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The China Analyst - October 2012

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China's hand-picked next generation of leaders will be tasked with solving deep-rooted problems formed during China's 30 years of socio-economic development. A growing (and increasingly visible) disconnect between top wage earners and the working class, frustrated factory owners, and a rapidly-ageing population are just some of the key issues facing modern China.

Beijing needs to rebalance its economy away from excessive reliance on investment towards a more domestic consumption driven growth model. Beijing will only be able to accomplish this feat through targeted market-oriented reforms such as deepening reforms in the land, labour and financial markets. In the meantime, the vested interests of China's powerful SOEs, who have long enjoyed preferential government policies in an effort to breed global champions, will remain a major hurdle in pushing long-awaited reforms.

China is still on track to become the world's largest economy sometime during the new leadership's 10-year tenure. If China's policymakers fail to push much-needed reforms, foreign investors will look to other markets and marginalised sections of the population will grow even more restless. However, if China can stay on course - while battling increasingly visible signs of strain - it will herald yet another chapter in China's unrivalled growth story.

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Click here to download the October 2012 edition

In the October 2012 edition of The China Analyst, we gauge China's progress in implementing these market-oriented reforms and highlight the opportunities that companies need to be aware of as China enters a new, more sustainable growth phase.

This edition includes the following lead articles:

  1. China's Economy: Heading for a Firm Landing?
  2. China's SOEs: Stalled Reforms or Agents of Change?
  3. FOCAC 2012: Sino-African Partnership Gains Momentum

A new Commodities section focusing on China's role in global commodities trade is included to complement other regular sections such as: Procurement, where we take a closer look into China's rising labour costs; Strategy, where we explore China's role in Africa's development as an investor and major trading partner; Investment, where we analyse China's overseas resource investments; BRIICS, a macro economic comparison of the world's six major emerging economies; and four Regional Focus sections with analyses of the latest China-related trade and investment activities in Africa, Australia, Latin America and Russia.

The China Analyst is published by The Beijing Axis, a China-focused international advisory and procurement firm.

To view the current and past editions of The China Analyst online, please visit our website.

The China Compass - August 2012

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The China Compass - August 2012, published by The Beijing Axis, combines basic country data of China, as well as other major world economies, with more detailed analysis of a wide range of macroeconomic and social data; presents a comprehensive picture of the ever-changing and evolving Chinese landscape; contains up-to-date statistics, topical themes and insights; and is presented in a reader-friendly format as a useful desk reference for executives with a China agenda.

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Click here to download the August 2012 edition

Since our last edition, the developed world has been unable to escape from a self-induced sovereign debt crisis, which has fuelled speculation as to whether China's economy is headed for a 'soft' or 'hard' landing. While China's GDP growth has subsequently slowed to 9.2% in 2011 and 7.8% year-on-year in the first half of 2012, fears of 'hard' landing seem overblown. Even growth of 7.6% in the second quarter fits with our core view that China's annual growth rate for 2012 is still expected to be around 8%.

As China attempts to rebalance its economy towards a more sustainable growth pattern that puts a greater emphasis on domestic consumption while sheltering the economy from the global slowdown, we expect many cyclical and structural changes and increased volatility. However, we still do not foresee a hard landing.

Our focus and theme of this edition is 'China Moves Towards Growth Moderation and Sustainability', featuring sections on:

  • Selected Macroeconomic Indicators
  • Domestic Consumption and Foreign Trade
  • Domestic and Foreign Investment
  • Financial Indicators
  • Social Indicators

We trust that this edition of The China Compass will continue to shed light on past developments, current issues and future prospects of the Chinese economy, making this fascinating and complex story slightly more comprehensible.

As always, we welcome and appreciate all feedback. 

The China Compass is published by The Beijing Axis, a China-focused international advisory and procurement firm. 

For more publications by The Beijing Axis, including past editions of The China Compass, please visit the 'News & Media' section of The Beijing Axis website.

Here's a little mental leap. In the last few years Beijing's subway has expanded substantially, especially after a building blitz before the 2008 Olympics. At the time, Chinese companies have entered the Fortune 500 in increasing numbers. What if you would literally put these two completely disparate phenomena together?

