Climbing Up the Global Value Chain

The new growth model for Chinese manufacturers.

Leslie T. Chang, an Egypt-based journalist who brings the lives of ordinary Chinese factory girls to Westerners’ attention, impressed the world with her quote, “Just because a person spends her time making a piece of something does not mean that she becomes that — a piece of something.” Today, around 10mil young workers have left their home far behind to work in booming factories in Southern China. Under the surface of China’s spectacular industrial growth is concern for the harsh realities of life as a Chinese worker.

Foxconn City, where 40 percent of the world’s consumer electronics are assembled, has seen the suffering of Chinese workers who earn no more than $17 a day. For example, in 2010 Apple manufactured 90 percent of iPhone components offshore while capturing 58.5 percent (2010) of an iPhone value. In contrast, Chinese manufacturers earn only 1.8 percent, for little value is added on during the electronics assembly line.

As an economy highly dependent on exports, the increasing wages of domestic labor has reduced China’s cost advantages as a world factory. Analysis suggests that China will experience the lowest growth rate (7.5%) this year within the past 20 years, a phenomenon that does not favor the coming political transition. However, such economic downtown might even become a blessing for the whole country, where past growth was largely fueled by short-term investments in infrastructure and real estate. Concerning the rising salary as well as the environmental problems caused by energy-intensive fixed investments, the previous model is hardly sufficient to allow for sustainable economic growth in the long-run.

While it remains to be seen whether China’s new leaders are determined to make changes in their economic plans, a new growth model is already brewing, characterized by less dependency on low-end exports and more on high-end technology innovation and domestic consumption. Only in this way can Chinese manufacturers climb up the global value chain, earn a greater proportion of profits, and compensate more to local employees, who in the end will drive up the level of consumption with well-paid jobs.

Given the massive benefits associated with high value-added exports, why do Chinese companies limit themselves in the manufacturing, especially low-end manufacturing across the global supply chain?

While the availability of funds is never an issue in China, they seldom go into the pockets of real entrepreneurs. Overheated real estate markets have attracted vast volumes of hot money that could otherwise be invested on cultivating entrepreneurial organizations, developing innovative products, establishing international brands, and providing value-added services. Real estate as an investment opportunity is especially profitable and favorable among Chinese, where home ownership is deeply rooted in local culture. Nevertheless, an economy relying too much on fixed asset investments is difficult to sustain.

Additionally, even though more investments flow to innovation with hopes of shifting China toward a higher-tech economy, they would not end up in good returns without a well-developed legal system to support intellectual property rights. The copycat culture erodes innovators’ profit margins and provides entrepreneurs with fewer incentives to come up with something truly novel. The lack of trust that arises due to insufficient intellectual property protection discourages researchers and organizations to collaborate on innovative projects. The concept of Silicon Valley is therefore hardly applicable in China’s context.

The discussion of intellectual property protection leads to an unavoidable issue — juridical independence. Companies with strong government backers are less likely to be enforced by law in Chinese courts. On the contrary, real innovators with the best technology would be disadvantaged at pursuing their original ideas. Therefore, as long as the Chinese government keeps control over the courts, enforcement of intellectual property stays in the indefinite future.

In order to have a greater share of world trade in higher value products and to benefit from sustainable economic growth, the Chinese government has ambitiously initiated a national strategy in May 2012 to develop an innovation-driven economy by 2020. The new innovation policy tends to reduce funding for state-owned enterprises, which used to absorb most of the governmental R&D funds while achieving unsatisfactory results. Unfortunately, the feasibility of such a new policy is under serious doubt, as channeling innovation funds towards the private sector is at the expense of local government officials and heads of the state-owned enterprises. When private sector companies ask banks for loans to finance their new technology, they are in competition with politically connected state-owned enterprises asking for financial support on huge construction projects. Thus, to provide high-tech enterprises more financing opportunities, an open and efficient capital market is indeed necessary.

The role of government is only one part of the whole story. As long as Chinese companies continue to earn substantial profits owing to the large size and low cost of local labor market, they would not be less inclined to take riskier innovation projects that could lead to high-end export. Whenever funds are made available, entrepreneurs would rather choose to increase the scale, hire additional workers, and supply products of the same standard to the rest of the world. However, once these Chinese manufacturers can no longer reply on low value-added export to make a living in the global market, they would have to find a way out. In the end, innovation is not something that can be invented. It can be pushed by the government, but only when technological innovation becomes a necessity to survive will it eventually arrive.

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

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