Milton Exhibits to stage four simultaneous events on August 14-16, 2012, at the Imigrantes Exhibition Center, Sao Paulo. The four shows will be for Electronics, Gifts & Premiums, Garments & Textiles and Hardware & Building Materials.

China-Brazil Trade

Prior to 2001, the year of China’s accession to the WTO, the annual value of goods exchanged between China and Brazil never exceeded USD 3 billion. Yet after this date, bilateral trade increased substantially every year, rising from USD 3.2 billion in 2001 to a full USD 56.4 billion at the end of 2010. In 2009, despite a drop in overall traded value, China surpassed the United States to become Brazil’s top trade partner. China’s leading position continued in 2010, when it accounted for 14.7% of Brazil’s total traded value for the year. Items exchanged in the two-way trade between China and Brazil are now primarily along the lines of Chinese manufactured goods for Brazilian natural resources.

China's Leading Exports to Brazil

Electronics is an obvious choice for one of the four shows, as it was the most sought after Chinese products by Brazilian consumers in 2010, comprising 31% of all Chinese exports to Brazil. This category included around USD 1.3 billion in telecommunications equipment, nearly 616,000 laptops and USD 291 million worth of static converters. Machinery, at 22% of the China-to-Brazil export total, was the number two category by value, supported by USD 281 million worth of air conditioning machinery imported by Brazil in 2010. Other top items in China-to-Brazil exports include organic chemicals (comprising 5% of China’s exports to Brazil), products of iron and steel, vehicles such as tractors and bicycles, and technical equipment.

Shift Away from Lower Value-added Items

In the last ten years, the composition of China’s exports to Brazil has shifted away from low value-added items such as clothing and toys— although these are still increasing in terms of absolute value—toward a greater emphasis on electronics and machinery. The new China sourcing fairs in Brazil only partly reflect this reality, however, as they include a mix of both higher and lower value-added sourcing items.

Chinese Manufacturers and Incremental Innovation

2011-09-26T07:45:31Z

Lower value added goods such as textiles are becoming less competitive to source from China, and Vietnam, India, and Bangladesh are just some of the countries picking up the slack in the supply of goods at the lowest rungs of the value chain. As evidenced in the chart above, China’s manufacturers are becoming more competitive in product categories ranging from electrical switching apparatuses to cruise ships, cargo ships and barges. For some product categories on the chart above, it shouldn’t come as a big surprise. Take motorcycles for instance; although commuters’ adoption of cars in China’s first-tier cities are well documented, an overwhelming majority of the population covet motorcycles as a convenient, efficient and cost effective means of transportation in China’s megacities and up and coming second- and third-tier cities.

In this cycle, China’s manufacturers are earning a sound reputation for being “extremely efficient at creating new versions, often simpler, cheaper and more efficient, of technologies and products shortly after they are invented and marketed elsewhere in the world,” according to Dan Breznitz, co-author of a newly released book titled, ‘Run of the Red Queen’. The authors further argue China should focus on what it does best: making incremental innovations in everything from manufacturing to logistics. In other words, the millions of US dollars Chinese enterprises under guidance from the central government spend on R&D, in an effort to come up with breakthrough technologies that will put them on par with the West, is money better spent elsewhere. A healthy portion of investment should be allocated to the sectors shown above where Chinese manufacturers have taken on significant shares over the past three years. In doing so, consumers both at home and abroad stand to benefit, along with merchants and sourcing managers who are able to identify the most competitive products Chinese manufacturers are producing.

The China Analyst - September 2011

2011-09-23T05:00:17Z

The Beijing Axis has just released the new edition of The China Analyst, and this September 2011 edition focuses on the impact of China's business in the wider world, but especially the momentous impact on the developing world, which we describe as a new era that China is building in regions like Africa and Latin America.

With this new edition we have also launched a dedicated website for The China Analyst, where all the sections can be read online in an interactive format. The new website can be found at www.thebeijingaxis.com/tca.

To download the new edition, please click on the link below or go to the The China Analyst website URL provide above.

The China Analyst - September 2011.pdf

The Correlation Between Power Generation and Industrial Output

2011-08-15T08:51:12Z

In 2007, Chinese deputy prime minister Li Keqiang told the American ambassador (whose report would become a famous wikileaked cable in 2010) about his (Li's) misgivings about the quality of provincial GDP figures in China. Instead, Li said, he used three proxy figures for GDP, namely cargo volume on provincial railways, bank loans and electricity consumption. The Economist went on to make a 'Keqiang index' that juxtaposed China's official GDP with Keqiang's proxies. This chart revealed an economic 'just as dynamic but even more volatile').

