China's Real Munfacturing Revolution

Here's a nice piece for a change from the WSJ, and as they say, it's 'fair and balanced'. The message seems to be that there are scale and 'learning by doing' components to working in China, which is what theory would lead you to expect. Supply chain reliability and local management expertise are things which will only develop with time. This is really the strongest, and the only really uncontroversial globalisation argument. The third world isn't going to 'bootstrap up' if it doesn't have the opportunity to learn. Of course, once they start, then they become potential competitors, and we get to hear another set of arguments.

The argument about plant design is interesting, since having a high labour component is only a temporary option for China: with time wages and living standards will rise. Of course if they also manufacture capital goods there, then this will keep capital cheaper, and if a large part of capital costs are in IT hardware and software, and these come from China and India, then where we are going is anybody's guess. (BTW, thanks to Walter for drawing this article to my attention).

The Real Contest Between America and China
By THOMAS HOUT and JEAN LEBRETON


Shopping at Wal-Mart will give you the wrong idea about where China's threat to U.S. manufacturing lies. Most made-in-China consumer goods on those shelves represent industries which left the U.S. for Mexico and Southeast Asia years ago. Instead the real contest between American and Chinese factories is taking shape over industrial goods, a $2 trillion market of everything from small motors to oscilloscopes to locomotives, where fast-moving U.S. productivity and technology have kept production at home.

The problem is that China's rapidly-growing capability and huge scale are turning these U.S. defenses on their head, creating astonishing cost advantages in moving to China. These can amount to savings of 20-35% with no loss of quality -- opening the doors to moving even high-performance, highly-automated product lines there.

Unlike Japan a generation ago, which reinvented manufacturing through quality and continuous improvement, China is deinventing it by removing capital and reintroducing manual skill and handling on the plant floor. China's far lower cost of not only production workers but plant technicians, accountants and managers allows U.S. companies to rethink everything from how the product and its parts are designed to how they are made and tested.

The result is more craft, less complexity in plant processes, and often a shorter time from design to production -- all at a far lower total cost. Together with the improving quality of materials and reliability of supply chains inside China, this means some American companies are moving whole core product lines there.

But many are not. China is still small fry in the U.S. industrial-goods market. Domestic production accounts for 70% of industrial goods sold, and imports from Japan and Western Europe account for another 20%. Only 10% comes from low-wage economies, and China has less than one-third of this -- or 3% total penetration of the U.S. market, shipping fewer goods than Mexico.

Many American companies find China's cost advantage elusive. Sending buying teams to China from their headquarters in the U.S., armed with drawings and specs in search of lower-cost sources, often doesn't work -- as American auto companies have recently learned. Small engine and low-end farm equipment producers, among others, have looked at taking production lines to China and found uneven quality and unreliable supply lines back to their U.S. customers outweigh the advantage of lower production costs. The higher technical- and inventory-support costs plus all the risks just aren't worth it.

Sourcing in China works best for companies which invest know-how and painfully nurture their China operations over sustained periods, and only a limited number of foreigner manufacturers have done this so far. Our research shows that companies committed to large-scale manufacturing in China think differently in several important ways from competitors without such commitments.

First, committed companies accurately cost the labor and capital costs of their products. Accounting statements may tell a finished-equipment manufacturer that factory payroll is only 10% of its costs, but when the full payroll cost of the purchased components and company overheads are added in, the total labor costs are typically 40% to 60% of the final product cost. And those labor costs are lower across the board in China. Production workers typically cost 5% of their U.S. counterparts, while good engineers and plant managers may cost 35%.

But what about higher U.S. labor productivity? True, American workers in capital-intensive factories can be several times more productive than their Chinese counterparts. That's because U.S. plants have replaced many factory workers with complex flexible-automation and material-handling systems. This has reduced labor costs but raised capital and support systems' costs.

Chinese factories reverse this process by taking capital out of the production process and reintroducing a greater role for labor. Parts are designed to be made, handled and assembled manually. This reduces the total capital required by as much as one-third. So output per worker is lower in Chinese factories, but the combination of lower wages and less capital typically raises the return on capital above U.S. factory levels.

American companies like Kodak or Copeland that develop several factories in China will see more cost savings than a competitor taking its first steps. Several factors working together explain this. These companies develop and improve their local suppliers. Their Chinese engineers learn the quality disciplines. And they become smarter in hiring people and designing incentives. The costs and benefits of manufacturing in China increase with scale and experience there, meaning that the more you grow the easier it is to continue to grow.

