|
 |
|
| China´s competitiveness at center stage
|
|
|
From low cost to lead competitive country? Join Marcelo Sette Mosaner
Some sarcasm surrounds the term “LCC”, since people never really know if it refers to a “Lead Competitive Country” – meaning that a certain country possesses strategic cost drivers, such as logistics and hi-tech parks, which places them into a valued position in companies global supply chain, or if that is just an elegant and politically correct way of saying for “Low Cost Country”, read: “sweatshop”. The image of underpaid, semi-slave Nike employees at a half-lit workshop always come to the mind of most people when talking about producing in China, but most shoe and apparel companies such as Nike and Reebok are already moving their production centers towards other Asian countries to reduce cost!
The important debate here is whether China – already the world´s second largest economy, with a exchange-rate based GDP of around USD 5 trillion – is really leaving the “Low Cost” condition for good, and spinning up to a more high-tech, “Lead Competitive” research, design and manufacturing economy, like the Japanese model. The second question is that whether China is really moving up the added value ladder, as many defend, at what pace this is happening and how this process will impact a company’s global sourcing operations in the near future.
China has been long known as the world source of low-cost industrial and consumer goods, with very diverse quality and technical standards, although under constant improvement. In a huge array of industrial sectors, it’s still possible to purchase superior quality components and finished goods for a fraction of local prices in China, even with the protectionist trade tariffs and non-trade barriers imposed by many developing nations. Will that be true in 2020? Or will China’s main production hubs focus on valued-added goods, and will purchasing managers for basic, low-valued commodities have to move on to other emerging countries, such as Vietnam and India, or even go and source their materials in more remote areas inside mainland China hinterlands?Will our current suppliers still be focused on exports, with an ever-growing internal market and an undervalued currency?
The question that should puzzle worldwide purchasing teams and industry directors in the short run (3-5 years from now) is how long China will be able to keep its current competitiveness in terms of landed costs, considering the new labor law, the future of RMB exchange rate against USD and the continuity of tax incentives in a government-driven economy that is struggling against the two-digit annual growth. Not to mention the increasing cost of sea freight that impacts China’s cost twice: on the input –imported raw materials, such as iron ore; and output – finished goods to the world.
One can not find answers to this question without analyzing China’s complex cost matrix. Different sorts of industrial goods may continue to be competitive for years to come, but that may not be the case for low added value, low tech, high-polluting industries that most municipalities and provinces in China desire to banish from their land.
The main factors that bolstered China’s competitiveness can be divided into two analysis groups – strategic and tactical, being the criteria of division for the lasting effects of each development to drive it through the next decade. Tax incentives and especially exchange rate variation impact commodity prices overnight, causing major changes in companies` sourcing strategies; thus we are calling them “tactical”, just for data analysis purposes.
Among the strategic components of China’s previous export-oriented development strategy are the huge investments in college education and applied R&D, the constant investments in logistics infra-structure, the creation of Special Economic Zones all along the coast and the “absorption” and further improvement of foreign technology by all possible means. Among the “tactical components” one can cite the low labor cost, export tax rebates and the controlled, undervalued RMB exchange rate.
The cost of sea freight is an independent variable that affects both China and other LCC economies. It will decrease China’s competitiveness against local suppliers (let’s say, local producers in MERCOSUR , for instance) if it continues to increase, but it will not have a major impact against other Asian LCC, such as India and Vietnam, that will also suffer from freight increases. On the other hand, it may impact negatively all Asian suppliers in favor of MERCOSUR associates, such as Mexico, that has trade agreements reaching zero percent import rates in some product ranges into MERCOSUR. Due to time and space restrains, we will not go more deeply into this subject in this article.
The Strategic Drivers
When launching the four modernization programs in the early eighties, after over a decade of educational system breakdown during Cultural Revolution, Deng Xiao Ping could hardly have imagined that corporate behemoths, such as Nokia, GE and Microsoft would be tossing multi-million dollar R&D investments into Chinese land in merely three decades.
Obviously this stage was reached with strong educational policy and constant investments in the building of a Chinese modern technocratic society: China has over 2,000 universities and more than 4,000 research institutes; the country is quickly winning market share in world scientific publications, holding already a fifth part of the world`s publications on material sciences and over 150,000 patents filed by 2005. Since the patents and R&D are linked to industrial development, these investments quickly evolve into new product launches, productivity gains, genuine new tech development and quality improvements that add value to Chinese export goods.
