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Manufacturing a trade pact with China

Business Day, South Africa

Manufacturing a trade pact with China

Martyn Davies

3 April 2006

China’s rise as an exporter of manufactured goods into the global economy has taken all recipient economies by surprise. While its export growth routinely tops 20% a year, the developed world continues to run mounting trade deficits with China. This includes SA. The trade and industry department recorded a trade deficit of R18,3bn with China last year. The proposed free-trade agreement with China is intended to better position South African business to gain access to China’s economy. But will it?

SA’s trade relationship with China is characterised as “strategic” by government and commodity companies or “antagonistic” by organised labour and manufacturers. China presents a global economic opportunity not seen since the rise of the US in the early 20th century as well as the greatest threat to manufacturing in traditional and emerging markets alike. States are grappling with how to manage their China relationship. It is within this context that a free-trade agreement is to be negotiated.

China is not the über-competitive manufacturer it is assumed to be. Its competitiveness is both sector and region specific. China’s exports are primarily in labour-intensive sectors that include apparel, footwear and electrical equipment. Guangdong province accounts for almost 60% of China’s total exports. Other regions of the country, notably the west and northeast, are far less productive.

Even though products may be “Made in China”, they are most often not made by Chinese companies. Roughly 60% of China’s exports are produced by foreign-invested enterprises.

According to a recent study published in the Far Eastern Economic Review, China “has emerged as the last stage in a pan-Asian production system that has become one of the most important features of global manufacturing”. Regional economies including Taiwan, Singapore, and Korea are rapidly offshoring their manufacturing operations to China.

While Asian economies are succeeding in plugging themselves into this supply and value chain, African economies are consigned to supplying simple raw materials to it. SA’s trade relationship with China is characterised by garments and textiles. But as China moves further up the value chain, increased competition for South African sectors higher up the value chain is to be expected.

What factors are making specific regions in China competitive platforms for global manufacturers?

‖Labour: China’s wage rates are market-determined with vast differences across regions. Organised labour has little influence over the wage rates and working conditions of the labour force. But as China’s economy becomes more “marketised”, inflationary forces will have an impact on labour costs.

‖Currency value: China is emulating the historical Asian development model - export-driven supported by an undervalued currency. The success of Japan and the newly industrialised economies was underwritten with the political and (not reciprocal) economic support of the US. The global economy may be different but China seeks to shape market conditions to its own benefit through a monetary policy that up until now has been mostly able to withstand external political pressure.

‖Cost of capital: The state-owned Chinese banking sector has traditionally provided low capital costs to exporting companies that have state ownership. Although privatisation of the Chinese economy is a largely completed process, minority equity ownership by the state is often retained in order to allow the firm to access cheap capital through the state banking system.

‖Manufacturing capacity: A legacy of a centrally planned economy is political rather than market-determined investments. China’s manufacturing industry was quota-driven regardless of market demand. In every traditional industry, China suffers from overcapacity of production. Three decades of economic reform have yet to remove these overcapacities. Price deflation results with too many products chasing too few consumers. These products are then exported into the global market. This factor is the major driver of competitiveness of China’s manufacturing industry.

The manufacturing competitiveness China now enjoys is not sustainable. Labour inflation in more developed regions of the country will push up wage costs; increased international political pressure on its monetary policy will result in a gradual appreciation of the renminbi; China’s banking sector will partially privatise, introducing better risk management and loans based on commercial rather than political decisions; and market forces across all manufacturing sectors will continue to push less competitive companies into bankruptcy. “Marketisation” will thus undermine competitiveness.

Negotiations between the South African Customs Union and China will begin later this year toward the signing of a free-trade agreement. China’s pursuit of a free trade-agreement with SA is driven by three factors: to secure access to strategic commodity resources; market access for its manufactured products; and to counter antidumping actions being taken against its exports.

Chinese industry is undoubtedly very competitive in manufacturing and will remain so for the next decade at least. As the economy continues to restructure, its input costs will escalate and its price competitiveness will begin to erode. But as Chinese industry rapidly moves up the value chain, so its exports will be of greater value and result in new trade-management challenges to its trading partners.

‖Dr Davies is a senior lecturer at the Gordon Institute of Business Science, director of the Centre for Chinese Studies at Stellenbosch University and CEO of strategy consulting firm Emerging Market Focus.