The future of 'Made in China'

Since its emergence in Guangdong Province in 1978, the processing trade in China has developed rapidly. The processing trade refers to the process by which raw and auxiliary materials, parts and components, accessories and packaging materials are imported from abroad and used to produce a finished product which are then re-exported. In 1996, the processing trade became the principal form of international trade on the Chinese mainland. China henceforth became the world's biggest workshop. "Made-in-China" products have flourished in almost every corner of the planet, loved for their affordable prices.

The thriving of China's processing trade has been seen as a result of the combination of the globalization trend in the world economy and the inherent nature of China's economic realities. This trade helps China make optimal use of its abundant labor supply and exploit international resources including advanced technologies, capital and marketing channels. Boosted by the mass transfer of foreign industries to Chinese shores, the processing trade plays an important role in such aspects of development as expanding exports, promoting employment, increasing revenues and stimulating growth of related industries.

China's entry to the World Trade Organization (WTO) in 2001 has lent more momentum to its processing trade. According to statistics released by Chinese Customs, the import and export volume of China's processing trade rose to US $1.16 trillion in 2010, marking an annual increase of 19.1 percent from US $241.43 billion in 2001.

A Remarkable Achievement

China's processing trade rose on the back of the nation's low labor and land costs. However as these advantages gradually disappear and the Chinese people's concern for the environment increases, the focus of China's processing trade development has shifted from sheer volume to the strength and health of the sector.

As an important indicator of the overall level of processing trade, the value-added ratio of the processing trade, the ratio of export value to import value over a specific period, reflects the size of added value in processing. This indicator is useful in understanding the position of China's processing trade in the global industrial chain. Since its accession to the WTO, China has successfully sustained the expansion of its processing trade. This growth has relied more on improvements in efficiency than on the expansion of trade volume. Thus, although the proportion of processing exports to overall exports has been declining, its value-added ratio has continued to rise. Over the decade from 2001, the year in which China joined the WTO, to 2010, the proportion of processing exports to China's overall exports dropped from 55.4 percent to 46.9 percent, while the value-added ratio climbed from 56.9 percent to 77.4 percent.

The rise of the value-added ratio of the processing trade not only signifies the increasing role that the sector plays in driving the domestic economy, but also reflects the progress China has made in transforming and upgrading its processing trade. This project has proved to be an exceptionally difficult to carry out, and there are still many challenges to be faced. For one, weak in research and development, Chinese enterprises engaged in the processing trade remain at the lower end of the international industrial chain with regards to added value, and this makes it difficult for them to break away from the labor-intensive and low-added-value model. Take for example, a Barbie doll. It is sold for US $9.99 in the U.S market, but China's manufacturer sells it to the U.S. importer for a mere US $1, earning only 35 cents after costs are deducted. From a macroeconomic perspective, every RMB 1 worth of export in general trade contributes RMB 0.7 to China's domestic economy, while the figure is only RMB 0.3 for the processing trade

Starting in the second half of 2008, demand from the international market shrank as a result of the global financial crisis, and China's processing trade faced unprecedented difficulties. In 2009, China's processing trade volume declined by 13.7 percent. However, in retrospect we know the crisis offered China a strong incentive to transform and upgrade its processing trade. As the world economic meltdown shattered the status-quo of the international industrial chain, many Chinese enterprises dealing in the processing trade took advantage of the chance to improve the structure of their exports and increase their added value and technical content, building up momentum to challenge the old race leaders on the international market.

Of course, it takes more than endeavors by individual enterprises to help China's processing trade survive and grow in a worldwide crisis. Government support plays a vital role in this regard. To help these enterprises ride out the downturn and expand domestic demand, the government took measures to facilitate the domestic sale of processing trade products, such as relaxing and simplifying Customs declaration procedures. Owing to such help from the government, many enterprises survived the financial crisis, enabling the processing trade sector to make a strong and swift rebound once the world economy became more stable. In 2010, China's processing trade volume increased by 27.3 percent over the previous year, with exports rising 26.2 percent and imports up 29.5 percent.

