The Chinese Century -Part Two
Collective I.Q.
Look, China is the most exciting place in the world right now to be a manufacturer,'' says Mark Wall, president of the greater China region for G.E. Plastics. His operation sells the plastic pellets used to make everything from DVD's to building materials. Within two years G.E. will sell $1 billion in advanced materials, including plastics, in China. Wall, who came to China from G.E. Plastics, Brazil, describes a country in love with manufacturing like no other, where engineers come in excited and readily work long days. Where university students clamor to get into engineering and applied sciences. Like many American manufacturing executives in China, Wall talks about working in China with the delight that young computer whizzes felt when they found cool in Silicon Valley. There's no going to a cocktail party and then trying to talk around the fact that you make things in factories. Wall says he feels at home. He loves it. G.E. has every plan to capitalize on the local zeal for manufacturing. It recently opened a giant industrial research center in Shanghai, and by next year will it employ 1,200 people in its Chinese labs. The company has also set up scholarship programs at leading Chinese technical universities. It will have no shortage of good candidates.
The government is pouring resources into creating the world's largest army of industrialists. China has 17 million university and advanced vocational students (up more than threefold in five years), the majority of whom are in science and engineering. China will produce 325,000 engineers this year. That's five times as many as in the U.S., where the number of engineering graduates has been declining since the early 1980's. It is hard to imagine Americans' enthusiasm for engineering sinking lower. Forty percent of all students who enter universities on the engineering track change their minds.
The case for the ability of American industry to stay ahead of its international competition rests on the national gifts and resources that the U.S. devotes to innovation. Certainly, the confidence of big American companies like Motorola, General Motors and Intel, all of which have billion-dollar-plus stakes in China, is based on the brainpower they have at home. The research gap between the U.S. and China remains vast. In December, Washington authorized $3.7 billion to finance nanotechnology research, a sum the Chinese government cannot easily match within a scientific infrastructure that would itself take many more billions (and years) to build. Yet, when it comes to more mainstream, applied industrial development and innovation, the separation among Chinese, American and other multinational firms is beginning to narrow.
Last year, China spent $60 billion on research and development. The only countries that spent more were the U.S and Japan, which spent $282 billion and $104 billion respectively. But again, China forces you to do the math: China's engineers and scientists usually make between one-sixth and one-tenth what Americans do, which means that the wide gaps in financing do not necessarily result in equally wide gaps in manpower or results. The U.S. spent nearly five times what China did, but had less than two times as many researchers (1.3 million to 743,000).
For now, the emphasis in Chinese labs is weighted overwhelmingly toward the ''D'' side -- meaning training for technical employees and managers. Nevertheless, foreign companies are quickly moving to integrate their China-based labs into their global research operations. Motorola has 19 research labs in China that develop technology for both the local and global markets. Several of the company's most innovative recent phones were developed there for the Chinese market.
Motorola's newest research center is located 40 minutes from Chengdu, the capital of Sichuan, a province in southwestern China. Sichuan is slightly larger than California, but three times as populous. There are around 90 million people in the province, 43 universities and 1.2 million scientists and engineers. Sichuan's fragmented transportation system prevents Chengdu from rivaling the eastern powerhouses as a manufacturing center, but the city is promoting the advantage of its plentiful, relatively low-cost brain pool with its new research corridor, the West High-Tech Zone. And Motorola regards its building -- subsidized generously by the development zone -- as a world center for software engineering. The company now employs more than 150 developers there and has plans to add hundreds more. That will pit it against a growing number of the world's top research-driven enterprises taking advantage of Chengdu's largess: Intel, Ericsson, D-Link, Siemens, Alcatel, Mitsui & Company and Fuji Heavy Industries of Japan and more than 200 other firms in one of the area's special tech districts.
In all, foreign companies have been involved in establishing between 200 and 400 of their own research centers in China since 1990. China's People's Daily has reported that 400 of the world's transnational corporations have set up research and development projects in China. In part, tax incentives attract such financing. But the biggest incentive of all, of course, is access to China's consumers. The Chinese government knows that foreign tech companies can be coaxed into sharing technology and training in exchange for easier access to the Chinese marketplace. The World Trade Organization forbids formal bargains that demand international tech transfers, but it does not police winks and nudges.
