Books proclaiming ‘the end of cheap China’ started to appear about five years ago. But the businessmen of the Pearl River Delta have been experiencing the trend for longer. The door had started to close on the first generation of the export-processing model in 2007, when the Ministry of Commerce announced that thousands of products would no longer be granted tax rebates. Plastics, textiles and furniture businesses were particular targets.

Factory bosses already complaining about surges in wages in each of the previous three years were also saddled with new legislation guaranteeing overtime payments and mandating increases in social security contributions. Weaker demand in the wake of the global financial crisis made for the perfect storm. The newspapers began to report that thousands of factories were facing closure, with the Federation of Hong Kong Industries estimating that at least a quarter of the 70,000 Hong Kong-owned companies in the region would be gone by the following year.

 

The end of ‘cheap China’

The PRD’s export sector had specialised in the role of assemblers, exploiting its comparative advantage of low labour costs to dominate this part of the supply chain. For years wages were relatively stagnant, there was cheap land for factories, new roads and ports, and a constant stream of migrants looking for work. But when these conditions started to change, the profits of the golden era began to subside. Some of the drawbacks of the ‘made in China’ model were becoming more apparent too. Although Guangdong’s production lines had emerged as an integral part of the global supply chain, advances in technology and logistics had allowed their international customers to break down the manufacturing process into a series of sub-contracts, and put them out to tender to the lowest bidders.

That meant that there was a race to the bottom as far as many of the PRD’s factories were concerned. Contract prices were falling fast and much more of the value of the goods being made in China was captured by companies that owned the brands in Europe and the United States, or by suppliers of some of the more sophisticated parts from countries like Japan and South Korea. While the international firms feasted on the profits of the “China price”, the China-based ones had to be content with the contractual crumbs.

12%

Guandong province’s growth rate in 2010. It fell below 8% last year

With costs increasing, the Pearl River Delta’s businesses haven’t been able to keep growing at the same pace. Guangdong’s economy has slowed from more than 12% growth in 2010 to less than 8% in 2015, its worst rate of growth for many years. Still, Guangdong performed better than China’s national average last year. And despite the rises in labour costs and land prices, the industrial ecosystems of the PRD provide a competitive base. The various clusters of suppliers and assemblers, the massive investment in road and rail infrastructure, and the speedy access to ports and airports are hard to match anywhere else in the world.

Plus there is the proximity to the vast domestic market, which brings millions of consumers into easier reach for Chinese manufacturers versus those from other parts of Asia.

There’s also been a sustained campaign from the local authorities to upgrade PRD businesses. The automotive and petrochemical sectors have taken the lead, with car plants from Honda, Nissan and Toyota in Guangzhou now joined in the PRD by the major auto parts manufacturers, such as Japan’s biggest car parts maker, Denso. Further east in Huizhou the priority is petrochemicals, where Shell and the Chinese oil major CNOOC have invested in a massive new refining complex.

The upgrading plan is part of what Wang Yang, then Guangdong’s Party Secretary, once described as “replacing the bird but keeping the cage” – or upgrading the more outdated parts of the economy to more modern and more profitable businesses. The intention is to put the PRD at the forefront of China’s efforts to evade the “middle-income trap”, in which rising labour costs cripple an economy’s lower-end industries before it has the research and innovation base to move into more productive sectors.

 

German lessons

Last May there was a refocusing on the PRD’s upgrade plan with the release of the ‘Made in China 2025’ blueprint, which promises special funds and tax incentives for 10 priority sectors, and sets goals for the share of made-in-China parts and materials that Chinese manufacturers are using.

“For the Pearl River Delta it means continuing with the process of transforming the local economy,” explains Peter Helis, founder of Helis & Associates, an investment advisory firm based in Guangdong.

Helis – who was born in Germany and runs his business from Foshan’s Sino-German Industrial Services Zone – says that parts of the ‘Made in China 2025’ plan seem to have been inspired by his home country’s “Industry 4.0” programme, which puts intelligent manufacturing at the heart of its growth campaign.

Made in China 2025: the priority industries

Older industries have already been moved into less-developed parts of the PRD, or even pushed out of it entirely, with sectors like steel and papermaking relocated to Zhanjiang in the west, and the metalworking industry to Jieyang in the east of Guangdong.

At the same time Helis has been working with the local governments of Guangzhou and Foshan to attract the next generation of manufacturing investment, much of it from partnerships with German companies.

Prioritising the industries in the ‘Made in China 2025’ programme means that the charm offensive is different to the 1980s, however, when foreign investment was pursued more indiscriminately.

“The investment promotion teams are a lot more choosy than they used to be,” Helis explains. “It is businesses from the targeted industries that they want the most. To attract new investment they might offer rental holidays on factory land or office space. Sometimes there are tax breaks or more direct financial incentives. But the selection process is much more strategic – the newcomers have to be bringing the right skills and technology.”