The result is this infographic. It illustrates the progression of Chinese companies in the Fortune 500 from 1994 (when the first Chinese company joined the list) with a visual reference to the expansion of the Beijing subway system from 1971. All but two of Beijing’s current 15 lines were opened in the last decade; in the same period, 47 of the current total of 58 mainland Chinese companies joined the Fortune 500. The circles around each company portrays visually the expansion in revenue of the companies at time of joining the Fortune 500 vs. currently. Note the subway map is not exhaustive of Beijing’s current subway system of 15 lines.

Click for a closer view.
Note: This infographic appeared on page 3 of the April edition of The China Analyst

The China Analyst - April 2012.jpgThis is the new edition of The China Analyst - April 2012. In this edition we ask you to prepare for a more competitive China. We ask you to change your perspective on China. 

How competitive is China really? It has changed a lot in the last three decades, yet now it is aiming to transition to innovation-driven competitiveness. If you apply a little imagination and envision where current trends are heading, you might be induced to change your opinion on China. This process has started happening in a number of industries, such as heavy and construction equipment, where Chinese companies have begun to shake up the competitive landscape, especially in emerging economies. Yet in various other industries as well a number of Chinese companies are approaching the 'technological frontier.' It is a process that is occurring in gradual steps, as Chinese companies adapt, improve and innovate, but it is a process that all companies in the world should be aware of and prepare for. 

In other usual sections we also look for example at how companies procuring from China are using the Product Positioning Matrix (China Sourcing Strategy), and we look at China in the context of the global debt landscape (China Strategy). In addition, we look as usual at the trade and investment landscape in four key geographies: China-Africa, China-Australia, China-LatAm, and China-Russia. 

To download this edition, please click on the link below, or see The China Analyst website at

The shipbuilding industry has been the scene for a major uptick in Chinese export market share in the period 2007-10. 

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The OECD countries that China captured market share from were in this case Japan and South Korea. These two, in their turn, were responsible for capturing the market from Europe as early as the 1970s, but it was only in 2010 that South Korea was surpassed by China as the world's leading shipbuilder. The chart above illustrates how rapidly this occurred in the period 2007-10. 

According to the global shipping services provider Clarksons, in 2011 China accounted for around 41% of the global shipbuilding share in dead weight tonnes, while South Korea had 33%, Japan 20%, and Europe only 2%. China's ascent in the industry was complicated, however, by the global financial crisis. With sluggish demand for new ships and rising costs for labour and steel, the volume of new orders in 2011 fell 52%, according to the China Association of the National Shipbuilding Industry (CANSI). 

China's smaller shipyards are bearing the brunt of the downturn, and more than 30% of them could go bankrupt this year, according to some observers. The current dearth of orders is not a new phenomenon, moreover, as Clarksons have pointed out that the numbers of orders for local Chinese yards have been declining all the way since 2007.     

Early in 2012, the dire situation facing China's smaller shipyards seems to have contributed to China's Transport Ministry banning from its ports any ships larger than 300,000 dead weight tons. For more on this somewhat controversial issue, see this Reuters report.   
Its always tempting to compare economic aspects of China and India, as we have done before. Exports is one area that is commonly compared; the chart below summarises briefly China and India's performance over the last decade. There are some striking observations. 

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Firstly, the scale indicates that India's exports are dwarfed by China's, yet both Chinese and Indian exports have increased substantially in the last decade. China's advance in exports was mainly situated in the Machinery and Electrical Equipment category, in which it has gained market share all over the world (i.e. in Australia, as we have outlined before) and which reflect the strategic evolving of its economy from the 1990s.  

India, however, have not focused on equipment as China has, but instead the bulge has occurred in the 'Other' category. The bulk of this 'Other' category includes Manufactured Goods, of which Engineering Goods in 2010 constituted about 65%. Petroleum Oil Products (or POL products) constituted a significant share of about 15% of India's total exports by 2010, and was the fastest-growing Indian export over the decade. Gems and Jewelry constituted another 16.2%. For some more info on India's recent export performance, see here
This is the first in a new series of posts looking at certain trade and industrial 'hotspots' in China.

