China's manufacturing needs high-tech edge

China's long-held, low-cost manufacturing advantages are dwindling and it must make greater inputs into innovation.

Manufacturing has played a key role in the growth of China's economy. In 2010, China's manufacturing output accounted for 19.8 percent of the world's total, slightly higher than US manufacturing's 19.4 percent. Statistics from the United Nations show that the output of China's manufacturing reached $2.05 trillion last year under the early 2011 exchange rate, compared with the $1.78 trillion of the United States.

Despite this, "made in China" still lags behind the US in terms of its wealth creation capabilities. Statistics show that China's manufacturing productivity and value added are about 4.38 percent of the US', 4.37 percent of Japan's and 5.56 percent of Germany's. China had only 17 of the world's 500 most influential manufacturing brands in 2010. Lying at the middle- and low-end of the world's manufacturing chain, China's exports are mostly low-technology, low value-added products, while its imports are high-tech, high value-added products.

China's export momentum has primarily been driven by quantity expansion. The country's export model, which is dominated by the processing trade, has caused a large volume of transferred trade within its borders. In fact, the biggest contributors to its trade surplus are China-based transnational corporations. In the last 10 or so years, the country's mushrooming foreign trade has to a large extent been driven by foreign-funded enterprises, which have in particular played a very important role in its exports. Take 2008 as an example. In that year, China's export surplus was $295.4 billion, of which $170.6 billion, or 57.7 percent of the country's total trade surplus, was created by China-based foreign-funded enterprises,.

Due to their relatively low resource prices, the marginal productivity of capital in China and other developing nations, a ratio used to measure the additional output resulting from the use of an additional unit of capital, is usually higher than in developed nations. According to a survey conducted by the World Bank of 12,400 enterprises across 120 Chinese cities, the average net assets return ratio of China's industrial enterprises exceeded 15 percent in 2005, while the ratio for private enterprises was 19 percent and for foreign-funded enterprises it was 22 percent. Such a high capital return ratio stems from a long-time distortion in the country's labor prices. Compared with a faster-growing capital return ratio, China's labor remuneration has shown much slower growth in recent years. From 1998 to 2008, the country's industrial enterprises achieved an average growth in profits of 30.5 percent year-on-year, far higher than the 9.9 percent growth in its labor remuneration.

Given that there is not too much space for boosting the growth of its middle- and low-end manufacturing, China should try to press for the transition to high-end manufacturing.

Still mired in the consequences of the global financial crisis, the US has accelerated a review of its industrial structure, as indicated by President Barack Obama's vow to get back the "lost American manufacturing" from China. According to an estimate made by the Boston Consulting Group, about 15 percent of China-based US enterprises will go back to the US from China in the next five years amid the rapid rises in China's labor prices and Washington's expedited efforts to reverse the trend for outsourcing, a tendency that emerged about a decade ago, especially with regard to electronics, appliances, furniture, plastic, rubber and metal products and computers, which account for 70 percent of the US' imports from China and cost US consumers about $2 trillion every year.

In an era when the global manufacturing pattern is undergoing drastic changes, the US' future competitive advantage will undoubtedly come from the rejuvenation of its manufacturing sector.

What will such an increased US manufacturing edge mean to China?

With the expected rises in China's labor costs as well as the yuan's appreciation and its resources and environmental bottleneck, China's long-held low-cost advantages in the manufacturing sector are ebbing away. The possible "double lose" of both high-end and low-end manufacturing advantages will be a big challenge to China in the decade ahead if the country fails to set up a solid foundation for innovation and successfully raise productivity as soon as possible.

China has no reason to delay its efforts to increase its input into research and development and innovation, which will facilitate its transformation into a technological power.