China Rebalancing Won't Doom Region

China’s growth slowdown and economic rebalancing have sparked understandable concerns that the good times are over for Asia. The argument is straightforward: China’s neighbors piggy-backed on Chinese growth by becoming part of the China-centered global supply chain, manufacturing the components assembled in China and exported to the West.

Not only is Western demand growth anemic, but China is rebalancing its own economy, moving onto a lower growth path and shifting away from reliance on exports of low-value-added manufactures in favor of consumption-led growth. In the process China will pull the rug out from under Asia.

These concerns are unwarranted and based on an incomplete reading of the dynamics of China’s rebalancing. The process is likely to be positive overall for China’s regional trading partners. New opportunities will emerge for Asian manufacturers and consumer- and service-oriented firms as China becomes a source of regional final demand and of foreign direct investment, boosting its domestic consumption and seeking to enhance its international competitiveness and move into higher valued-added manufacturing.

China’s rebalancing is best understood as part of a broader process of regional industrial development now being accelerated by Beijing as it seeks to follow in the path of Japan and South Korea before. The government’s plans are based on labor-market reforms geared towards boosting incomes and consumption. Higher wages are designed to motivate firms to exit industries intensive in labor and raw materials and climb the value chain.

In addition, China is moving ahead with an industrial development model based on import substitution and national self-reliance with the aim of gaining market share in export markets for advanced equipment and heavy machinery.

This rebalancing process is well underway. Wages for blue-collar workers have risen by an average annual rate of 15 percent since 2008, and the government’s 12th Five-Year Plan (2011-15) calls for further wage hikes and new measures to boost consumption including income-tax reform and new social welfare schemes.

So the Chinese processing trade – in which electronics and machinery components from Taiwan, Singapore, Hong Kong and South Korea are imported by China, then processed or assembled for export to the rest of the world – has declined in importance. Chinese imports for processing trade as a share of total imports have fallen 10 percentage points to 22 percent between 2006 and 2012.

Beijing is also just starting to make progress in its push to move away from being the world’s factory floor and assembly hub to move up the value chain to produce and gain international market share in sophisticated products including heavy machinery and equipment, biotech, green energy, high-tech and next-generation IT.

Manufacturing investment is rising as Chinese firms move to both increase productivity and boost quality to compete in global markets. So far China has been successful in making rapid inroads into the global export market for heavy equipment and machinery. From a standing start 10 years ago Chinese bulldozers, for example, have almost caught up with Germany and UK in terms of global market share, and are eating into the market share of US, Japanese and Korean firms in emerging markets.

China’s neighbors confront two new sets of opportunities – helping China as it moves up the value chain, and picking up the slack as China moves away from low-value-added manufacturing. High-tech is a good example of the first opportunity. Although China may have successfully gained global market share in heavy equipment, it has a long way to go before it can do so in high-tech or IT. It needs help getting there. China must import or buy the high-tech capital goods and expertise needed to climb the value chain, and that benefits countries like South Korea and Taiwan, which have the technology and skills.

South Korea, in particular, is well positioned to meet Chinese demand for high-tech inputs, with its vertically integrated supply chains and emphasis on brand building rather than contract manufacturing. Korea and Taiwan stand to benefit as China attracts foreign firms to invest in the mainland and supply the capital equipment to help build domestic technological skills. Samsung’s US$7 billion investment in a NAND flash memory chip fabrication plant now under construction in Xian in western China – Samsung's largest such plant outside Korea – is a case in point.

In addition to importing skills and technologies it needs to start competing in global markets, China will also employ other strategies that benefit the regional economy. These include overseas direct investment and localization. Asian firms will benefit as China increases the use of overseas direct investment as another way of gaining technological and managerial expertise. And Chinese firms looking to tap international markets will find its Asian neighbors a useful steppingstone. Thailand, for example, will remain a hub of auto manufacturing and assembly because the cluster effect helps retain competitive advantage, but it also stands to benefit as Chinese automakers localize production and assembly there to better access the fast-growing Southeast Asian market.

China’s move away from low-value-added manufactures is a potential positive for low-wage countries such as Vietnam or Indonesia. As a result of the loss of export rebates, tougher environmental regulations and higher wages, the share of light manufactures – garments, footwear, furniture and more – in Chinese total exports has been falling steadily. So far, only the lowest rung of the value chain, manufacturing that does not rely on intricate supply chains or clusters such as footwear and textile production, is moving out of China. Anecdotal evidences suggests countries in Southeast Asia, such as Vietnam, Myanmar and Indonesia, are already benefiting from this trend and stand to gain more as Chinese labor costs continue to increase. The shift to a China-focused supply chain, to serve Chinese demand, as opposed to a developed country-focused one, will require more cooperation between China and its neighbors, both in terms of trade and investment, as well as corporate cross-pollination, as Korean firms in China, for example, seek to tap into the local market.

Finally, there’s the opportunity to satisfy Chinese demand for more sophisticated consumer goods. South Korea, and possibly Taiwan, could be a winner in feeding China’s appetite for high-quality branded consumer electronics like smartphones demanded by China’s increasingly empowered consumer base. Korean consumer-oriented firms like Hyundai and Samsung are well placed to tap into burgeoning Chinese consumer demand. Consumer services in Asia will benefit from higher Chinese consumer spending, potentially creating new opportunities for regional travel and leisure industries, for example. Japanese firms have an opportunity to tapping into Chinese consumer demand, though they’ll continue to be buffeted by waves of anti-Japanese sentiment and face increasingly tough competition from Korean firms. Japan will likely also benefit from increased technological cooperation with and investment from Chinese firms.

While the opportunities are there for the taking, it won’t be an easy ride. South Korean firms have the least adjustment to make to the new reality. Taiwan must reorient away from component manufacturing to find ways to cooperate with Chinese firms and improve branding to tap into Chinese final demand. Asian countries with low-cost manufacturing bases, such as Indonesia and Vietnam, must invest in infrastructure and improve their business environment to capitalize on the chance to capture low value-added manufacturing starting to leave China. But these are changes that these countries would have to make in any case to sustain growth and remain competitive. China is giving them an incentive to do so sooner rather than later. And that can only be positive all around.

(Deepak Gopinath is global markets director of emerging markets research and consulting, Trusted Sources. This is reprinted with permission from theYale Center for the Study of Globalization.)