Further Transformation and Upgrading

Since China's accession to the WTO its processing trade has been growing robustly. The question of how to develop the processing trade in a more advantageous way has thus come to the forefront of debate. Several factors are critical in enhancing the total competitiveness of China's processing trade, including industry security, environmental protection and research and development ability. All signs show that China's processing trade is steering away from over-reliance on quantitative expansion, and making headways in elevating the quality of trade. However, to extricate itself from its former position at the lower end of the international industrial chain, it still has many challenges in its future development. The solution lies in bolder moves to transform and upgrade the industry.

Although China's accession to the WTO gave impetus to its processing trade, the institutional bonus coming with the membership has been largely exhausted over the past decade. To further confound the situation, the global financial recession and the debt crises in Europe and the U.S. put more stress on China's processing trade. This partly explains the recent woes of the city of Wenzhou. Though the liquidity crunch that jolted that manufacturing powerhouse and sent shockwaves through the rest of the nation were primarily caused by unlawful loan-shark operations and real estate speculation, the sluggish global economy also had a role to play. Transforming and upgrading is now vital for China's processing trade, and breakthroughs have to be made.

Such transformation should involve several aspects of trade. The main parties engaged in the business should shift from foreign companies to domestic enterprises. More of the raw materials and parts/components they work on to build finished products should be purchased from the domestic market instead of being imported. Processing and manufacturing should be pushed forward in tandem. The production of low-end commodities should be moved from the southeastern coast to the less developed central and western regions, so that the coast can concentrate its resources on development of mid- and high-end products.

With regards to upgrading, an emphasis should be laid on moving up the position of China's processing trade in the global value chain. This demands going beyond processing and assembling to taking up independent research and development, reducing the industry's labor intensity and increasing its technological and capital intensity. Also needed is the agglomeration of relevant industries. These goals cannot be achieved without the coordination of all relevant government organs, which by modifying existing policies and making new regulations should raise the permit requirements for processing trade companies, to restrict or forbid products whose production is highly pollutant or consumes excessive energy and resources, and to discourage low-added-value exports. Meanwhile stimulus policies should be adopted to optimize the product mix of the processing trade and increase technical intensity and added value.

To date, China has made remarkable achievements in the transformation and upgrading of its processing trade. But many problems still remain unsolved, and more effort is needed. The mainstay of China's processing trade is no longer textiles. In 2010, machinery and electrical products accounted for 59.2 percent of the overall processing trade volume, and 90 percent of China's exports of high-tech products also passed through this form of trade. However, China has no reason to be smug about these seemingly impressive figures. Even in the category of the more lucrative high-tech products, processing in China involves neither significant use of advanced technologies nor yields decent added value. On examining China's processing trade more closely, we will find that the steady growth of the value-added ratio in processing trade is largely driven by increasing spending on domestic raw materials. One part of these increasing outlays comes from rising prices in the domestic market, and another can be attributed to the trend of using local substitutes for imported low-end materials and parts. This substitution however comes at an environmental cost, and runs against the state policy for green development.

Since its accession to the WTO, China has paid more and more attention to transforming and upgrading of the processing trade. Guided and encouraged by government at all levels, many enterprises have successfully achieved this goal. But there are still some yet to do so. To make changes effective and efficient, China's processing trade players should work towards the following four targets: adding layers to the processing trade, making more domestic purchases, shifting to deep processing and cultivating more technicians.

The next few years will be critical for transforming China's processing trade. Relevant government departments should create favorable conditions and build a platform for these enterprises to realize the process of transformation and upgrading. This could include the following measures: establishing industrial parks in underdeveloped regions to facilitate industry relocation; clarifying the functions and emphasis of various industrial parks to rationalize their locations and make them complement each other; upgrading existing industrial parks; establishing industrial parks abroad, and guiding the uncontrolled outbound shift of some processing enterprises in the coastal areas to become a more orderly move. One further point should be emphasized: some sections of the processing trade could be converted into general trade in certain circumstances. This kind of conversion is not a rejection of the processing trade, but an inevitable result once the processing trade develops to a certain degree. Therefore, relevant government departments should make efforts to create favorable conditions to facilitate this conversion. Of course, such conversion should conform to natural economic laws. There is no need to forcefully precipitate the processing trade into general trade if conditions are not ripe.