Yet as Damien Ma points out in The Atlantic earlier this month, the use of electricity consumption as a proxy for GDP has been in vogue in China since the 1990s. And one reason electricity consumption has correlated relatively well with economic growth, he adds,

is because industry is by far the largest consumer of power, at perhaps 70 or 75%. As the last decade has been basically defined by China's hyper industrialization phase, capturing a large enough slice of industries--which are massive energy guzzlers--meant you had a rough, but imprecise, picture of the broader economy.

The chart above juxtaposes not GDP and electricity consumption, but two slightly different indicators, namely industrial value add (hence output for the industrial sector of the economy, including manufacturing, mining, and utilities) and electricity production. The correlation is strong, yet it is striking that electricity production is (as with the Keqiang Index) just as dynamic as industrial value add but even more volatile.

What Makes a City Tier in China?

2011-07-28T02:10:14Z

We often hear of China’s first or second or third tier cities, yet what actually makes a city tier? The terms are so often used, yet there is actually no official formula for determining what tier a city falls in. Instead, everyone makes up their own rules.

There are a few common views on which Chinese cities fall in which tier, often pointing to population, development of services and infrastructure, and the cosmopolitan nature of the city. First tier cities are naturally the fewest and easiest to find common ground on. China’s four city municipalities (Beijing, Shanghai, Tianjin and Chongqing) are candidates as a clearly-defined group of leading cities. Yet this group doesnt hold up in terms of the development and stature criteria mentioned above, and in their stead a different quartet is often put forward: Beijing, Shanghai, Guangzhou and Shenzhen – four huge metropolises with well-developed property markets.

It becomes much more trickier when we move down to second tier cities. According to Xavier Wong, head of research at the Knight Frank real estate office in Hong Kong, to be considered in the second tier, a city should have a population of at least three million and a minimum GDP equivalent to USD 2,000 per capita. By this definition, back in 2007 when Wong made the calculation, there were about 60 Chinese cities that qualified as second tier. In addition to the simple population and income guides, according to Wong, the cities should also have a strong history of exports, a robust record of foreign direct investment and good policy initiatives. This seems at least a more robust definition than simply grouping China’s 28 provincial capitals as the second tier cities, as some (including apparently AC Nielsen) have done before, and grouping prefecture and country level capitals as third tier cities.

In 2009, RightSite.com, an online property trading website, identified five criteria for defining a city tier in China, namely

Propulation of more than five million people
Povincial GDP of at least RMB 250 billion, or RMB 350 billion in more prosperous provinces
Cities with strong economic growth (for which RightSite provided no threshold)
Geography, i.e. cities which are the most significant in their area, like Xiamen (even though it only has around 2.5 million people)
Advanced transportation infrastructure
Historical and cultural significance. Here Rightsite provides the example of Guilin, which is relatively small yet could be considered second tier due to it being a tourist centre

Due thus to the fact that there are many different views on what delineates a city tier, some have ditched the term altogether. A China consumer study published in 2009 by consulting firm McKinsey, for example, recognised the limitations of using city tiers, and opted to use a classification of city clusters instead, which are groups of cities that are developing around one or two large cities. The report identified 22 such clusters in China, divided into groups of mega, large and small (for the full report and map showing the clusters, click here).

Dividing China’s cities into different tiers has obvious advantages, as it can illustrate how economic development is moving inland or westwards in China, and how China’s large metropolises are being gradually matched by cities with rapid economic growth yet that are not yet quite as big or have as many people. The idea seems simple and practical enough. Yet the snag of using the tiers system is in setting the exact parameters for them, because with so many different classifications being used, the result is confusing and contradictory. So the only way to go about it if you really need to divide all China’s cities into tiers, is to put forward (your own) clear formula for what makes a first tier city and especially what makes a second or third tier one. Perhaps its just case of 'know one when you see one' to define a second or third tier city - not exactly a science.

Then again you can opt to sidestep the whole tiers issue altogether, like McKinsey did. Yet it seems that ‘tiers’ have made such a strong impression on foreign observers of China that the confusing term will be with us for a long time still, in its various guises.

Without any mention of tiers, however, a map of China’s major cities (the municipalities, provincial capitals and fastest-growing cities) would look like this:

CHINA IN NO TIERS

How would you define China’s city tiers? Do we even really need them? Please let us know in the comments.

