Well-known stresses in the current model are becoming more apparent, including a downturn in total factor productivity, which is the vital, unmeasurable part of economic growth resulting from technological change and institutional efficiency. The transition will require difficult political reforms and an effective response to the competitive threat posed by advanced manufacturing, which is slowly tilting advantage back to the US in particular.
China’s attraction as a global manufacturing base has not worn off yet, but several developments are chipping it away. At home, these include rising labour costs and skills shortages, as well as discriminatory application of the policy of indigenous innovation, insecure intellectual property rights, weak rule of law and the stifling impact of state-owned entities on enterprise.
By contrast, the US is a clear leader in top-end manufacturing, the creation of “smart” companies and in intricate touchscreen technologies. Even more important will be its competitive advantage in new shale oil and gas extraction technologies, and in the development of so-called additive manufacturing, or 3D printing, which is set to change the way we think about manufacturing.
Additive manufacturing allows companies to produce locally and respond quickly to changes in demand, without holding large inventories. The advantages of flexibility and of proximity to one’s market and centres of technological excellence may then outweigh those of offshoring, and large-scale process manufacturing. These have made China the hub of global production, but its position is under threat.
Even if China matches advanced economies in additive manufacturing, it may no longer make sense for foreign companies to incur the cost of shipping raw materials and components in, and products out, over long distances. Shenzhen’s assembly lines, supply chains and economies of scale will be out; Silicon Valley’s knowhow, its integration of research and development with production, and its emphasis on marketing, sales and value extraction, will be in.
China’s competitive advantage in low labour costs is already being eroded; and its artificially low cost of capital and of borrowing will end if economic rebalancing is successful because of financial liberalisation.
“Reverse offshoring” will follow, because additive manufacturing lowers all costs of production, from capital, labour and other inputs to packaging and distribution. Companies will want production to be close to design and to customers. Quality-control, protection of intellectual property and “after service” such as consulting and maintenance – not China’s strengths – will be even more important.
China’s manufacturing strategies will have to get smarter. Its 13 per cent of global R&D spending and prowess in incremental process innovation will have to focus more on product innovation, management organisation and the fusion of new information, biological, and materials technologies. Its prominence in patent registrations masks weakness in indicators such as cited patents. Chinese scientists and engineers are prolific, but their work is often viewed as a triumph of quantity over sometimes dubious quality.
It may be hard to overcome these shortcomings, which are rooted in a tradition that has rewarded good administrators over freethinking innovators, and made it hard for individuals to exchange ideas. It has also discouraged the curiosity, critical spirit and collaborative approach that are the hallmarks of advanced manufacturing.
These problems will not retard Chinese innovation and technological competitiveness forever. But to adapt, China requires extensive political reform, more robust institutions and a tilt in the role of the state towards supporting enterprise. It will not be helped by the uncertainty over the nature of its downturn and the consequences of the leadership change.
The writer is an economist, consultant to UBS Investment Bank and author of ‘Uprising: Will Emerging Markets Shape or Shake the World Economy?’