Second and counterintuitively, it usually makes more sense to send a distinctive new product line to China than an old, price-pressured one. The payoff from sending the latter to China is low. The many one-time expenses -- product and process redesign, new local suppliers to sort out, and the need to requalify the finished product with U.S. customers -- could wipe out any profit margin. But designing a new product for China makes sense for a company well down its experience curve there.

For instance, Tektronix's new oscilloscope was designed by U.S.-based engineers working virtually with their China-based tooling counterparts. Although some materials and components were imported, the product will have only one set of start-up costs and a lower capital investment to amortize.


Third, companies committed to production in China take a more realistic view of the risks involved. Supply-chain risks are often exaggerated by outsiders. As for country risk, again China's resilience and production security tend to look better to insiders. That was recently demonstrated when the outbreak of severe acute respiratory syndrome earlier this year caused few supply disruptions from China. And Chinese authorities regard foreign-owned plants as valuable assets not to be disturbed.

But some risks are not exaggerated, such as the need to protect intellectual-property rights, which deters many companies from bringing highly proprietary processes to China. Armstrong, the world's leading floor- and ceiling-tile manufacturer, keeps some material formulas and processes in the U.S. AMP, the world's leading connector producer, had no choice but to move to China because of the cost savings involved. So its proprietary inline plating process in China is done in a special secure enclosure with specially licensed employees. U.S. auto companies know their technology is leaking to Chinese joint-venture partners, but in return they get a head start in China's exploding market.

There are limits to what can move to China. Products where customer-driven innovation is frequent and critical will not go. Nor will those where customization and intimate user contact with the factory are required. Some American customers, especially publicly funded organizations, will insist on goods being produced in the U.S. The most persuasive barriers to movement will be customer-related, not technology-related. Production technology is often surprisingly mobile and divisible between locations. Large portions of leading-edge medical diagnostic equipment are being made in China, and jet aircraft engines will follow.

While China today has only 3% of the U.S. industrial goods business, its shipments are growing at 21% annually in a basically flat market. This penetration rate will be governed by the rise of capability of foreign-owned and operated plants in China, not by wage increases or exchange-rate revaluations. The cost differences are too great. In addition, China is becoming the world's largest market for some industrial goods, for example machine tools and power equipment. There are many reasons to make more things in China. As more companies discover this, the impact on American jobs will grow, making it an increasingly potent political issue.

There are limits to what can move to China. Products where customer-driven innovation is frequent and critical will not go. Nor will those where customization and intimate user contact with the factory are required. Some American customers, especially publicly funded organizations, will insist on goods being produced in the U.S. The most persuasive barriers to movement will be customer-related, not technology-related. Production technology is often surprisingly mobile and divisible between locations. Large portions of leading-edge medical diagnostic equipment are being made in China, and jet aircraft engines will follow.

While China today has only 3% of the U.S. industrial goods business, its shipments are growing at 21% annually in a basically flat market. This penetration rate will be governed by the rise of capability of foreign-owned and operated plants in China, not by wage increases or exchange-rate revaluations. The cost differences are too great. In addition, China is becoming the world's largest market for some industrial goods, for example machine tools and power equipment. There are many reasons to make more things in China. As more companies discover this, the impact on American jobs will grow, making it an increasingly potent political issue.
Source: Wall Street Journal
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One Little Noticed Consequence

In all the heat generated over the collapse of the talks at Cancun, one, apparently minor, consequence does not appear to have received the attention it may deserve: the expiry of the so-called 'peace clause'.

Can any of these failures be addressed and the Doha round be revived? Some countries are more optimistic than others. The G21, for instance, left Cancún determined to stick together and fight another day. Brazil, in particular, is convinced that sooner or later rich countries will be forced to reform their outrageous farm policies. One weapon it points to is the expiration of the “peace clause”.

As part of the trade round before Doha, the Uruguay round, countries pledged not to file formal WTO complaints over the dumping of farm products as long as each country stuck to its (limited) farm-trade commitments. That peace clause runs out at the end of this year. The ensuing flood of disputes, claim some Brazilians, will at last force the Americans and Europeans to negotiate seriously on farm trade.
Source: The Economist
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Indian agriculture Rajnath Singh seems to follow this interpretation:

Speaking to mediapersons at his office, Singh, however, ruled out any review of the move to phase out quantitative restrictions on imports. Other means were available to the country to curb the import of any item hurting domestic interests, he pointed out. The minister said the peace clause was slated to lapse in December this year and there was little chance of its revival after the collapse of the Cancun negotiations. "This, in a way, will benefit India", he maintained. Elaborating on the provision, he explained that in case any country tried to export its goods to India below domestic prices, it would be possible to impose counter-veiling duty to offset the price advantage. Singh expressed doubts over the true intentions of developed countries such as the US and the European Union (EU) in pushing their trade agenda. "It seems the US did not want any progress at the (Cancun) talks in view of the Presidential elections due in November 2004. It wanted a holiday from reforms to continue with its high farm subsidies till the polls", he said.

