China is moving up the value chain

It’s a natural process. Most of the Asian ‘tiger’ economies started out as cheap assembly places for foreign companies and/or textile producers, and moved on from there as economic growth invariably made them more expensive. It’s happening in China as well, only on a grander scale, and with reduced time frame.

Consider countries like South Korea and Singapore today, and compare them where they were 40 years ago. A lot can happen over a couple of decades with the right policies in place. South Korea was actually one of the poorest countries on earth in the 1950s, after a bloody civil war and the lack of resources, it was last on the list of experts for the next place to develop.

When countries grow faster than abroad, they become more expensive, so they have to figure out ways to add more value to their products, as they cannot rely on being cheap as their main advantage for much longer.

How do countries become more expensive? Simple.

  • Productivity growth will sooner or later translate into higher wages (even if repressive regimes can, for a while, repress this)
  • Export success and high domestic saving rates tends to increase the value of the currency, making the country more expensive

The same is happening to China:

China Too Costly for Manufacturers

  • Tuesday, September 9, 2008 8:30 AM China has been enjoying a robust annual manufacturing growth rate recently of 11 percent or more, but the party may soon be over.
  • According to The New York Times, Chinese factories reported a sharp drop in new orders in August. Economists now expect Chinese growth to go as low as 9 percent or 9.5 percent over the next year. Exports are barely growing, several Chinese factories are either closed or cut back on their consumption, and the real estate market is weakening, particularly in southeastern China.
  • “China has slowed down a lot already, but it’s going to slow down more,” Hong Liang, the senior Chinese economist at Goldman Sachs in Hong Kong told The Times. That rate, says Liang, will make it harder to supply jobs to the millions of Chinese who are moving to cities from rural areas looking for work.
  • In addition, any slower growth could prove a shock to workers who have been receiving double-digit pay increases each year, as companies struggle to find enough labor to keep factories open, Chinese policy makers took a series of steps over the last five years to keep inflation under control, and now they’re starting to remove them to prevent growth from slowing too much.
  • China’s currency, for example, rose sharply against the dollar in the first half of this year, and China’s central bank has aggressively lowered it against the dollar in each of the last four trading days.
  • But Darren Gardener, chairman of the international practice at the law firm of Seyfarth Shaw, tells Moneynews that the manufacturing-related issues in China are less about the exchange rate than they are about increased costs.
  • China is a heavily regulated and complex jurisdiction. Corporate citizenship is a key feature in the global economy, and U.S. companies are always striving to comply with the law which is difficult and time consuming in China,” Garener tells Moneynews.
  • “This impacts on the companies’ ability to make quick commercial adjustments and overall adds to the expense and uncertainty in their operations. In a low cost environment, people can tolerate this. When combined with the fact that China is developing and generally now more expensive, it means that the perceived cost advantage may of itself no longer actually of itself justify the investment.”
  • Chinese manufacturers are now looking for other, lower-cost markets in which to make their products. H. David Hennessey, a professor of marketing and international business at Babson College, near Boston, told Moneynews that the country is looking at Vietnam and North Korea as possible alternative manufacturing sites because the labor rates were significantly less than in China.

Might even spell some hope for desolate North Korea, but China is moving up the value chain, as the following example illustrates:

A Chinese Challenge to Intel

  • In California last week, Chinese researchers unveiled details of a microprocessor that they hope will bring personal computing to most ordinary people in China by 2010. The chip, code-named Godson-3, was developed with government funding by more than 200 researchers at the Chinese Academy of Sciences’ Institute of Computing Technology (ICT).
  • Tom Halfhill, an analyst at research firm In-Stat, says that the objective for China is to take control of the design and manufacture of vital technology. “Like America wants to be energy independent, China wants to be technology independent,” Halfhill says. “They don’t want to be dependent on outside countries for critical technologies like microprocessors, which are, nowadays, a fundamental commodity.” Federal laws also prohibit the export of state-of-the-art microprocessors from the United States to China, meaning that microchips shipped to China are usually a few generations behind the newest ones in the West.
  • Despite its late start, China is making rapid progress. The ICT group began designing a single-core CPU in 2001, and by the following year had developed Godson-1, China’s first general-purpose CPU. In 2003, 2004, and 2006, the team introduced ever faster versions of a second chip–Godson-2–based on the original design. According to Xu, each new chip tripled the performance of the previous one.
  • Godson chips are manufactured in China by a French-Italian company called ST Microelectronics and are available commercially under the brand name Loongson, meaning “dragon chip.” Loongson chips already power some personal computers and servers on the Chinese market, which come with the Linux operating system and other open-source software. “They use a lot of open-source software because it’s free,” says Halfhill. “The Chinese government wants to get as many PCs into schools and as many workplaces as they can.”

Microprosessors are a core technology with many links to other technologies, so it’s understandable that they’re going after this market, although the chip isn’t quite on the same level as Intel’s yet (it’s manufactured on a 65nanometer level, basically a generation behind Intel).

It’s the right move to make though. They also pursue their own standards in a variety of issues (for instance, the AVS standard for HD TV signals), that seem a dire bet, but because the Chinese market is so big, it is difficult for foreign companies to ignore these standards.