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Much of the world's manufacturing base has migrated to China, attracted by low-cost labour and favourable policies from the Chinese government
Photo by STR/AFP via Getty Images
With the current geopolitical challenges between China and the United States, as well as the ongoing supply chain issues affecting manufacturers and consumers, there’s been much talk about moving global manufacturing out of China.
But despite the talk, U.S.-China trade reached a record level in 2022, with no signs of any slowing in the near future.
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While former U.S. secretary of state Henry Kissinger is credited with opening China to the West under then-President Richard Nixon, it wasn’t until 2000 that the U.S. granted China permanent normal trade relations — a legal designation that allows foreign nations be granted most favoured nation status, and hence be treated similarly to other members of the World Trade Organization.
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This move reinforced China’s growing role in global trade. Since then, much of the world’s manufacturing base has migrated to China, attracted by low-cost labour and favourable policies from the Chinese government. These policies include massive investments in infrastructure and trade capacity.
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Tariffs and trade wars
The spectacular economic rise of China has created many geo-political challenges, from spy balloons to unfair trade practices and accusations of intellectual property theft. This has resulted in an active trade war between the U.S. and China.
In 2018, Donald Trump invoked Section 301 of the Trade Act of 1974 to apply tariffs on billions of dollars on Chinese goods when he was president. As a result, pressure intensified on global companies to relocate their manufacturing to lower-cost destinations across Asia, such as Vietnam, Bangladesh and India.
After the COVID-19 pandemic caused chaos in global supply chains, there were calls to bring manufacturing back closer to home either by “nearshoring” — building factories in Mexico for the U.S. market, for example — or reshoring back to home countries.
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Despite these significant financial and political pressures, many companies are still not moving more of their production out of China. Why not? As it turns out, China has mastered the craft of manufacturing.
As part of our ongoing research into global competitiveness, we had the opportunity to review confidential data from some manufacturing firms. This data indicated that even though labour costs associated with production are significantly lower in other markets, such as Bangladesh, so is productivity.
Chinese labourers are both more expensive and more productive than labour in other emerging economies in Asia. Both of these factors must be taken into account when making the decision to relocate production out of China. But this is only part of the story.
The reality of manufacturing
We interviewed Joseph Eiger, our former student and an executive in a global sourcing company that manufactures consumer products, about how the world of manufacturing operates.
Consider the case of making a baseball cap, for example. Some baseball caps are very basic, while others are more complicated and involve embroidery and more expensive fabrics. As Eiger put it: “While producing baseball caps is not the same as producing a cell phone, it’s still pretty complex.”
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China’s manufacturing industry has access to a high level of agglomeration economies — or ecosystem. Take the example of producing a hoodie. It’s not just about the textiles needed to cut and sew into a hoodie. It is also about the trims, dyes, zippers, cords and other necessary pieces that are required for assembling the product, Eiger explained.
China has deployed a strategy that ensures the entire manufacturing supply chain is located there, and has mastered each step of the process. China even imports and processes much of the world’s wool and cotton, including a significant amount of U.S.-grown cotton that comprises approximately 35 per cent of the world total.
This cotton is then processed, made into fabric, dyed and sewn into clothing and other products. They are then exported globally, including back to the U.S. as finished goods. The entire textile ecosystem for production is located in China. And this is not just the case for fabric, it’s also the case for all of the components.
If a retailer in the U.S. or Canada wants to move the production of the textiles it sells out of China, it would have to move the entire ecosystem with it. Either that, or they would need to source the inputs needed from China into other countries like Bangladesh, where final production would take place.
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Costs are too high
It turns out that the costs associated with leaving China are simply too high. As long as the ecosystem for manufactured goods remains in China, then so will its significant share of the world’s manufacturing.
Will there be a tipping point when companies will relocate production out of China? It is unlikely that conditions will suddenly switch one day in favour of other countries.
In the coming years, as manufacturing sectors in other Asian countries emerge and develop their own ecosystems, the economic case to move production out of China will as well. But this is some years away.
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China is the world’s largest manufacturer, sometimes referred to as ‘the world’s factory’. It has been an attractive destination for manufacturing in recent decades thanks to its low labour costs, technically skilled workforce and good infrastructure. But China’s competitiveness and manufacturing profile are changing, with more developed regions moving up the value-chain and labour-intensive manufacturing moving inland. Businesses are increasingly choosing to manufacture in China to service the growing Chinese market, rather than use it as low-cost option to manufacture export items.
Manufacturing’s percentage share of Chinese GDP has been slipping in recent years, but it remains a major sector, accounting for 42.6 per cent of GDP in 2014. The sector employs about 30 per cent of workers in China, and has ensured China remains the world leader in gross value of industrial output. On the more developed Chinese eastern coast, the focus has increasingly moved to advanced manufacturing, while lower cost and more labour intensive manufacturing is increasingly located further inland.
However, as China’s focus on the services sector likewise grows, increasing numbers of Chinese will be employed in the financial services sector, rather than manufacturing or agriculture.
Advantages of manufacturing in China include access to increasingly sophisticated Chinese research and development (R&D) and science and technology, as well as incentives offered by local, provincial and central government agencies. Another positive of manufacturing in China are the efficiency gains thanks to larger economies of scale in China. However, rising labour costs, skills shortages and intellectual property protection are significant issues to be considered when looking at manufacturing in China.
Other concerns and challenges when manufacturing in China are the current development stage and inconsistency with application of commercial law in China and variable quality of logistics and infrastructure systems. Using contracted manufactures or subcontractors may also cause serious difficulties that have to be strictly managed. These include the need for rigorous quality control, possibility of leak of products to the domestic and international market, production overruns and ethical and corporate socially responsible manufacturing.
There are a number of ways for foreign businesses to go about manufacturing in China. Contract manufacturing is a popular option for both large and small businesses across various industries. Australian businesses can also choose to invest directly in a factory in China, either independently as a wholly foreign-owned enterprise or as part of a joint venture with a Chinese company.
Location is another key consideration for manufacturing in China, with the Chinese Government encouraging investment in different types of manufacturing in different regions. On the more developed eastern seaboard, where wages are higher and the infrastructure is better, the Government encourages investment.
in high-end, low-polluting manufacturing. Further inland in China’s central and western provinces, where labour is cheaper and infrastructure less developed, the Government encourages investment in more labour- intensive manufacturing. Some cities and provinces specialise in certain industries and producing specific goods.
Quality control is an important consideration when choosing to manufacture in China. There have been high- profile cases in which poor quality control by Chinese manufacturers – usually sub-contractors – has caused significant problems for international brands, ranging from clothing to toys and food products. Make sure you have robust quality control mechanisms in place and perform due diligence.
Australia’s own manufacturing sector has been given a boost by the entry into force in December 2015 of the China-Australia Free Trade Agreement (ChAFTA). Under the ChAFTA, wholly Australian-owned companies will now be allowed to establish in China. In addition to this, almost all of Australia’s manufacturing exports will enter China duty free within four years. Australia has great opportunity to invest in advanced manufacturing in China, which has been earmarked as important future driver for China’s economy.
In 2006, 145-year-old Australian family business Michell Wool opened their 14,000-square metre Suzhou factory for carbonising wool – a required process to clean the wool.
Read more on their successful engagement with China’s manufacturing industry.
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