No.5 | Jiajun Xu, Stephen Gelb, Jiewei Li and Zuoxiang Zhao: Adjusting to Rising Costs in Chinese Light Manufacturing —What Opportunities for Developing Countries?
Accelerating real wage growth in China from the mid-2000s has raised the possibility of relocation of jobs from export-oriented labour-intensive light manufacturing (LILM) industries on China’s east coast to low-income countries in Africa and other parts of Asia. We investigate through a large survey of firms in four sectors – home appliances, garments, footwear and toys – collectively employing about 16 million workers in China, and in which annual real wage rises ranged from 9% to 11% during 2005-2014.
We interviewed 640 firms, all ‘above-scale’ and exporting more than half of turnover. A cluster-based sampling strategy was used, since industrial clustering is crucial in Chinese manufacturing. The survey focussed on three cities (Guangzhou, Zhongshan and Dongguan) in the Pearl River Delta (PRD) and one (Ningbo) in the Yangtze River Delta (YRD). The survey sample is representative of all above-scale exporters in the four industries in the two regions: it included 13% of these firms, and one third of these firms in footwear and in toys and one fifth in home appliances, though only 7% in garments.
All 640 firms were privately owned but only 42% by domestic Chinese owners, while 52% were wholly owned foreign subsidiaries. Foreign ownership was especially high among firms in the PRD, and in footwear and toys, but relatively low in-home appliances.
Just over half the firms were small (fewer than 300 employees), and another third medium (300-1,000), with 15% large (above 1,000). Small firms were more prevalent in the YRD and in garments, but less common in footwear. Significantly, 91% of surveyed firms operated only a single plant. Two thirds of firms were original equipment manufacturers (OEM), 17% original design manufacturers (ODM) and 13% original brand manufacturers (OBM). OEM was much more common in garments, but in footwear ODM was more frequent and in-home appliances and toys OBM.
Annual real wage growth in the sample over 2014-2016 was very high, at 10.8%. Annual turnover growth during 2014-2016 averaged 6% for all firms, but was at only 0.1% in footwear versus 9.4% in home appliances. Nearly a third of footwear firms, and nearly a quarter of garment firms, had contracted their operations between 2014 and 2016.
Main challenges and responses in 2014-2016 according to sample firms
Rising wage costs were identified as the main challenge faced during 2014-2016 by 38% of firms, with another 40% rating it second or third. More than 40% of firms in garments, footwear and toys rated it top, but only 27% in home appliances, where 24% pointed to material input costs. A further 6% of all firms rated non-wage labour costs the top challenge, though this was at 13% in footwear, where 22% pointed to decreasing market demand as the top challenge.
‘Technology upgrading’ was firms’ most common response to their challenges – 31% of firms ranking it top and 54% in their top three responses. Tighter cost control over inputs and in production was next (top for 27% of firms), and changing product lines or expanding markets was third most common (24%).
In contrast, only 6% (36 firms) identified relocation of operations as their top response, with half of these preferring relocation abroad rather than within China. However, 14% of all footwear firms opted for relocation abroad. Only 8% of foreign-owned firms preferred relocation, but they were four times more likely to go for this than domestic-owned firms. These modest proportions may have been affected by the survey inevitably excluding firms that had already relocated in their entirety (within China or abroad), and by non-reporting of investment abroad undertaken by the parent company of the surveyed firm. Closing operations was the top response of 8% of all firms, but 17% of footwear firms.
Trends among firms that have invested or will invest abroad
We examined closely the 62 firms (10% of the sample) that indicated they had invested abroad in the past or planned to do so during the next three years. Findings on this small group should be treated with caution, but suggest outward investment is more likely if firms are large, foreign-owned, in footwear and located in the PRD. Southeast Asia remains a far more likely destination than Africa, where only three firms have invested to date (all in footwear in Ethiopia); only two indicated Africa was a preferred destination for planned foreign direct investment (FDI). Importantly, nearly three quarters of the firms first undertook FDI after 2010. For more than half of firms planning future FDI, low-cost labour was the primary factor in location choice, and for nearly half, major customers had the greatest influence over the location decision.
Conclusions and policy implications
In sum, Chinese LILM firms most often respond to the challenges of rising costs and tighter demand by means of adjustments in existing operations – upgrading technology, controlling costs, expanding markets or product ranges – rather than by establishing production operations in a new location. Large and foreign-owned firms are more likely to invest abroad: not surprisingly, they are more likely to have the necessary resources – management, business networks and finance – to bear the costs and demands of operating across multiple jurisdictions, while foreign-owned firms by definition already have experience of doing so. For small, single-plant OEM firms – the most common in LILM industries – establishing new production operations in a new location is a ‘collective action problem’, involving very substantial challenges unless other interdependent firms do the same, both large customers and small firms in the same cluster.
Footwear firms’ responses were clearly distinct from other sectors. Mechanisation in footwear may be less possible than in toys, but the larger size of footwear firms and their stronger ODM capabilities enable independent internationalisation more easily than in garments, where a high share of firms are small OEM producers. The survey confirms that the footwear industry in China is stagnating, and firms’ ongoing migration to Southeast Asia and to Africa.
Investment promotion by potential host countries or Chinese agencies should focus in the near term on large foreign-owned firms in the PRD, particularly in footwear. In the longer term, cluster-focused strategies are needed to support joint relocation by groups of firms. Large ‘anchor’ firms in clusters and global brand or retail corporations can facilitate the co-movement of groups of OEM suppliers, and promotion efforts with them are already beginning.
Greater emphasis should also be placed on attracting individual entrepreneurs who may close OEM operations in China, migrate and restart elsewhere. This group often faces significant personal and business barriers to entry in potential host countries. Though addressing large numbers of small potential entrants is burdensome for promotion agencies, mechanisms for economies of scale and scope within these agencies should be investigated.
To download the article, please click HERE
‘Chinese manufacturing may not be moving to Africa all that soon’, Quartz Africa, 5 December
‘China Light Industry Survey Report: Labor costs have become the number one challenge’, Shanghai Securities News, 5 December (in Mandarin)
‘China Light Industry Enterprises “Going Global” Survey: Nearly 30% of shoe companies have plans or have invested abroad’, 21st Century Business Herald, 6 December (in Mandarin)
‘Labor costs rose, 27% of China’s footwear companies surveyed to be “going out”‘, Yangcheng Evening News, 12 December
‘”Promote economic restructuring – China’s manufacturing enterprises to upgrade and go global research report” successfully released in Guangzhou’, Southern Network, 13 December
‘China’s manufacturing enterprises to upgrade and go out, research report released’, Guangming, 13 December