An adequate and ever improving logistic structure (ports, airports, railways and highways) as well as the special high-tech and export-oriented development hubs all along the coast are contributing to the reduction of manufacturing and distribution costs in mainland China. The development zones rely not only on fiscal benefits in the first years, but also companies installed in these parks enjoy the short distance from their supplier base that dramatically cuts component logistics cost ( transportation and warehousing). This sort of investment has lasting effects over any country´s competitiveness. The bonded export parks, for instance, are a vivid example of how the investments in infra-structure can deliver lasting results to the country. In these parks, industries are located merely two blocks from the port docks, they “import” the duty-free raw material and components, process the material and assemble the components and re-export it, paying taxes only for the value-adding activities.
The “tactical” drivers
The cost of labor (manpower), inflation level, raw material level, cost of energy in different provinces and specially the export tax rebate system and the artificial exchange rate, that may cause a price uprises in very few time, are considered “tactical” cost drivers. Because of its relevance, we quickly comment on exchange rate and export tax rebate below.
The Exchange Rate
China´s exchange rate is certainly one of the hottest topics in today’s economics. Since its creation in late forties, the RMB was pegged to the US dollar at rates ranging from 1.50 to 2.46 RMB per USD, depending on the economical levels, but during the eighties and early nineties, China’s government gradually shifted the controlled exchange rate, reaching its lowest peak by 1994, when 1 USD = 8.62 RMB, and latter kept the 8.27 RMB/USD peg from 1994 to 2005.
By 2005 there was widespread criticism already from central bankers around the globe, especially in the US, about the so-called “RMB artificial valuation”. China’s government also desires to revalue their currency in order to help in controlling the country´s double-digit growth, in an effort to soft-land the economy before the global economy and make it less dependent on exports and little by little more focused on the internal market. That’s basically the reasons why China moved from fixed peg to the Micro-band “float” system, by which the daily RMB interbank rate is determined by the market (demand and supply), but the daily variation is restrained within a permitted deviation band of 0.3% plus or less from the Bank of the People published rate. That variation resulted in a revaluation of around 20% in just three years, since in pre-crises period, by 2008, the RMB exchange rate reached a plateau of 1 USD = 6.5 RMB.
Facing a 20% direct increase on product costs may just throw the China card out of the deck for many industries` supply chains, since the estimated landed costs from China to MERCOSUR seldom surpass 30%. Well, local prices also evolved during these 3 years and most companies in MERCOSUR continue to buy from China.
The challenge now is figuring out what’s happening inside Zhou Xiao Chan’s head and try to understand how (and at which pace) the black box of China political agenda will influence in the inexorable revaluation of the RMB. It is a complex chessboard involving China’s financial and diplomatic relations to the United States and the European Union, China’s internal market and the interests of a growing middle-class, inflation and unemployment rates, etc.
Tax incentives
There are many kinds of tax incentive in China, including local, provincial and nationwide incentives, such as the export taxes rebates, that are not simply a drawback but partial exemptions on the 17% nationwide TVA tax, depending on product class, ranging from 5%, 8%, 13% or 17% (full rebate), respecting government interest in attracting and keeping certain kind of industry (mainly high-tech, low pollution) or the political intent to move low-add value, high-pollution trades to as far as possible from Chinese borders. That also accounts for a major price raise risk, as the government already had determined that these rebates were due to gradually finish before the global crisis, but re-evaluated this position to avoid even more shutdowns during the global crisis. A retreat on export subsidies can mean an overnight “raise” of 5% to 17% for Chinese exports goods. A combined effect of exchange rate variation plus a withdrawal in tax incentives can dramatically increase the Chinese commodity FOB price in USD, since many exporters usually count on the tax rebate to calculate a more favorable exchange rate while composing FOB prices.
This sort of questions that we brought up in this article should be taken in serious consideration by corporate managers while drawing up the procurement strategy of their companies for the years to come.
|
|
|
|
 |
|
 |
Founder of Golden Bridge International Business, company with expertise in cost reduction and security increase for import processes from China. He graduated in International Relations at PUC University São Paulo and specialized in Chinese language and culture at Peking University. He lived in the US, China and New Zealand and masters English, Spanish, French and Mandarin, besides Portuguese. |
|
|
