Hao Fengxia, Associate Professor of Tongji SEM

Source: Jiefang Daily

In recent years, the US, Germany, Japan, the UK and other countries have successively issued new industrial plans, and implemented the “re-industrialization” strategy to intensely promote the development of the manufacturing industry. For China, in the face of changing domestic and international situations, the traditional resource-driven or investment-driven development modes have encountered great challenges. How can we achieve breakthrough and move toward higher quality development?

Producing Employment Multiplier Effect

The development of manufacturing industry is the foundation of economic re-structuring. The more competitive the manufacturing enterprises are and the stronger organizational resources they have, the higher service output efficiency they will make.

Meanwhile, the development of manufacturing industry has a significant employment multiplier effect. In the early 1990s, China’s share of global manufacturing value addition was only 2.7%; after 2000, the share increased sharply, accounting for more than a quarter of the total in the year of 2016. In the same period, the total employment in the manufacturing industry increased from 40 million to 80 million.

Studies have shown that for every 10 jobs created in the manufacturing industry, four new jobs will be created. Of course, the magnitude of the multiplier effect varies from industry to industry, from region to region, and from stage to stage.

Manufacturing is the foundation for the emergence and growth of startups and service industries. The increase of productivity comes from two mechanisms, first, the internal restructuring and performance improvement of existing enterprises; second, excellent enterprises replacing existing ones with low efficiencies. The motivation of economic growth comes from market competition. If the manufacturing industry is not strong enough, manufacturing startups will not be able to emerge. The same is true for the service industry. The service industry accounts for a large proportion in the economic structure of developed countries, but this is achieved with the support of highly developed manufacturing industry. The knowledge economy proposed by developed countries is also backed by the strong foundation of their manufacturing industries.

The smiling curve is getting steeper and steeper

The transformation and upgrading of China’s manufacturing industry is not carried out in a closed environment, and it is necessary to pay close attention to changes in the global industrial value chain. In the past 10 years, there have been some vital changes in the global industry value chain:

The trade density of global value chain is decreasing. Trade density refers to the ratio of exports to outputs. In the past 10 years, the cross-border flow of products has decreased from the original 28.1% to 22.5%, and the rate of trade growth is slowing down. More and more emerging countries with increasing per capita income are demanding higher quantity and quality of local consumption, and are consuming more of their own products. The shift of the end market brings opportunities for Chinese companies to develop more designs and brands for the domestic market.

The added value of trade in services is growing. In the past 10 years, the growth rate of trade in services has accelerated, and the growth of intellectual property, telecommunications, IT and other industries is even two to three times as much as that of product industry. Despite the fact that the service industry in traditional trade statistics has been neglected seriously, the trade in services has created 1/3 of the added value in product trade. Moreover, R&D, engineering, sales, marketing, finance and human resources may all come into market in product forms. The boundary between product trade and service trade is increasingly blurred.

The level of knowledge intensity is increasingly higher, and the traditional smiling curve is getting steeper and steeper. The value-added gap between different links is being widened. The value of intangible assets such as R&D, brand, software, and intellectual property in the global industrial value chain is increasing, and value creation is shifting to both ends: one is moving to upstream activities, such as R&D and R&D design, and the other is moving to downstream activities, such as marketing and after-sales service.

According to the World Input-Output Database, the labor-intensive manufacturing industry fell from 55% in 2005 to 43% in 2017. On one hand, the wage level is rising in developing countries, and on the other hand, the application of automation and artificial intelligence is becoming a trend. As a result, the labor-intensive manufacturing industry has turned into a capital-intensive industry. The added value that intangible assets occupy in the global value chain has increased from about 5% to 13%, which also presents new requirements to the participation model of developing countries in the global value chain.

Not solely relying on low-wage strategy

Along with the globalization of trade and specialization of production division, more and more countries are participating in the vertical specialization system. However, the developed countries are still occupying the high end of the value chain. For “Made in China”, the development strategy should be adjusted accordingly, providing new momentum of high-quality development from a longer-term perspective.

The first step is to expand the market resources of local and developing countries, and seek re-balance of domestic and foreign markets.

Research by the Organization for Economic Co-operation and Development (OECD) shows that by 2025, the consumption of emerging market countries will account for 2/3 of global manufacturing products, which is mainly reflected in the fields of automobiles, construction, machinery, and luxury goods. Through the “Belt and Road Initiative”, China can take comparative advantage to form a regional division system, and achieve the leading capacity in industrial value chains of certain industries. Meanwhile, it can reduce domestic transaction costs and leverage local market resources.

The rapid development of China’s economy has also provided a huge market for countries all over the world. In 1995, developed economies exported only 3% of their products to China; in 2017, the number grew to 12%. Nearly half of the cars produced in Germany, the United States, Japan and other countries are sold in developing countries including China.

The second is to capture more added value through service.

Regardless of software design, intellectual property or sales, the value in manufacturing industry is increasingly coming from services. As a result, the sales cycle is shortened, the marginal revenue is increased, and more interaction with consumers can lead to better design concepts. Meanwhile, the business model is shifted from selling products to providing services, or from selling software to data analytics, providing service-based products through deep insights into customer needs.

The third is to improve the vertical integration of “Made in China” in the global value chain.

Since the reform and opening up, China has developed a relatively complete local value chain and vertically integrated industry structure, and local enterprises continue to enter new market segments. While building new advanced industrial production capacity, China is also steadily advancing the industrial modernization process and eliminating old factories.

First and foremost, benefiting from low wage level, companies that pursued high efficiency and low cost were relocating their factories to emerging new economies. However, when the factor endowment structure changes, developed countries such as Germany and the United States will start the way of manufacturing rejuvenation. Under the dual pressure, “Made in China” will not rely solely on the low-wage strategy. The advanced industrial base and the modernized industrial chain will become the inevitable way for the transformation and upgrading of the manufacturing industry.

In this regard, there are precedents in foreign countries. From the end of World War II to the 1970s, Germany, as a major manufacturing power in Europe, produced a large number of industrial manufactured goods. Starting from the 1980s, German manufacturing was facing new challenges. During this period, the advantages of low labor costs in Asia were obvious. The quality of products in Japan and South Korea was excellent, and the German manufacturing industry did not have the advantage of function and price.

Therefore, Germany adjusted its industrial structure based on its leading edge in technology, and consolidated its research and development capabilities by formulating industrial policies to achieve world-leading levels in the production of durable capital goods, such as mechanical products, large medical equipment, electrical and electrical products. At the same time, Germany gave up some manufacturing industries that were gradually losing competitive advantages, such as household consumer electronics and textiles. It is obvious that the structure of the German manufacturing industry has been changing all the time, but the pursuit of competitive advantages remains constant.

The fourth is to encourage the growth of technology-intensive startups.

Each startup enters the market as an extra competitor, and high-level start-ups directly threaten the dominance of existing companies. From the perspective of output markets, there is a positive correlation between market competition intensity and economic performance; from the perspective of input factors, new ventures need resources and will create additional demand for inputs such as labor and land resources. This additional demand will pose a threat to the profitability of existing enterprises. To maintain profitability, companies need to increase their productivity to offset the increased input cost. As a result, start-ups can effectively promote economic growth in the region.