China in Transition

Japanese Carmakers Shouldn't Race into China

Chi Hung KWAN
Consulting Fellow, RIETI

Following China's entry to the World Trade Organization, Japanese automakers such as Toyota and Honda have been reinforcing their production bases in China in what appears to be bold attempts to conquer the potentially gigantic market. Following WTO accession, however, China will substantially lower import tariffs, so that imported cars will become cheaper. As a result, the advantage of producing cars in China would be sharply reduced. One cannot help wondering whether the increasing inclination towards local production is the right strategy for Japanese automakers to penetrate the Chinese market.

Up until now, the Chinese government has encouraged foreign automakers to produce in China by allowing auto sales in the domestic market on one hand, while imposing high tariffs on auto imports on the other. Under this "swapping market for technology" strategy, foreign automakers would hit a wall of high tariffs when they tried to export to China, but the very same wall would protect them if their production were inside China.

Japanese automakers used to face nearly 100 percent tariffs on their auto exports to China. Their domestically produced car with a price tag of $10,000, for instance, would have to be sold for $20,000 in the Chinese market. They were no match for competitors, such as Volkswagen of Germany and General Motors of the United States, which were already producing in China. Thus, Japanese automakers had no choice but to begin local production if they wanted to sell cars in China.

But things are changing. Following its entry to the WTO, China has been gradually revising its trade-related policies. Regarding the automobile sector, China will abolish import quotas and lower import tariffs on finished cars from the current 80-100 percent to 25 percent by mid-2006. As a result, it may become cheaper to export finished cars to China rather than producing them there.

Should Japanese automakers opt for exports as a way to increase their presence in the Chinese market, they will be able to shift their investment in China away from production facilities and into the reinforcement of sales networks, aftercare services, and the establishment of research and development facilities for improving auto designs to better fit local tastes. Meanwhile, expanding production at home to satisfy the rising demand in China would slowdown the hollowing out of the Japanese industry.

Moreover, the Chinese auto industry faces so many handicaps that cheap labor in China does not necessarily translate into low production costs. Most automakers there are so small that they are unable to benefit from the economies of scale. Their productivities and R&D capability also remain low and the quality of their products is far below global standards.

As a consequence, often the costs of local auto production are higher than international prices for cars of equivalent quality. Utilizing their technology and financial resources, Japanese automakers may be able to overcome some of the drawbacks to producing in China. But it is doubtful whether they can compete with imported cars produced by their foreign rivals when China's import tariffs on auto imports come down to 25 %.

The majority view among Japanese automakers is that they should produce close to the market so as to improve their brand image and meet the needs of consumers. But consumers rarely do their shopping by visiting car factories, and their needs can be served better by expanding local R&D facilities and aftercare services. Indeed, European automakers that are expanding their share of the Japanese market do not produce in Japan.

Also, for expensive goods like cars, other things being equal, Chinese consumers would certainly prefer a "made-in-Japan" to a "made-in-China" label. Above all, if Japanese automakers try to increase their production in China, they should also be prepared for the risk of overcapacity problems, which they may face in the near future as a result of too many foreign automakers rushing into the Chinese market.

While their US and European counterparts have already made massive capital investments in China, Japanese automakers should enjoy the advantages of being latecomers. Japanese companies have more freedom in formulating their business strategy. Instead of jumping on the bandwagon and building new plants in China, Japanese carmakers should consider an alternative option: staying in Japan.

June 21, 2002

June 21, 2002