(Roy Binkowicz contributed to this posting)

Droughts, Floods and Inflation

2011-07-19T03:57:02Z

Controlling inflation remains a top priority for China's policy makers and June's Consumer Price Index rose 6.4% from a year earlier, a 3-year record. This has been largely attributed to soaring food costs, which in turn have been largely attributed to unfavourable weather conditions. Yet what exactly is the link between bad weather and inflation?

Drought

This year China faced a severe drought in March-May which was reportedly the most severe in 50 years. The drought affected eight provinces in northern China, severely impacting most of China's wheat-producing regions. This impacted China’s economy, affecting agricultural production and prices through lower output and higher irrigation costs. Yet it also created expectations for higher inflation and inspired more speculative activity. The outcome was higher prices for food and raw materials. In Hubei province the price of rice increased by 20% in May to RMB 2.6 per kg. In Hunan province locally produced lotus root also climbed 20% during the same period to RMB 4.2 per kg. In the city of Wuhan the average price of 20 monitored vegetables climbed 7.3% in one month and additionally the price of cabbage almost doubled in May to RMB 2.22 per kg, according to China’s Ministry of Agriculture.

The drought also brought water levels in some of the country's biggest hydropower producing regions to critical levels, and partially because of this China is currently facing the most severe power shortage in the last seven years. This exerts pressure on coal-fired power plants to increase production, at the time of globally rising coal prices. All this contributes to increasing power prices, which will increase the cost of production, which will make manufacturers charge higher prices, which causes inflation to rise. Its all linked in a spiralling chain reaction.

Flooding

At the beginning of June the drought suddenly gave way to weeks of serious flooding which, according to some farmers, was the worst in the past 20 years and has left vast areas of Hubei and Zhejiang with more than 432,200 hectares of farmland flooded. 7,000 homes have either been damaged or have collapsed and the financial damage could amount to around USD 930 million. This has reduced vegetable output by 20%, which caused shortages of grains and fruits. As a result, at markets in Hangzhou, the provincial capital of Zhejiang, the prices of some fruits, vegetables and grains have risen by as much as 40% since early June, according to Xinhua. In the south of China the floods also pushed up the average wholesale prices of 18 staple vegetables by 2.3% as a whole, with the wholesale price of cabbage increasing first by 20.3% and then by a further 17.9%.

This has also impacted pork prices, which have steadily increased, partially due to the shortage of grain, which is mainly attributed to corn (the main feed of hogs), the production of which was severely affected by both floods and the drought. All this contributed to pork prices in June rising 57.1% y-o-y.

Is it all about food?

So is China's rising inflation overbearingly about rising food prices, which based on the above, are clearly very susceptible to factors like droughts and floods? The answer seems to be an unequivocal yes. Food prices have been the biggest driver of China's inflation, constituting nearly two-thirds of the rise in CPI. Food prices rose 14.4% in June from a year earlier, up from an 11.7% in May, and as long as they are edging upwards, all the other prices will follow in their wake.

China-Australia Trade: As Much About Machinery as Resources

2011-07-01T00:30:15Z

The China-Australia trade relationship is well-known for the flow of natural resources from Australia to China. Yet in the other direction, China has in the last decade become the leading supplier to Australia of machinery and electronic equipment. The two bubble charts below in Figure 1 illustrates the progress that China has made from 2000 to 2009 in becoming Australia’s leading supplier of machinery and equipment. In 2010, machinery and electronic equipment accounted for 39% of the total (see Figure 2), and China went from supplying 4% of Australia’s imports of these items in 2000 to 21% in 2010 (see Figure 1).

Figure 1:

In 2010 Sino-Australian total trade of goods amounted to USD 87.57 billion. China’s total exports of goods to Australia in 2010 was worth USD 35.26 billion, growing with a CAGR of around 20% between 2001 and 2010 (see Figure 2). Resources is clearly only one side of China-Australia commerce. The other side is the machinery and electronic equipment that Australia is sourcing from China, which respectively constitute 28% and 21% of China's exports to Australia.

Figure 2:

Could China be on the Verge of a Huge Power Shortage?

2011-06-24T02:15:42Z

The world’s fastest-growing major economy may be on the verge of a severe power crisis: a power shortage of 30 million kilowatts this summer. Some commentators have said that its the worst power shortage in China since 2004, while others have gone so far as to say it’s the worst in China’s history. Yet the China Electricity Council (CEC) denies that there is any power crisis in China at all. According to them this is merely a regional seasonal occasional shortage. They report that China's demand for electricity will increase by 12-14% this summer compared to last year and that the eastern and central provinces are likely to experience electricity shortage, but provinces in the north-east and the north-west will have a surplus. Unsurprisingly, electricity prices for industrial use rose by an average of RMB 0.0167 per kilowatt-hour on 1 June 2011, the first retail power price rise since 2009.

