Nikhil Kuruganti: China Is Here

China Is Here


Is China really taking over as the global manufacturing hub? In the past few months the alarm bells over the country's rapid penetration of industrial markets have grown louder. The main arguments are familiar: first, there is a significant migration of global manufacturing capacity to the mainland; and second, China is rapidly moving into capital-intensive and high-technology industries, threatening to erode the competitiveness of producers in developed countries. Both are based on a misinterpretation of China's astonishing growth.


First, take the question of manufacturing migration. This is not a complicated analytical issue but is nonetheless misunderstood by a surprising number of analysts. For China to be a global manufacturing hub, it has to be a net exporter of manufactured goods. And the best measure of the rate at which industrial capacity is migrating to the mainland is exactly the rate of increase of China's net manufacturing balance with the rest of the world.

Between 1993 and 2002, China's gross industrial output rose from $480bn to $1,300bn. This represents an impressive increase from 2.4 per cent of estimated global industrial production at the beginning of the period to more than 4.7 per cent last year. However, at the same time China's gross purchases of industrial products rose from $490bn to $1,250bn, or 4.6 per cent of world industrial production.

The difference represents China's net manufacturing exports to the rest of the world, which were $50bn in 2002, or a meagre 0.18 per cent of global manufacturing capacity. Moreover, that figure has not been increasing noticeably over time; the net balance reached $45bn in 1997 and has been broadly stable ever since. In other words, the mainland may account for an ever-greater share of the world's industrial output but this is almost completely offset by its growing industrial market. Far from sucking in capacity, China has had virtually no overall effect on manufacturing outside its borders.

The astute reader will argue that in lumping all manufacturing industries into one overall category, the above argument misses the point, which is that China has a much more devastating impact on those markets in which it competes directly. And the reader would be right. This brings us to the second argument, that China is rapidly moving up the manufacturing food chain. When we break down overall manufacturing by industrial category, we find that the mainland records a rapidly growing net surplus in textiles and light consumer goods (roughly $80bn last year) and an expanding deficit in machinery and capital equipment. Despite headline electronics exports of more than $100bn in 2002, the net balance was only $11bn, as China's information technology export sector is still predominantly made up of processing and assembly of imported components for re-export.

The bottom line is that China is becoming a manufacturing hub for the rest of the world in low-end, labour- intensive goods. Contrary to current fears, the rest of the world is becoming a manufacturing hub for China in high-end, capital-intensive goods. This is exactly how international trade should work.

So far, so good. But could all this change tomorrow? Is not China importing capital equipment today so that it can turn round in a few years' time and flood the world with cheap high-end products? Of course, there is no guarantee this will not happen - but the chances are remote. For China to jump multiple rungs on the global value-added chain, we would need to see a rapid build-up in capital-intensive sectors with both a high domestic value-added component and a significant export orientation. There are plenty of industries where one or the other is true but few examples of both.

A final worry is that China's economy could collapse, or at least slow sharply, resulting in a flood of excess manufacturing capacity on to world markets. After all, this is what happened in 1997 and 1998, when a post-bubble decline in domestic demand caused the trade surplus to rocket to nearly 5 per cent of gross domestic product. Again, however, the chances are remote. Goldman Sachs' index of activity in China points to rapid growth over the past two years and, despite objective macroeconomic risks in the future, the outlook is far more stable and manageable than it was six years ago. Chinese manufacturing is a force to be reckoned with but not one to fear.

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