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The World's Factory

Take a toy into your hands and, more likely than not, it will have a "Made in China" label. This is no surprise: China makes 7 of every 10 conventional toys sold in the world. That seems not to be a concern for the United States, which long ago conceded toy manufacturing to other economies, such as South Korea, Hong Kong, and Taiwan who, in turn, now have to contend with the new boy in town, China. U.S. toy giants such as Hasbro and Mattel remain competitive by moving production to low-cost locations while retaining design, development, and marketing skills in-house, under a powerful brand name. Toy manufacturing uses for the most part rudimentary technology, is not "strategic," and has no national security implications. The same is true for other labor-intensive industries, such as textiles that the United States exited, moved up market, or relied on immigrant labor to prolong its staying power.

China is no longer only about toys, however. Today, it is a major player in product lines that are still mass produced in America and Europe, such as home appliances, and China-made components are used extensively by the competition. The next phase will see subcontracting of entire operations, with the foreign firm maintaining oversight, branding, and marketing. When they export back, however, these established developed country firms will face competition from a new breed of Chinese manufacturers that export under their own brand name and in some instances set up for production on U.S. soil. China is also fast becoming a player in capital-intensive products, such as motor vehicles, as well as in technology-intensive lines, some of which, like flat-screen TV, have conceivable strategic use. Greater China now accounts for more than eight percent of global merchandise exports, with the mainland alone responsible for more than six percent. This may not seem much until you look at the growth curve: In 1996, the figure was less than three percent.

The shift toward China-based manufacturing is also underpinned by impressive advances in global supply chains. Driven by technological improvements and managerial efficiencies, the cost of logistics has been on a downward trend for two decades, and in some cases is down by two-thirds from its level a decade or two ago. The savings lower the cost of importation of finished goods and of components that travel back and forth between China and the United States (although volume increases have upped the cost of shipping from China). Savings also come from improved turnaround time, which is a crucial variable in customized products such as furniture, one of the fastest growing "Made in China" import categories. American imports of Chinese-made furniture and bedding have now exceeded $10 billion, up from less than $4 billion just two years ago.

The Export Imperative

China is still less reliant on exports than many other countries in Asia (such as Malaysia) and outside (such as Belgium), but its dependence is growing, and the export drive must continue for it to fund its growing imports of capital goods and production inputs and prevent a social and political time bomb from exploding, with unemployment serving as the trigger. Not only does China need to provide jobs to a huge cohort of young people, but it also must worry about the many millions still employed in money-losing state enterprises and the 100–200 million people who have left the countryside in search of work in urban areas and who would be the first to be affected by a serious economic downturn. Disaffected peasants have been a source of rebellion throughout Chinese history, and economic well-being is especially critical to a regime that has shed its ideological base and now relies on economic prosperity and nationalism as its sole sources of legitimacy.

Given the scale of its economy and its increased dominance in many product markets, the continuation of China's export drive will bring about commoditization of product markets that have previously relied on brand name and reputation for differentiation. With China as the cost leader, foreign manufacturers will have to meet or beat the Chinese "pricing floor" that rests not only on cheap labor and subsidies, but also on massive use of counterfeiting and piracy to circumvent development costs. This leaves industrialized country manufacturers with a limited range of options. The first option is to procure many if not most of the product's components and subassemblies from a Chinese producer, thus lowering the cost of the final product to the point of remaining competitive. This trend is already in full swing, with U.S. automotive firms sourcing billion of dollars in Chinese parts. The second option is to move operations to China to lower cost further as well as gain entry to the Chinese market. A third option is to find another production base, such as India or Mexico, that can meet or beat Chinese prices, but those locations rarely offer the combined benefits of a China base. A fourth option is to automate or otherwise increase productivity; however, in many traditional product lines, the most obvious productivity savings may have already been extracted; and, with key supporting industries exiting the market, it will be especially difficult to extend or even sustain productivity gains. Finally, firms faced with Chinese competition can shift from the fiercely competitive entry level into technology-intensive product lines, but they will find the steps leading up crowded by their counterparts who have had the same idea. Or, they can exit the business altogether, seeking to redeploy their resources into more promising endeavors.

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