China’s Global Competitiveness

I was recently interviewed by a major Chinese automotive magazine regarding China’s global competitiveness. Apart from the information contained in the answers to their questions, the questions themselves provide some useful insights into what is on everyone’s minds in China. What impact is inflation having on China’s global competitiveness? Is China becoming less competitive with India, Vietnam and its other Asian neighbors?

1. Jack, with RMB appreciation and increased inflationary pressures, does China still have an advantage in the export of automotive components in your opinion?

It’s true, inflation has spiked up in China over the past year, primarily due to rising costs of food and raw materials. Raw material prices are priced globally, however, so companies in other countries are affected to the same degree as those in China by rising prices for these manufacturing inputs. As a result, there is no loss of competitiveness by China based companies from higher raw material prices alone.

Many cite rising labor costs in China as a threat to China’s competitiveness globally, particularly given the changes brought about by China’s new labor law. While absolute labor costs have indeed gone up, rising wages have not contributed greatly to inflationary pressures in China because productivity has increased by a greater amount. For example, ASIMCO’s overall wage costs went up by about 18 percent across the company in 2007. Yet, we don’t consider rising labor rates a significant risk factor going forward due to the increased productivity of our work force. In the words of one of our General Managers, “Yes, Jack, our wage costs have gone up, but the base rate has remained the same. We are paying more for productivity.”

At ASIMCO, and at good companies all across China, the implementation of lean manufacturing to reduce waste and inefficiencies in the manufacturing process; the move to higher value added products, and an increase in the capital/labor ratio over the past five years has resulted in increased productivity of the work force. If productivity goes up faster than wages, then there is no impact on inflation or relative competitiveness.

A more productive labor force, and a move to higher value added products, can also act as partial offsets to the impact of an appreciation in the yuan. Increases in the value of the yuan strike hardest at products that are highly labor intensive. With products that requires more raw materials, for example, a higher valued yuan will make it cheaper for companies in China to buy raw materials. That is why exports from Japan to the United States from 1985 to 1988 increased substantially, despite a 50 percent increase in the value of the yen against the US dollar during that same period. It’s also why exports from China to the United States continue to increase, despite an almost 20 percent appreciation of the yuan against the US dollar since mid 2005. While a rising currency may impact the relative competitiveness of particular products, it does not necessarily impact the relative competitiveness of the country as a whole.

Let’s also remember that cost is not the only reason why companies source from China. Most global companies now have ambitious plans for the China market that depend on them developing an effective supply chain in China. Apart from cost, that is another major reason why Chinese companies have an export advantage over companies from other countries.

2. How do Chinese auto components companies deal with increasing cost pressures?

There are a variety of ways. First, a company needs to rethink and rebalance its customer and product mix. Products or customers that were profitable before may not be profitable now with the higher input costs. Second, companies need to do “value engineering” to reduce the use of expensive raw materials in its products. Third, companies need to implement lean manufacturing to reduce waste in the manufacturing process. Finally, companies need to increase their product development efforts. Margins are highest when a new product is first introduced, and then decline as the market becomes more mature. A steady stream of new, higher value added products is the single best way to combat higher costs.

3. Are there any threats from India to exports from China?

From time to time, we run into direct competition from India, but not very often. The China auto market is much bigger than India’s; the China market has many more components companies and is more competitive; and I believe that, overall, costs are lower in China. I don’t see Indian components companies as any greater competitive threat than companies from other countries.

4. Are multinational companies now thinking of moving their purchasing projects from China to India other low cost Asian countries?

For market reasons, I sincerely doubt that many multinationals are considering moving a substantial portion of their purchasing programs from China to other low cost Asian countries. MNC’s want to be bigger players in China, and they need to develop their China supply base.

Moreover, I doubt that costs in India are lower than in China, and any labor cost advantages that countries like Vietnam may have can quickly disappear with 25 percent inflation, which Vietnam is experiencing today. You have to remember that Vietnam is a much smaller country than China. Its population of 85 million people, while large, is only 7 percent of China’s; and its GDP of $71 billion is a fraction of China’s $3.2 trillion. Any significant increase in investment and jobs can quickly lead to inflation, as it is dong currently.

Finally, China manufacturers are much better developed than those in most other Asian countries. Exporting to the global auto industry requires a certain amount of manufacturing sophistication. A great deal of technology has already been transferred to China, and Chinese companies have been developing more sophisticated capabilities for some time.

5. Are there any lessons that China can learn from Vietnam’s current financial crisis?

Vietnam is in a different place than China from a development point of view. It is more like China was in 1994 when inflation peaked at over 21 percent. Time and time again, in country after country, inflation has proven to be any country’s biggest threat to economic development. The major lesson from Vietnam is that every country has to be vigilant about nipping inflation in the bud. All governments, not just China’s, have to have sound fiscal policies that keep spending under control and monetary policies that ensure its money supply does not grow too quickly. Inflation results when there is more money chasing the same amount of goods.

6. Are there any suggestions you can give to local auto components companies who want to export?

If a company wants to develop exports, the most important thing it can do is to change the “mindset” of its managers and employees. Although the China market is changing daily, global customers are still more demanding than Chinese customers. “Close” is not good enough in international markets, as it sometimes is in China. Processes and specifications need to be followed exactly, with no deviation or changes. And. deliveries have to be made on time. Every employee has to understand the requirements of selling to the international market.

Apart from the mindset change, Chinese companies have to improve their quality and management systems to compete internationally.

7. Are there any different plans or actions that ASIMCO is taking in its export program?

Eighty-five percent of what ASIMCO makes in China, we sell in China. Exports are important, but our main focus is the China market. If we can sell the right product to the right customer at the right price, we will export. If not, we prefer to focus on the China market. Because ASIMCO’s China business is growing so rapidly, I do not see our percentage of exports, which is currently 15 percent of sales, changing dramatically in the years ahead. In all of our export contracts, we negotiate clauses which provide for price adjustments for changes in raw material prices and currency fluctuations. In today’s market, you have to do this. Otherwise, you are certain to lose money.

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