China's competitiveness in a strong-yuan
George Zhibin Gu
7 October 2005
China's surprise July 21 revaluation of the yuan will
probably prove to be the most important business story
of 2005. As a result, both inside and outside of China,
there has been a great deal of commentary on how different
sectors of China's economy stand to gain, or lose, from
the policy change.
But the most important question is, how will the stronger
yuan affect China's competitiveness over the long term?
In fact, when the question is seriously analyzed, the
answer is that the revaluation could boost China's general
competitiveness. What is more, the entire world may
benefit from a more competitive Chinese economy. China's
most basic economic challenge, for the next generation,
will be to move from a low value-added, investment-driven
economy to a high value-added, efficiency-driven one.
The stronger yuan, and the outside world, will both
play a significant role in causing this shift.
Business chains: China's hidden strength
China's vast, underpaid labor force is widely regarded
as the foundation of its competitiveness. But cheap
labor is not the key ingredient in the recipe. True,
the average manufacturing job in China pays only $115
per month. But many other developing nations, such as
India and Indonesia, have a large supply of inexpensive
labor - yet China has pulled ahead of them, and other
developing nations, as a top business and investment
What has made the biggest difference is that China
has successfully built a set of complete business chains,
especially in the manufacturing sector. The term "business
chain" encompasses all the phases a product goes
through before it reaches the customer, from raw material,
to parts manufacturing, to assembly, marketing, the
provision of technology and capital, and so on. To a
far greater extent than competing countries, China has
successfully achieved critical mass for its business
chains: increasingly, all the required elements are
present within the country.
Very significantly, China's business chains increasingly
directly connect final products with global markets
and buyers: In 2004 alone, Wal-Mart purchased about
$18 billion worth of products made in China. General
Electric (GE) aims to reach $5 billion in outsourcing
in China in 2005, and Philips did $9 billion of business
in China in 2004.
A dominating reason for the localization of business
chains in China is that the country has become the number
one global consumption market. This rising Chinese consumption
has become a magnet for international rush.
In 2004 alone, China manufactured nearly 180 million
mobile phones, 80 million of which were sold to Chinese
customers, helping to make China the world's biggest
mobile phone market with 360 million subscribers. International
telecom players have little choice but to compete in
China if they intend to win in the world marketplace.
Nokia's global leadership in 2004 was helped in no small
measure by its $6.9 billion in business from China.
This foreign rush has further expanded the business
The great advantage from complete business chains is
that all manufacturers, Chinese or domestic, can make
all sorts of products in one place - China. Naturally,
they have decisively helped to make China a new economic
center around globe.
All participants have gained vast opportunities in
the process. For now, making any end-products gets support
from a self-sufficient business chain inside China.
In one extreme case, Geely Group, a private, fast-growing
Chinese firm which has been manufacturing cars since
1998, has been able to sell nearly 100,000 cars to 27
developing nations in Southeast Asia, Eastern Europe
and Africa. Its quick growth comes from the fact that
there are already thousands of auto parts makers inside
China. Geely Group is no more than an assembler of parts
made by these Chinese manufacturers. However, it has
been able to produce the cheapest cars in the world:
Geelys sell for as low as US$3,800, a price point which
has created a market not only in China, but in many
developing nations as well. Improbably, the company
is even planning to team up with the Hong Kong government
for a new plant in Hong Kong, which aims to sell sedans
to the international market.
Foreign MNCs and the business chains
China's complete business chains have helped the country's
enterprises to exhibit the international economy's key
virtues: efficiency, convenience, competitiveness and
low cost. A small increase in the value of the yuan
exchange rate can hardly harm these ever-growing business
chains. The latest trend is for foreign multinationals
to set up research and development centers within China;
IBM, Sony, Philips, Microsoft, Siemens, Intel and LG,
among others, have set up more than 600 R&D centers
in the country. These centers are not only responsible
for producing products localized to cater to Chinese
demand, but in many cases, next-generation products
for the global markets. Countless businesses from the
developing world have also rushed into China, developing
the business chains even further.
The business chains are bound to expand further because
all their participants, whether foreign or Chinese,
have vast vested interests in their continued progress.
