China in Transition

Chi Hung KWAN
Consulting Fellow, RIETI

Recently, Japanese imports of manufactured goods from China have surged and the reputation of Chinese products has improved substantially, giving rise to concern that China will soon replace Japan as the "factory of the world." An objective evaluation of China's industrial strength, however, suggests that there is still a long way to go before it will become a truly advanced industrial country on par with Japan.

First of all, the high proportion of labor-intensive products in China's exports means that its trade structure is typical of a newly industrializing economy (NIE). This is different from that of developed countries, where the major export items, such as machinery, are technology-intensive. Although China is increasing its share of the global market for manufactured goods, including some IT products that are classified as high-tech, Chinese exports are still highly concentrated in lower-end products. In the case of televisions, for instance, Japan specializes in high-definition and other higher-end models, while China produces standard models whose unit values are much lower.

Reflecting China's emphasis on processing trade, goods "made in China" contain large numbers of overseas components, some of which are made in Japan. According to official Chinese statistics, increasing exports by $1 million requires importing intermediate goods and components worth$500,000, which do not form part of China's GDP. Moreover, the proportion of this imported content is higher for high-tech than for low-tech products. A computer labeled "made in China" is likely to contain a large portion of imported contents including an Intel CPU, Microsoft Windows operating system, and a liquid crystal display made in Japan or South Korea.

In addition, approximately half of China's exports are produced by subsidiaries of foreign companies, to which dividends, interest charges, royalties and other fees must be paid. Even among Chinese companies with no capital relations with overseas companies, the majority of their exports are processed under OEM (original equipment manufacturing) contracts and sold with foreign brand names. Thus only a very small percentage of the value-added of products labeled "made in China" is actually "made by China." The latter corresponds to the concept of China's gross national product (GNP), and excludes import charges on intermediate goods and investment income paid to overseas countries.

China is so heavily dependent on foreign partners that it has yet to develop its own edge-cutting technology and internationally recognized brand names. On the top of this, Chinese companies are inferior to their overseas counterparts in virtually every aspect, be it capital, human resources, or business management. As a result, China has no option but to look to cheap labor for its export competitiveness. Indeed, the majority of China's contribution to the value-added of its exports lies with the cost of labor, and the very low wages in China averaging less than \$100 a month imply that this contribution must be very small.

As such, the common assumption that Chinese goods are competitive because the country's wage levels are low holds true for only labor-intensive products, and does not necessarily apply to industry as a whole. Instead, China's low wages should be interpreted as a reflection of the fact that its labor productivity is poor. It is when China's wage levels approach those of Japan, reflecting a rise in productivity, that China will really become a formidable competitor for Japan.

April 26, 2002

April 26, 2002

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