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If you look at trade statistics for Chinese provinces in 2011, it is clear that something is happening in Henan, an emerging central province, and particularly in its provincial capital of Zhengzhou, one of China's 20 fastest growing cities. Zhengzhou is what some might call a typical second-tier Chinese city (Bentley and Louis Vuitton have just set up shop there). Provincial Value Added of Industry growth was a solid 19.6% in the first eleven months of 2011, yet what sets the province apart is the huge jump in foreign trade achieved in 2011. In August 2011, Xinhua picked up on Henan's trade bounty when it reported that Henan had registered total foreign trade of USD 11.7 billion for H1 2011 (this is perhaps an underestimate), with the European Union serving as the main trade partner. The province's main exports were silver, aluminium, vegetables, porcelain, and fur, while main imports were iron ore, lead ore, machinery, and wood pulp. 

According to China's National Bureau of Statistics, in the first eleven months of 2011, the y-o-y growth in the province's foreign trade was 78.5%, the second-highest rate of growth (Chongqing registered a full 143%). This rapid growth was from a relatively low base, it now stands at USD 28.4 billion (light years away from the likes of Jiangsu with USD 490 billion and Guangdong with USD 830 billion). Henan still also has a very low GDP per capita as well as average household consumption expenditure of only RMB 7837, the ninth lowest of all China's provinces, and the lowest average wages of all China's provinces (RMB 22,552). Yet the province's rapid growth in trade in 2011 points to the fact that something is stirring in Henan. 

From backwater to transportation and manufacturing hub
Although it is often regarded as somewhat of a rural backwater, Henan has a lot going for it. Consider the following. As a province of China, in 2010 Henan: 
  • had the third-largest population of 94 million people (Shandong had 96 million; Guangdong had 104 million)
  • had the second-largest cultivated land area of 7.9 million hectares Heilongjiang had 11.8 million)
  • had the second-longest total length of highways at 245,089 km (Sichuan had 266,082 km), and the fourth-longest length of railways in operation at 4,282 km
  • had the second-largest freight traffic at 20.0 billion tonnes (Anhui had 22.8 billion tonnes)

In 2011, moreover, Henan very much lived up to its reputation as China's breadbasket: it was China's leading province for Output Value of Agriculture, Forestry, Animal Husbandry and Fishery, with RMB 560 billion. Yet with a large albeit low-earning workforce, good transportation networks and a suitable geographic location close to the eastern seaboard, Henan is well-placed to take advantage of the large-scale relocation of manufacturing to cheaper central provinces. 
It comes as no surprise, then, that Foxconn, the original equipment manufacturer for Apple products, plans to hire an additional 100,000 workers at its plant in Henan, doubling its workforce there. Foxconn's Henan factory is itself brand new, only opening in August 2011. 

In appreciation of the province's attractive set of advantages for its business, Kerry Logistics in January 2012 announced plans to build a new logistics centre in Henan that will be targeting the electronics and technology, automobile, industrial and material science sectors. Kerry's managing director in mainland China put it well: "China’s coastal provinces have refocused to attract manufacturers of higher value-added products and there has been a migration of production to the central and western regions due to lower land and labour costs, we see the potential to transform Zhengzhou into one of China’s manufacturing and processing hubs."

Foxconn and Kerry are both setting up in Zhengzhou, the provincial capital and rising star of Henan. The city has been included in 29th place in the Top 50 Chinese Cities by Investment Potential list, and Zhengzhou’s imports and exports last year reached USD 13.5 billion, up 196% from 2010. Exports jumped 166% to USD 5.3 billion, while exports increased by 258% to USD 5.3 billion. Another prominent city in Henan is Luoyang, where CITIC HIC, one of the world's leading manufacturers of mining equipment, is located. 

The next China
Although its people are still relatively poor, Henan is on the cusp of the next development wave in China. It has a strong agricultural reputation, yet it also has a number of advantages that positions it to become a manufacturing hub in central China, ideally placed in central China close to the eastern provinces. 

It all means that you should probably get used to hearing the name 'Zhengzhou.' 

Note: All data is from China National Bureau of Statistics, unless otherwise stated. 
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:

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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
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. 

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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. 

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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

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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. 

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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. 
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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.

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. 

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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. 
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.  

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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

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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.

TCA SEP 2011 Cover.jpgThe 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

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

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