Running out of power?

Thermal power accounts for 75% of China's total installed power capacity and 82% of its generating capacity. China's newly added thermal power capacity stood at 10.01 million kilowatts in the first quarter of 2011, 2.68 million less than the same period last year. The reduced new capacity for thermal power this year is essentially occurring because thermal power companies are struggling financially. The overall deficits for China's five major thermal power plants have topped RMB 60 billion (USD 9.23 billion) since 2008. This in turn is being attributed to the rising price of coal. The average price of thermal coal at Qinhuangdao port is currently RMB 815 (USD 125) a ton, 5% higher than the price in the first quarter of this year. This figure is the highest price in the last two and a half years, according to the China Coal Transportation and Distribution Association. The power shortage also has a lot to do with the fact that investment in China's thermal power industry dipped to RMB 130 billion in 2010 from 200 billion five years ago. Moreover the shortage is expected to worsen as electricity demand rises during the peak summer months just when hydro power capacity has been hit by drought. The drought has left water in some of the country's biggest hydro power producing regions at critical level just when demand is at a peak.

Unsustainable growth?

China is growing rapidly, but in order to sustain this growth it needs a lot of power. Can China sustain 9% GDP growth while energy consumption is growing at 12% in 2011 so far? Power stations are struggling to keep up with demand, they do actually have capacity to produce more, but expensive production costs, as outlined above, are eating away at their profits. Hence on 10 May this year it was reported that China experienced a shortage of 18 million kilowatts, which is expected to reach 30 million kilowatts for the summer, as mentioned above.

Implications: CPI, GDP

According to some experts, this large power shortage could significantly hamper economic growth in China. One example of this view is Gao Shanwen, an economist at China Essence Securities. In Gao's view, the shortage will have a direct impact on industrial output, which he forecasts to fall by 0.5% in the second quarter. This could produce a drop in GDP of 0.2%.

The rise in the price of power will increase production costs, thus the Producer Price Index (PPI) is likely to go up in the short term, and this will put further pressure on CPI, obviously a sensitive issue in China right now. It could get tricky in the months ahead.

Food Safety in China in 2011

2011-06-16T00:22:56Z

The past few months have been a particularly active period for food safety issues in China. The fact that something is wrong with the food that we are eating in China adds a panicky element to these food scandals that have cropped up with worrying frequency in recent months. The fact that there is deliberate malfeasance involved, moreover, adds an element of anger and general mistrust.

Tainted food is of course nothing new in China. We all remember the dramatic case of tainted milk in 2008, when six babies died and 300,000 people fell ill. What made this case so frightening, however, was the deliberate malfeasance involved: tainted milk for bigger profits. Since this time, the authorities have attempted to address the issue of tainted food, yet on recent results the outcome has not been overly successful.

Since February the following were some of the leading food safety issues in China:

On February 23, government scientists released research that millions of acres of Chinese agricultural land and over 12 million tons of Chinese grain are contaminated by toxic metal pollution. It was reported that Yunnan, Guangdong and Guangxi are particularly polluted. Crop contamination that soaks into the soil did not start this year, however this year the the extent of the problem is becoming clear

On April 10, it was reported that intentional poisoning of milk killed three children and caused 36 others to become ill in China's northwestern Gansu

On April 20, it was reported that 40 tons of bean sprouts treated with the chemical compounds sodium nitrite and urea, as well as antibiotics and a plant hormone called 6-benzyladenine, were sized in Shenyang. Sodium nitrite eliminate bacteria growth in food, yet can be toxic for humans

On April 22, Guangdong provincial authorities uncovered 16 tons of pork tainted with toxic chemicals. The pork was tainted with "colorings" made of sodium borate, bean flour and other additives. The authorities believe that it was done deliberately in order to make the pork look like beef and to sell it a higher price

On April 26, it was reported that 26 tonnes of milk powder tainted with melamine were seized in a Chongqing based company. The company bought the milk powder from a company in the southern region of Guangxi at a significantly lower price

On May 6, farmers in Jiangsu province reported cases of exploding watermelons, attributed to farmers excessively using forchlorfenuron, a growth accelerator. Chinese authorities do not actually forbid the drug, yet Chinese farmers have clearly made excessive use of this chemical