The likely outcome of all this R.&D. investment in China? Even more overcapacity. Just as China's abundant unskilled workers feed the world more shoes and more gadgets than it needs -- or at least more than it can absorb without forcing prices down -- China's abundance of newly skilled industrialists threatens to swamp the world's most highly prized, high-tech markets. The Wall Street Journal reported earlier this year that in the past three years foreign investors have invested or pledged $15 billion to build 19 new semiconductor factories. China imports 80 percent of the semiconductor chips it needs, $19 billion worth, and the government has made it a point of national pride to end the country's dependence on foreigners. Industry observers seem to agree that China will be able to compete with the world's leading semiconductor makers in a decade, but even before that it may exert strong downward pressure on chip prices. Will there be a 2005 recession in the chip market? Morris Chang, the influential founder of Taiwan Semiconductor Manufacturing, the world's largest dedicated independent semiconductor foundry, asked an industry gathering last September. ''Yes, I think there will be,'' he said. And who will cause it? China, thanks to all the capacity it's building.
The China Price
hina now offers the world a labor supply with depth unlike anything ever seen. In a recent policy brief for the Carnegie Endowment for International Peace, Sandra Polaski, a former State Department special representative for international labor affairs, writes that to put things in perspective, ''if all U.S. jobs were moved to China, there would still be surplus labor in China.'' That fact highlights what is most sobering about China's booming economy: it can force down the value of work in any job that is at all transferable.
In American business this is called the ''China price.'' It is the price American suppliers to other American businesses have to match to keep their customers. It is the price at which Chinese manufacturers can deliver the same goods and services. Last November, the Chicago Federal Reserve Bank noted the complaints that ''automakers have reportedly been asking suppliers for the 'China price' on their purchases.'' It also observed that U.S. suppliers had been asked by their big customers to relocate production to China, or to find subcontractors there.
The bellwether of American industry may very well be its foundries. Casting is one of those unsexy industries that rarely get top mention in personal ads. But no amount of buzz could overstate its importance. Without metal casting, the United States would boast hardly any industry at all. The U.S. Energy Information Administration of the Department of Energy notes that more than 90 percent of all manufactured goods and capital equipment use metal castings, or are made with equipment that uses them.
The American casting industry is the world's largest, with more than $25 billion in annual sales. Nearly 3,000 foundries are spread across the country, and are especially concentrated in the Midwest. Most are small businesses, with fewer than 100 employees who, on average, outearn their counterparts everywhere else in the world. The metal-casting industry once had generous trade surpluses with the rest of the world, but imported castings have increased their share of the American market by 50 percent since the mid-1990's; they now have 15 percent of the market. Imports from China are growing at between 7 and 10 percent a year, and worldwide by volume China is now the top producer of castings. The effect has been severe pressure on American foundries, 140 of which closed their doors in 2002, the last year for which the American Foundry Society has figures.
Bob Schuemann is executive vice president and part owner of Signicast Corporation, a privately held casting business located at the edge of Hartford, Wis. Hartford is one of the state's many midsize towns whose roads are shared by farm tractors and semitrailer trucks making their way to the loading docks of manufacturers that since the 1970's have stayed competitive by migrating out of the urban Midwest and into the more economical countryside. Schuemann, like many, now lives under the sword of the China price. His company owns proprietary technology for producing metal machine parts with extremely high precision. Yet the network effect means that the company's fate is tied in part to the economic vitality of its business community. Wisconsin lost roughly 90,000 of the 2.8 million U.S. manufacturing jobs that disappeared over the last four years. Signicast survived with automation. Robots fill its factory, moving everything from thumb-size precision parts to the boxes in the warehouse. Workers are scarce. Walking through the plant is a lesson in how the hardware business has become a software business. The whole plant seems to be run by smart ghosts.
Even so, the company feels the gravity of China's growing influence in manufacturing. Schuemann says some of his corporate customers also want the company to make the move to China and have offered to help cover the costs of doing so. The company won't move. Schuemann fears the Chinese will usurp Signicast's processes and thus its strength. Schuemann knows too that his company's selling points evaporate quickly when overseas investment casters drastically undercut the price of its parts. ''We don't need to match the China price dollar for dollar,'' he says. ''If we stay within 20 percent of their price, our customers will stay with us.'' It's getting harder to keep them anyway, however. The company used to have livelier business with a big local power tool maker, but the customer moved production to China and found jerry-built substitutes for Signicast's high-quality parts. ''Our part was one sturdy piece, and their new one is two inferior pieces,'' Schuemann says. ''Theirs will break more easily, but it's a lot cheaper.''
