China in Transition

China Aiming for Industrial Upgrading Without Hollowing Out

Chi Hung KWAN
Consulting Fellow, RIETI

(Published in the September 1, 2011 edition of the Allatanys Newspaper Guide)

The Chinese economy has been growing at a rate of nearly 10% annually since the launch of its reform and open-door policies. One of the factors that have enabled China to achieve this impressive growth is its enormous labor force, which has seemed virtually unlimited. In recent years, however, the competiveness of China's labor-intensive products has been slipping, reflecting a shortage of migrant workers and a corresponding sharp rise in wages. To avoid industrial hollowing out, the country is seeking to shift to more advanced industries, and much progress has been made in this direction.

Industry upgrading in line with the flying geese pattern

As experienced by many countries in the process of economic development, China's leading export items have shifted from primary products to industrial products, and within industrial products, from labor-intensive products to capital- and technology-intensive products. This can be confirmed by looking at changes in the shares of principal items in overall exports. Specifically, the share of primary products in exports fell from 50.3% in 1980 to 5.2% in 2010, while that of industrial products rose from 49.7% to 94.8%. Among industrial products, the share of machinery (which consists of capital- and technology-intensive products) in overall exports has been rising steadily from a low level of 4.6% in 1980 to finally exceed that of other products (centering on labor-intensive products) in 2009, making it China's leading export sector.

These changes in the trade structure of China have followed the flying geese pattern of industrial development observed in the Asian region after the Second World War, whereby countries specialize in the export of products in which they enjoy a comparative advantage commensurate with their levels of development, while at the same time seeking to upgrade their industrial structures through receiving foreign direct investment. In line with the flying geese pattern, since the 1960s, the major locations of many manufacturing industries including textiles have been shifting from Japan to the newly industrialized economies (NIEs), the ASEAN countries, and then China, in step with their stage of development. Meanwhile, in Japan, a developed nation, the central players in manufacturing have advanced from textiles, to chemicals, steel, automobiles, and the electronics and electrical industries. Efforts by both developed and developing countries in actively adjusting their industrial structure by combining the cultivation of new industries with the shifting of declining industries overseas have helped sustain the dynamism of the region as a whole.

Center of gravity shifting from light to heavy industry

China joined the flying geese formation in the Asian region at the end of the 1970s in the wake of a shift to reform and open-door policies. Particularly since 1992 when China set the building of a socialist market economy as its reform target, countries around the world have been sharply stepping up their investments in China, mainly in labor-intensive industries, to make use of Chinese advantages such as its abundant labor force and low wages. Leveraging the accumulation of capital and introduction of technologies accompanying these investments, China had solidified its position as the workshop of the world by around 2001, when it became a member of the World Trade Organization (WTO).

China joined the flying geese formation in the Asian region at the end of the 1970s in the wake of a shift to reform and open-door policies. Particularly since 1992 when China set the building of a socialist market economy as its reform target, countries around the world have been sharply stepping up their investments in China, mainly in labor-intensive industries, to make use of Chinese advantages such as its abundant labor force and low wages. Leveraging the accumulation of capital and introduction of technologies accompanying these investments, China had solidified its position as the workshop of the world by around 2001, when it became a member of the World Trade Organization (WTO).

Meanwhile, higher value-added industries such as automobile and steel are growing quickly in China, and the center of gravity of the industrial sector is shifting from light industry to heavy industry. Automotive output in China reached 18.26 million units in 2010, exceeding the combined sum of production in Japan and the United States, while crude steel production amounted to 630 million tons, accounting for 44.3% of global production. In particular, leading global auto makers are competing fiercely to increase their share of the rapidly expanding Chinese market.

Thus, low value-added industries are declining while high value-added industries are growing in China. This phenomenon should be recognized as industrial upgrading, rather than feared as a hollowing out of industry.

Industrial restructuring centering on China to gain momentum

In response to progress in industrial upgrading in China, Japanese companies are expanding the production of higher value-added products in China, while transferring the production of lower value-added products from China to other Southeast Asian countries where labor costs are cheaper.

As an example of the former, Aoyama Trading Co., Ltd. and Ryohin Keikaku Co., Ltd. plan to reduce the production rate in China from the current 75% and 60%, respectively, to 50% or less (see page 9 of the Nihon Keizai Shimbun on August 18, 2011).

As an example of the latter, leading machine tool manufacturers such as Yamazaki Mazak Corporation and Amada Co., Ltd. are ramping up production of computer-controlled, high-performance machine tools in earnest in China against the backdrop of a sharp increase in demand for labor-saving investments, reflecting continuously rising personnel expenses (see page 9 of the Nihon Keizai Shimbun on August 23, 2011).

Not only Japanese companies, but European and American companies are also being forced to change their business strategies in China. As a result, an industrial restructuring in Asia centering on China is expected to gather momentum going forward. This can be viewed as a good opportunity for Southeast Asian countries where costs are cheaper than they are in China, as well as in emerging economies such as India, to accelerate their industrialization based on the inflow of direct investments. It is, however, a challenge for Japan, which has been at the forefront of the flying geese formation in Asia. Unless Japan continues to advance its industries in the years ahead by developing new growth areas, concerns about the hollowing-out problem are likely to mount further.

The original text in Japanese was posted on September 7, 2011.

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