As long as China continues to be politically stable
with fast-growing consumption as well as a friendly
business environment, foreign investors and multinationals
will continue to treat China as a priority. This foreign
rush has naturally led to greater competition in China's
marketplace, thus helping the nation to become more
open and dynamic in all sorts of ways.
This new economic center has already altered global
map. Different nations are now trying to take advantage
of the opportunities China offers to boost their own
long-term development. But some are doing better than
others. Japan Inc, in spite of recent Japan-China tensions
that have somewhat cooled Japan Inc's ardor for China,
is arguably doing better than US Inc. The auto industry
is an example. Both Japanese and American automakers
have sought to reduce costs by shifting production to
lower-cost countries; US firms have mostly gone to Mexico,
while Japanese firms have used China. But the scale
of Japan's investment in China is greater, and partly
because of the greater scale of the market in China
as compared to Mexico, the potential gains to Japanese
firms are greater. Japanese automakers are now considering
selling their Chinese-made cars to international markets.
The challenges of the strong yuan
At the same time, the yuan's appreciation will undeniably
take a toll on Chinese exporters, in particular textile
and consumer product makers, whose profit margins were
already low, usually below 5%. So, they must try hard
to move up in the value chain or possibly be forced
out. But they are more vulnerable to potential punitive
measures imposed by foreign governments, which would
have more adverse consequences on their health.
All is said, domestically, there are tough issues raised
by the strong yuan. But there are more fundamental issues
China must resolve. One of the most pressing is overcapacity,
especially in the manufacturing sector. China Inc does
have enormous challenges ahead. But these challenges
go well a rising yuan.
Indeed, the overcapacity issue is worsened by two factors:
first, there are simply too many players in most economic
sectors. In air-conditioner manufacturing, for example,
there are more than 50 companies now, although this
is actually an improvement from the 400 that existed
in 2000. Though the market is still growing fast, many
of these companies are no longer profitable. Kelon,
the Chinese market leader in making cooling products,
which trades on both the Hong Kong and Shenzhen stock
exchanges, has been making serious losses lately, chiefly
due to the overinvestment in the sector.
But achieving a rational consolidation is difficult,
because most of these companies are still controlled
by government. Consolidation is clearly necessary, and
would be much easier if political interests could be
separated from the business world. But this remains
a tough task for today's China. Indeed, this excessive
government power remains the largest roadblock for China's
Fundamentally, China must resolve the institutional
barriers coming from a traditional government domination.
To move away from the government-centered economy and
society is an urgent necessity. But there is hardly
any alternative or shortcut.
Another difficult issue is that most Chinese manufacturers
don't have sufficient intellectual property and cutting-edge
technology. Instead, they must pay high prices to buy
technology from the outside world. This problem is a
significant contributor to the poor profitability of
many Chinese manufacturers. For example, in 2004, China
produced some 73 million TV sets; but most Chinese TV
makers lost money.
In general, to most Chinese manufacturers, a rising
yuan will produce both good and bad effects. On the
minus side, their already low profit margins are further
eroded by loss of the competitive advantage provided
by the weak yuan when selling to Wal-Mart and other
international buyers. But on the plus side, throwing
away the undervalued-currency crutch could force them
to become more competitive. This means that China Inc
would have no choice but to focus more on innovation,
intellectual development and rational consolidation,
among other beneficial measures. In the long term, this
pressure should make China Inc perform better.
China has walked a long way to reach this stage of
development, despite all the imperfections. Above all,
China has successfully integrated its economy with the
global economy to a high degree within the last three
decades. This has created vast new opportunities for
the entire world, China included. Though there remain
huge trade, political and economic issues for China
and the outside world to work on, the entire world has
directly benefited from the expanding Chinese pie. The
small, but decisive increase in the yuan's value shows,
above all, that China is committed to playing its part
in the maintenance of a stable, growing global economy.
George Zhibin Gu, a business consultant
based in China, is the author of a newly released book,
China's Global Reach: Markets, Multinationals, and Globalization
Sept 2005). He can be reached at firstname.lastname@example.org.
Copyright 2005 George Zhibin Gu