The business cards of executives at Milwaukee Valve Company Ltd., located in Wuxi, a city of more than four million outside Shanghai, list the company's address at ''End of Guangrui Road.'' By the outward appearance of the trio of decades-old, corrugated-tin roofed industrial buildings that make up the small factory, ''end of the road'' might seem an apt description. Along the interior of a wall at the back of the factory yard is a pile of wooden kindling that is used to stoke the factory's large furnace when the local electric grid is out of power, which lately has been often. Inside one of the barns, the furnace's orange glow heats and dimly lights a shop that looks little different than that of a foundry early in the last century. Sandboxes with molten brass are assembled manually and set end to end in the black earth floor to cool.
While the method looks primitive -- the Chinese have been making castings for 2,500 years -- workers in Wuxi manage to produce quality castings comparable to those made in spiffier factories in the U.S., Europe and Japan. Milwaukee Valve is a family-owned company whose manufacturing is still anchored in the United States. Its management entered China 20 years ago, soon after economic liberalization began. The company's valves are critical components in pipelines used in many industries. A faulty valve produced by one of the company's Chinese suppliers several years ago nearly ended the relationship with China. But that mistake, according to the company's management, is what made this Chinese manufacturer a ''world-class operation.'' Engineers from both countries redesigned the valve and changed the production process. Since then, Milwaukee Valve has stationed five Chinese quality-control engineers as roving inspectors at all of its factories in China. Apply this learning-curve experience at the Wuxi plant to China's manufacturing economy generally, and you get a sense of how the country is moving up the manufacturing feeding chain so quickly. (Of course, no one would be interested in seeing the Chinese improve if the cost of high quality were not still a bargain.)
Out in front of the valve factory is another telling symbol of China's competitiveness. It is a small $2,000 truck, a circus car of a truck, and one of many quaint but operable models still turned out by China's state-owned vehicle factories. In the U.S., cheap trucks prone to failure and always in need of new parts would wreck production and delivery schedules by causing down time and burden bottom lines with $50-an-hour mechanic bills. But in China, mechanics can tend such cheap trucks the way pit crews tend Indy cars -- and for less than a dollar an hour. Chinese factories can take advantage of all sorts of machinery that is one, two or three generations past its usefulness in more expensive economies, because the Chinese can afford to run them and fix them. Thus China wrings further cost savings from the manufacturing process, and American companies are forced to go there to get them.
''First there was the wholesale price, then the retail price and now there is the China price, and it is very real,'' says Oded Shenkar, a professor at the Fisher College of Business at Ohio State University. Big manufacturers, Shenkar says, come into their American suppliers with the China price in hand and present ultimatums, often veiled, that the price be met.
The China Savings
o politician declares it. There is no Association of Big Box Store Customers beating the drum. But, as nearly any shopping trip in America will teach you, China saves American consumers enormous amounts of money.
The worry that Chinese producers are hurting American businesses and eliminating American jobs misrepresents the problem -- at least geographically. While the U.S. trade deficit with China is growing, most of the goods from China, between 60 and 75 percent of them, simply would have been imported in past years from other countries. Still, because the China price forces manufacturers the world over to drop their own prices, the jobs that have not moved have been shaken up all the same, in the U.S. and in other countries. In Mexico, for example, which has lost nearly half a million manufacturing jobs and 500 maquiladora manufacturers, workers earn four times what their Chinese counterparts do. So for Mexican factories to stay competitive, they must get by with fewer hands or smaller profits.
Americans who would demonize China also have a local problem: the China price is a boon to American consumers. Gary Hufbauer, a senior fellow at the Institute for International Economics, has done some rough math that shows how. ''From time immemorial,'' Hufbauer says, ''most American and Japanese businesses have been reluctant to move their manufacturing to new locales unless they can save at least 10 to 20 percent with the move.'' For the $152 billion worth of goods coming in from China last year, those savings have already been realized.