Helis says that businesses with backgrounds in automation, smart manufacturing, energy efficiency and industrial services are particularly welcome. One of the early successes was investment by Volkswagen and its joint venture partner FAW Group in a huge factory in the Nanhai district of Foshan, which began operations three years ago with capacity for 300,000 vehicles a year. Other German companies have also invested in the area, including lighting manufacturer Osram, robot maker KUKA, recycling giant Remondis, and the industrial gas specialist Messer Group

Other Chinese cities are also trying to cultivate ties with German companies, Helis says. But Foshan’s heavy concentration of private sector firms makes it a better fit with the medium-sized enterprises that make up Germany’s Mittelstand economy. “This kind of industrial model applies better in Foshan than parts of northern China, where state-owned firms tend to be more dominant,” he explains. “Many of the companies here operate from business clusters too, which is another similarity with the Mittelstand.”

A third area where Germany is mentioned as a model is the training of a more skilled workforce, because local officials are realising that many of Guangdong’s university graduates aren’t the best fit for the newer industries that they want to encourage. “What’s needed is more vocational training, and we are helping our Chinese clients to partner with German technical colleges to produce more technically-skilled students,” Helis says.

 

Rise of the machines

If migrant workers were a defining feature of the PRD’s ‘boom 1.0’, the next ‘2.0 phase’ of its growth looks likely to have more of a role for workers of the non-human variety.

As labour markets have tightened, more factories have started to switch to automated production, even investing in companies that make robots for industrial applications.

While investment in fixed assets in general has slowed, interest in robots has been more buoyant, and sales to Chinese customers currently make up more than a quarter of the global market. China is in catch-up mode with 30 industrial robots for every 10,000 manufacturing workers, versus a global average of 62 (the ratio is 10 times below Germany’s and 15 times less than South Korea’s). The Chinese are expected to close this gap, following Japan’s experience during the 1980s when rising wages and the need for productivity gains saw policy support for companies that invested in automation.

The central government in Beijing has been cheerleading the change with Xi Jinping calling for an “industrial robot revolution” and backing it up with tax deductions for purchasers of advanced automation.

30

The number of industrial robots for every 10,000 manufacturing workers in China. That’s less than half the global average

Guangdong’s provincial government has also been trumpeting a three-year programme to subsidise robot purchases at nearly 2,000 of its largest manufacturers.

It helps that the payback periods on these kinds of investment are shortening. Between 2004 and 2013, manufacturing wages grew at 14% a year, making robots a more attractive option. This should mean more cases like that of Changying Precision Technology, which shifted its plant for mobile phone parts to an all-robot operation last year. Less than a tenth of its Dongguan workforce of 650 remained in their roles, and the number was set to fall further to 20, the media has reported. Changying says the impact was dramatic. Operations ran round the clock, output tripled and product quality improved markedly.

Another major investor in industrial automation is Gree, a leading manufacturer of air conditioners, headquartered in Zhuhai. It has been boosting productivity with more automation since 2012, including making its own robots and automated guided vehicles.

Industrial robots do the heavy lifting, welding and drilling, and apply coatings such as glue or paint. More advanced models can perform pressing, polishing and packaging work. Importantly, some of the PRD’s key industries are well suited to automated production, with producers of carmaking and transportation equipment, electronics, computer components and electrical machinery all expected to benefit.

Multinational suppliers dominate robot sales in China, however, with ABB, KUKA, Yaskawa Electric and Fanuc commanding about 60% of the market, according to the Shenzhen-based consultancy MIR Industry. Shunde, part of Foshan, is one of the districts trying to establish homegrown capabilities, and it currently boasts more than 20 robotics companies. Shunde-based Midea Group is another of the pioneering customers, having introduced robotic assembly to its production lines for household appliances.

Industry analysts warn that most Chinese robot makers are some way behind their foreign rivals, however. Although government subsidies have triggered the creation of a wave of new robotics firms – from 200 to 815 in the two years to 2014 – only 30 of them had completed meaningful research and development, MIR Industry has reported. Of course, the rise of the robots also presents a dilemma for the Chinese leadership. If more factories buy into this kind of mechanised revolution, thousands of workers seem set to lose their livelihoods.

Many businesses must adapt or die. Hence Dongguan’s authorities say they will sponsor more than 1,000 “Robots to Replace Humans” programmes by the end of this year, despite speculation that these efforts could put nearly a million people out of work. The central government seems to have come to a similar conclusion – that the robot revolution is coming regardless, so it’s better that Chinese firms are using new technology, as well as making more of the robotic equipment that is going to be installed on the world’s production lines.

That way, even if robots end up taking over from humans in factories, at least Chinese companies will profit from building, programming and servicing them.