Economy

A question of capacity

Japanese firms leave China, but supply chains are set for a bigger overhaul

Experia-w

Not made in China: Sony Experia

When Sony first set up shop in China in 1996, globalisation was in full swing and the world was getting to grips with an exciting new technology called the digital versatile disc, or DVD.

Just over two decades later and Sony is on the move again. This time it is leaving China, at a time when globalisation is in partial retreat and the DVD is close to death.

In late March the Japanese giant announced that it was closing down the Beijing factory that makes its smartphones. Company executives say production will be optimised at a second factory in Thailand where costs are cheaper.

Sony joins the growing list of Japanese firms that are reconfiguring their supply chains away from China. Others include Seiko Epson, which announced that it would close its watch plant in Shenzhen last month. Late last year Japanese electric motor manufacturer Nidec and electronics giant Panasonic both said they were moving production to Mexico as well.

Some of the Western media has framed these departures in geopolitical terms, saying that companies are trying to limit the risks of depending on production in China at a time when it is in conflict with the US and, increasingly, the EU too.

Moving operations elsewhere is a “conscious uncoupling” is how the Australian Financial Review puts it, or a defensive move propelled by the economic imperative of avoiding tariffs.

In a rare acknowledgment of Donald Trump’s achievements, the New York Times opined that some of these withdrawals mean that the American president has “scored a big victory” and that companies are rethinking their reliance on China.

The newspaper also cited hydraulics manufacturer Danfoss in support of its case. In 2018, the Danish group purchased an American heating system manufacturer that had just moved its production to China. But it soon moved its operations back to the US, conscious of being hit by a first round of tariffs that would add 25% to its prices.

The Chinese media looks at things differently, portraying the closures by foreign firms as a positive sign that local industries are moving up the value chain, forcing more basic manufacturing capacity to move to lower-cost countries.

Typical of this claim is an editorial from portal Gongkong.com, which related what Gree chairwoman Dong Mingzhu told delegates at the National People’s Congress last month. The boss of the air-con giant argued that China

is undergoing a manufacturing makeover and is set to become an industrial innovator. Gongkong.com concluded: “Foreign companies always cite operating costs when they shut up shop in China. But some believe the real reason is that they’re being crowded out by the rise of local enterprises.”

Sina Finance agrees, as do legions of social media commentators, who see the exodus of foreign firms as a sign that their time is up.

One of the most ‘liked’ comments about Sony’s decision was: “Japanese companies aren’t major mobile phone manufacturers, so if profit margins aren’t high, it’s not worth continuing.”

Back in the US, some of the most liked comments on the New York Times article about the reshoring of manufacturing took issue with suggestions that Trump had scored a win in bringing back production to American soil. “A race to the bottom for wages is not the kind of victory that any American workers actually want,” warned one.

Washington think tank ITIF (the Information Technology and Innovation Foundation) comes to a similar conclusion that not all manufacturing capacity is created equal. In a report published this week, it argues that the US needs to do more to boost its higher-end industries because China is closing the innovation gap. If the Chinese were merely copiers of existing expertise, the competitive threat to advanced economies would be more limited, the authors venture. But they believe that China is following the same developmental path as Japan and South Korea before it, and that the Made in China 2025 strategy puts it close to the point where it will make the transition from a fast-follower to independent innovator.

The ITIF’s warning is that developed economies need to find ways of entrenching their advanced industries because the decades of investment that got them there in the first place make these sectors much more difficult to rebuild than more basic manufacturing plants.

Without efforts to bolster higher-end industries against Chinese competition, the Americans could end up as a nation that sells China natural gas and soybeans, while Europe is left peddling “tourism services,” the report warns.

Data from China shows that the economy is moving in a higher-tech direction. In the first two months of 2019, FDI rose by 5.5% year-on-year. But investment in high-tech industries accounted for 27% of the total, according to government estimates, or a 48% increase year-on-year.

On the other hand, research from the World Bank underscores just how hard it is for countries to keep moving up the manufacturing chain once they reach a certain level of performance. South Korea and Japan have both managed it, with medium and high-tech industries in the two countries rising from 45% and 51% respectively as a percentage of manufacturing value-added in 1990 to 64% and 55% in 2017.

The US dropped from 49% to 41% over the same period, while France slipped from 53% to 49%.

Some have argued that Chinese manufacturers are going to hit a performance ceiling, in part because of their government’s inability to make way for market forces. In 2014, a trio of economists penned a commentary in the Harvard Business Review concluding that Chinese firms would stall in their bid for world-class competitiveness, for instance.“The problem, we think, is not the innovative or intellectual capacity of the Chinese people, which is boundless, but the political world in which their schools, universities and businesses need to operate, which is very much bounded,” it predicted.

The interesting point about analysis like this is how it jars with calls from think tanks such as the ITIF that governments need to intervene to help their companies succeed. Policymakers can tread a middle-line, of course. Higher spending from the state on skills and education, wider provision of lower-cost finance for innovative businesses, and heavy investment in ancillary infrastructure, are generally starting points on the wishlist.

In the meantime, there’s no shortage of companies in China with an eye on striking out in new directions. A recent exhibit is food and beverage company Wahaha, which put out an announcement at the beginning of April that it had set up a robotics company, based in Hangzhou. Readers of the news might have wondered whether this represented some kind of April Fool’s Day joke, given that the firm is best-known for its kids’ drinks brands. But Wahaha is looking to try something different. Back in 2013 it was making revenues of Rmb78.28 billion ($11.66 billion) and anticipating the day when it would pass the Rmb100 billion mark. But sales headed in the other direction, dropping to Rmb45 billion by 2017, according to Jiemian.com.

Even if Wahaha is no longer the revenue-generating machine it once was, its founder Zong Qinghou is never one to write-off. He now believes that Wahaha’s manufacturing expertise makes it a strong candidate to develop industrial robots, not just for internal usage but also to be sold to others.

Zong is a couple of years behind He Xiangjian, founder of white goods giant Midea, which took over German robotics company Kuka in 2017. Midea makes similar claims that the robotics expertise will be useful in-house, but also that it will help it become a major player in industrial automation in its own right.

Strategies like these will take time to play out and there are grounds for arguing that both firms are taking massive risks with their shareholder capital. Whether beverage brands in Europe or white goods makers in the US could convince their investors to do the same thing is open to question. Yet both Chinese firms will be hoping for some form of policy encouragement and financial support from the state, especially as robotics is regarded as a priority sector. A report in The Economist in February claimed that China’s working-age population could shrink by as much as 124 million (or 13%) by 2040, making automation a must-have asset. And China simply isn’t producing enough robots to meet future demand, so Wahaha won’t be the last firm to try its luck making them…


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