The multiplier effect on the rest of the world's manufacturers, however, dwarfs the savings that come directly from China. Hufbauer figures some $500 billion in goods come from countries that are China's low-wage competitors, and another $450 billion in goods come from China's American and Japanese competitors. That means savings on nearly a trillion dollars of goods. If the savings on that non-Chinese trillion dollars' worth of trade are just 3 to 5 percent, rather than the 20 percent the Chinese can deliver, Hufbauer calculates further savings starting at $500 for the average American household. And people who spend more, get more back. Have a drawer full of $3 T-shirts, a DVD player in every room, a Christmas tree annually encircled with piles of toys? You probably have tons more stuff -- and additional savings -- thanks to the China price.
This inexorable downward pressure on prices now shows up even when the prices of raw materials rise, costs that in the past were hurriedly passed on to consumers. The Chinese industrial boom has, for example, pushed up the cost of copper, aluminum, nickel, plastics and nearly every other important industrial commodity. Chinese demand has caused the price of steel to rise 20 percent this past spring. (China is now the world's top steel producer, by the way, while the U.K. has dropped out of the top 10.) Nevertheless, the price of cars, which reflect nearly the entire commodity index, has been weak. In April, cotton climbed to its highest price at this time of year in seven seasons, but the price of clothing declined.
American firms can find it hard to compete. ''China hits domestic U.S. manufacturers twice,'' Oded Shenkar says. ''They drive down the price of goods, but they drive up the price of raw materials. It's a wholly different environment.'' And yet it's a good one for Americans too.
The efficiencies forced on the market by Chinese factories also hold U.S. inflation in check. Lower inflation means the Federal Reserve can keep interest rates low, making money more freely available for investment in new and stronger industries. Chinese competition forces American businesses -- Signicast, for example -- to use capital as efficiently as possible. And to run their plants full tilt. And to find ways to save on labor costs. The Americans who lost manufacturing jobs over the last three years, and the millions more who are expected to see their white-collar jobs migrate overseas, may have not only China to blame, but also the very economic benefits that China has provided for them.
And that's to say nothing of what happens once the Chinese countryside, thinned of its oversupply of farmers, turns into efficient farms. Already the Chinese have their eyes on cash crops. Though it has only recently begun exporting apple juice, China already produces seven times as many apples as the U.S., enough to cause a depression in the price of apple juice worldwide. Whole apples for exports are individually wrapped by hand in a foam sock. Given the country's wealth of manual labor, it can assert dominance in crops that must be tended by hand.
In a stable China, where its great resource, its people, are allowed to work and spend money in a reasonably well functioning market economy, the growing place of China in a global economy cannot be legislated away with tariffs, quotas or tax incentives for struggling industries. China's strengths cannot be altered by changes in the value of its currency or by restricting the flow of foreign investment into the country. By having changed itself, China is changing the world.
That doesn't necessarily mean things will be worse for Americans as the century -- the Chinese century -- unfolds. Following World War II, the nations of Western Europe, Japan and the so-called tiger countries of Asia rose from the ruins, aided, not thwarted, by the strength of the American economy. In turn, those economic booms fed our own.
So perhaps we will be as Europe is to us today, and China will be our America.
Imagine Pekin, Ill., a few decades from now. It may, like innumerable small Chinese cities today, be accustomed to a stream of foreign business managers. Perhaps the regional boss for a Wanfeng Automotive dealership is there to be host of a ''dig to China contest'': the team that gets closest in 40 minutes might win one of the company's hot new red-and-gold Lucky 8 hybrid sports coupes, worth $4,000. As a promotion, Wal-Mart's new World Store is rolling prices back to 2004 levels for the day -- shoppers are grabbing the steaks and fish, whose prices Chinese consumers have driven up fourfold since then. Wal-Mart might have competition, however, perhaps from a new giant outpost of Homeworld, a Chinese retail giant that has learned to exploit its proximity to Chinese suppliers and beat Wal-Mart on price. A big event scheduled for the evening might get knowing smiles from the town's old-timers. The Foreign Devils, a high-school basketball team from Manhattan, a new suburb of Beijing, is due in for an exhibition game. Provided its flight, on an all new Chinese jumbo jet, arrives on time.
Ted C. Fishman, a contributing editor for Harper's Magazine, is writing a book about China's place in the world. This is his first cover article for The Times Magazine.
Copyright 2004 The New York Times Company |