Source: Business Standard

My big worry is that, while Singh is probably right that the initial US horizon is the 2004 election, things can change and move so much during the next year that what began as a tactical retreat can turn into a wholesale rejection of the multilateral process. In this sense, let's hope the ending of the truce doesn't turn into the declaration of the war. My feeling, for what it's worth, is that here in Europe while the issue of agricultural dumping is no great deal, the issue of subsidies to the farmers is. The possibility of anyone outside the EU being systematically able to sell to us at competitive prices anytime soon seems just about zero.

What really happened at Cancun?

Since the breadown of talks last week in Mexico, economics commentators around the globe have been all asking themselves the same question: what happened and why. The economist, whilst blaming the EU for not being sufficiently prepared to give ground, and the ONG's for firing unreasonable expectations amongst the poorest countries, seems to have little doubt where the responsibility should be placed for the proximate cause of the breakdown: the problem of cotton subsidies. (BTW: this is I'm sure not interesting to any of you, but while I'm writing this, I'm listening to British playwright Edward Bond being interviewed on the radio. He isn't half giving-it to Bertholt Brecht. Well done! His definition of tragedy: the hands of the blind man must see. What is worth remembering here is that the principal bard who 'composed' the works of Homer was - according to the tradition - blind. What is pre-wired at birth for Bond is a sense of the tragic, a sense of the comic, and an imperative to impose meaning on things. He also says that he feels his characters write his plays more than he does, I sometimes think this about the blog, it is written more by the news, and by the way things evolve, by the random contacts I have across the planet than it is by me. Would that the blind man had been in Cancun!)

While the fight between Europe, America and the G21 received most attention, another alliance of poor countries, most of them from Africa, was also worried about agriculture, but for different reasons. They feared that freeing farm trade would mean losing their special preferences. (Europe's former colonies, for instance, get special access to the EU's markets for their bananas.) They were even more worried about cutting tariffs than India, fretting that imports would ruin their small farmers. And many, particularly a small group of countries in West Africa, worried most of all about cotton.

Prodded and encouraged by non-governmental organisations (NGOs), especially Oxfam, a group of four West African countries - Benin, Burkina Faso, Chad and Mali - managed to get cotton included as an explicit item on the Cancun agenda. Their grievances were simple, and justified. West African cotton farmers are being crushed by rich-country subsidies, particularly the $3 billion-plus a year that America lavishes on its 25,000 cotton farmers, helping to make it the world's biggest exporter, depressing prices and wrecking the global market.

The West African four wanted a speedy end to these subsidies and compensation for the damage that they had caused. Though small fry compared with the overall size of farm subsidies, the cotton issue (like an earlier struggle over poor-country access to cheap drugs) came to be seen as the test of whether the Doha round was indeed focused on the poor.

But the draft text that emerged halfway through the Cancun meeting was a huge disappointment. The promises on cotton were vague, pledging a WTO review of the textiles sector, but with no mention of eliminating subsidies or of compensation. Worse, it suggested that the West African countries should be encouraged to diversify out of cotton altogether.

This hardline stance had American fingerprints all over it. Political realities in Congress (the chairman of the Senate agriculture committee is a close ally of the cotton farmers) made American negotiators fiercely defensive of their outrageous subsidies. For the Africans, the vague text was a big blow. It caused "anger and bitterness" said one delegate. As a result, the poorest countries dug in their heels when it came to the other big controversial area: that of extending trade negotiations into the four new Singapore issues. Along with many other poor countries, the Africans had long been leery about expanding the remit of the trade talks at all.
Source: The Economist
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Now what the Economist seems to be suggesting here is quite important. They are suggesting that the US allowed a draft text to emerge halfway through the meeting in the full knowledge that it would be resisted by the four 'agrieved' west African countries, who would then proceed to become more obstructive on other matters, like the Singapore issues, and thus place any possibility of worthwhile agreement greatly in jeopardy. If the passage of time allows more credence to be placed on this version, it will certainly be worth while asking what has caused the United States to act in this way? Certainly it cannot be the issue of cotton subsidies alone. Possibly the whole problem of another round of trade expansion is just too much for the US to handle in election year. Or again, we might ask ourselves the question: are we witnessing the beginings of a turn in the tide of globalisation itself?

