China in Transition

Will China Become a Major Automobile Exporter?

Chi Hung KWAN
Consulting Fellow, RIETI

The entry of foreign manufacturers aiming to secure a foothold in the Chinese market has triggered rapid growth in the country's automobile industry, and of late we are beginning to see moves by Chinese firms to export their own vehicles. However, in addition to high production costs, there are several other challenges that must be overcome if Chinese automakers are to successfully enter the international market. Concentrating production resources in the auto industry would boost its international competitiveness, but this would make it even more difficult to solve the problem of employment. Rising auto exports would, in particular, lead to a revaluation of the yuan, reducing the price competitiveness of labor-intensive industries. Since China is saddled with excess labor, it should not rush to promote its industry at the expense of employment.

It is too soon for full-scale export of automobiles

There has been a series of announcements from automakers laying out plans for full-scale export of cars from China. On December 23, 2004, Honda Motor Co. announced the completion of the first phase of its Guangzhou plant (with an annual production capacity of 50,000 vehicles), China's first factory geared solely toward passenger car exports. The compact cars that will start rolling off the assembly lines from the end of February 2005 will be exported to Europe. Also, on Jan. 5, 2005, Chinese automaker Chery Automobile Co. announced it would begin selling five passenger-car models in the United States starting in 2007 through Visionary Vehicles LLC, a retailer of imported cars. Chery has set an ambitious U.S. sales target of 250,000 vehicles for 2007. And on June 1, 2004, the Chinese government lent a hand to the auto export drive, publishing its "Automobile Industry Development Policy," whose stated goal is "to make the automobile industry a pillar of the national economy by 2010."

The path to China's becoming a major auto exporter will be treacherous, however. In the case of Chery, not only will the products themselves need to be competitive, the company will also have to tackle such problems as meeting American environmental and safety standards, developing sales channels and reinforcing an after-sales service network.

Even Chery, which is regarded as having the highest brand value among Chinese automakers, will have to follow a low-price strategy in the U.S., selling its cars at prices roughly 30% lower than similar competing models. However, the Chinese auto industry is still in the early stages of development, and it must import key technology and parts from other countries. In the absence of economies of scale, production efficiency is also low. As a result, although wage levels in China are much lower than those in industrialized countries, the production cost of Chinese automobiles is comparatively high and thus Chinese autos have yet to become internationally competitive.

In addition, their price competitiveness will be further hampered by the cost of having to meet overseas emissions and safety standards. Because these standards become stricter over time, Chinese automakers will have to shoulder the development costs associated with meeting them. Development costs are also relatively high for Chinese automakers, which lag behind their counterparts in developed countries in terms of technology. And the cost of setting up a network of 250 exclusive dealers for its foray into the U.S. market puts it at a disadvantage compared to automakers that are already firmly established in the U.S. market.

Furthermore, Chery's rivals in overseas markets are not just new cars of the same class. The U.S. has a well-developed used car market, and if the car was manufactured by an automaker in a developed country buyers can expect high-quality after-sales service. Even if a new car built in China is less expensive, consumers may opt to purchase a used car when they consider the cost of after-sales service. However, as in the case of building sales channels, the initial investment necessary to provide a high level of service further dents the cost competitiveness of Chinese auto manufacturers.

The dilemma of promoting industry and creating jobs

Of course, one cannot deny the possibility that China will develop an internationally competitive auto industry if it gets unlimited support by the government. However, as the auto industry develops, China will be burdened with two dilemmas. The first problem is that of employment. The automotive industry using the state-of-art robotics is technology-intensive and requires relatively less manpower compared to traditional processing industries. Thus, if the same amount of money is invested in a labor-intensive industry, more jobs will be created.

The second problem has to do with foreign exchange rates. As Japan's experience shows, once the automobile industry becomes highly competitive internationally, the currency will have to be revalued. A rise in the yuan's value will make it difficult to maintain the cost competitiveness of the labor-intensive industries that have been China's forte up to now. A stronger yuan will also push unemployment higher as a result of a fall in sales and a rise in corporate bankruptcies in labor-intensive industries (see note). When we consider the fact that China has a surplus of labor amounting to some 150 million people in rural areas alone, the argument that it should promote hi-tech industries even at the cost of higher unemployment does not hold up. How to increase employment while helping its industries to advance has become a major challenge to China's economic development.

(Note): This is similar to the "Dutch disease" found in international economics textbooks. As the theory of comparative advantage shows, no country can be internationally competitive in all industries. In the 1960s, the crude oil exports of the Netherlands increased as the country developed its North Sea oil fields. But the subsequent rise in its trade surplus led to a surge in the value of the currency, which in turn caused the competitiveness of its manufacturing sector to decline and led to a hollowing-out of industry.

January 14, 2005

January 14, 2005