Are Trade Talks Really About Freeing Trade?

Cancun and the Singapore issues: Eddie, our man in Singapore, at it again.

Why Cancun couldn't

By Eddie Lee

AFTER the Cancun trade talks imploded, Singapore's Trade and Industry Minister George Yeo, who was the facilitator for agriculture, lamented that developing countries were the biggest losers 'because many of them would have stood to gain the most from the reform of agriculture'. He felt the talks failed because resentment against the United States and the European Union (EU) resulted in demands being pressed, 'often to unreasonable limits'. EU Trade Commissioner Pascal Lamy said he would not get into 'the blame game', but then implied that the developing world was responsible for the breakdown.

It was, indeed, a lost opportunity for all. You could say the unity among developing nations is providing a new dynamic in the trade talks, while the US offered little leadership. But if both the developed and developing nations wanted an agreement so much, why were they both so stubborn? Free trade in agriculture certainly means a lot to the developing countries, since most of their people live in the rural sector. According to The Guardian, a Malian trade representative came away from the meeting saying, 'This is a great loss to three million farmers in Mali who live on agriculture. Back home, there will be mourning because nothing had been agreed. I do not know how we will explain this to our people.'


THE talks, however, did not collapse over agricultural subsidies, but over the so-called 'Singapore issues'. The latter term was coined after working groups were set up by the 1996 Singapore Ministerial Conference to negotiate rules involving investment and competition policies, trade facilitation and transparency in government procurement. The Europeans and Japanese insisted on negotiating the 'Singapore issues' in exchange for a deal on agricultural subsidies. Of the four 'Singapore issues', the one concerning foreign direct investments (FDI) was particularly contentious. Developed countries wanted restrictions on investments by overseas corporations removed. Developing nations, however, were concerned about nurturing infant industries and sovereignty issues.

Whatever your views on FDI, you have to ask why talks on free trade should also involve an issue like foreign investments. Why should they be related? Was it a show of muscle by developed countries, extracting FDI concessions in return for granting access to their agricultural markets? The US demanded its own quid pro quo when it slapped environmental conditions on Mexico's membership of the North American Free Trade Agreement. It did the same when it demanded curbs on capital controls in FTAs with Chile and Singapore. Sceptics however suggest that the developed countries' demands on FDI were merely a smokescreen to disguise their own intransigence over agriculture.

Anti-globalisation activists, of course, had a field day. They have been arguing for years that the World Trade Organisation (WTO) is merely a cynical exercise in forcing developing countries to accept foreign ownership and control. Cancun was a chance for the developed countries to give something up for the benefit of the developing countries. It would have meant giving a little for a lot - the average European subsidy per cow, for example, matches the US$2 (S$3.5) per day poverty level on which billions of people barely subsist. But that became a side issue. Perhaps they never intended to give anything up. Why else would the EU and Japan have insisted on negotiating the 'Singapore issues' at Cancun, when there has been virtually no progress on these since the 1996 WTO Ministerial Conference in Singapore? There has always been little connection between trade policy and what's good for a country. Trade policy is made in the world of politics where interest groups count. And right now, in the developed world, there are real concerns with jobless recoveries.


THE gains from trade have always been an abstract concept to grasp. They are derived from taking advantage of differences between countries. The larger the differences, the more there is to benefit. So an urban economy can profit from trading with a rural economy by exporting manufactured goods while importing agricultural produce. But trade also brings pain. This comes during the adjustment process. The problem is magnified when unemployment is already high in an economy. Economic theory does not provide a timeframe for the adjustment process and the human costs.

There are deeper concerns among developed countries. When farm jobs were first lost to poorer nations in the past, new manufacturing jobs made up for the loss. When manufacturing jobs were lost, there were services jobs. But what if services jobs are being lost too, as they are now? Hidden underneath the so-called 'Singapore issues' at Cancun was something which in WTO jargon is known as Mode 4 of the General Agreement of Trade in Services. It concerns removing barriers to the supply of services through allowing temporary migrant labour. Developing countries want their people to be allowed into developed countries to work; the latter are more sticky about it.

Many developing countries had expressed their disappointment with the first pre-Cancun draft ministerial text which omitted this issue altogether. Even then, there was only a token acknowledgement of the 'interest of developing countries' in the final draft issued before Cancun. Whether or not migrant labour should be allowed into developed countries will surely be another test of the latter's commitment to the principles of free trade. But I get a feeling that it will continue to be met with indifference. So tell me again, are trade talks really about freeing trade?
Source: Straits Times
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