China’s declining manufactures

Recent reports have China’s manufacturing activity falling for 11 months in a row. With much of the world’s developed economies feeling the pinch of slowing or declining activity, orders for China’s exports reportedly fell the sharpest in 42 months, leading to significantly reduced production, piling stocks of unsold goods and declining jobs. From double-digit growth rates through much of the past decade, the Chinese economy’s growth fell to 7.6 percent in the second quarter, the lowest seen since the height of the global financial crisis in 2008-2009. Is the ongoing decline in Chinese manufacturing a temporary setback simply borne out of the world economic slowdown? Or is it a portent of the long anticipated “landing” of the erstwhile high-flying China economy? Analysts vary on their prognoses for the future of what had recently become the world’s second largest economy.

Most analyses tend to attribute the ongoing manufacturing decline in China to slow world demand. Having become the acknowledged “factory of the world” in the past decade or so, slowing or declining economies in the world’s richest consumption centers inevitably spell difficulties for China’s manufacturers. There is an implicit expectation here that eventual recovery in the major economies—particularly the United States, Europe and Japan—would restore Chinese manufacturing to its former growth track. The task at hand, then, is to stimulate domestic demand to fill the gap left by slow outside demand for the meantime.

To do this, government uses the standard textbook economic tools—monetary policy and fiscal policy—to induce greater domestic demand. The former entails getting more money to circulate in the economy through such measures as reducing interest rates on loans, and changing other rules on banks that influence their lending and investment behavior. The latter involves directly hiking government’s own spending, through state-owned firms among other means, thereby pumping more money into the domestic economy. Government can also reduce taxes, leaving more money in people’s hands to spend. The problem with doing any of the above measures is that more rapid price increases could be induced if done to excess. This is exactly what happened when Chinese authorities sought to counteract the external downward pressures of a declining world economy in 2008-2009. This time around, China has to do more careful fine-tuning of its monetary and fiscal interventions in order to walk the tightrope of inducing growth while maintaining price stability. The optimists expect that if China does things right, its economy could get back to its breakneck growth pace once the rest of the world economy “normalizes.”

Another school of thought sees the current fall in China’s manufacturing output as the start of a long-term and inevitable decline, induced by both massive imbalances in the Chinese economy and adverse demographic trends, both built up through the years. The first refers to the way China accumulated massive dollar reserves through a phenomenal export growth that way overshadowed its imports over the years. This was coupled with a foreign exchange policy seen by the Americans to have distorted the value of the Chinese currency at their expense. The inevitable market correction that is bound to happen could have cataclysmic effects on both the China and US economies, and with them, the rest of the global economy.

The other part of this doomsday story has to do with population trends leading to a society with too few workers to support its growing dependent population of retirees, along with children and youth. The projected outcome traces in large part to China’s decades-old one-child policy that has led to a generation of pampered “little emperors and empresses” who have little taste for factory work now that they are of working age. Going by this story, the cheap labor advantage that was China’s key to gaining manufacturing supremacy will reverse itself. I have written before of anecdotes told by Filipino businessmen who had invested in factory operations in China who are now being driven to relocate production operations back here at home due to the tightening labor markets there. Foreign investors in general now see the wisdom of either repatriating their production operations to their home countries, or shifting them out of China to other countries in Asia, especially Southeast Asia. The Asia Economic Institute observes that factories are being set up in other regions of Asia as companies and foreign investors seek to diversify their country risks, apart from minimizing costs of production.

But still other analysts don’t necessarily see China’s economy crashing as a result of all these, but merely undergoing a fundamental restructuring. Aaron Lo of KPMG sees the 15 to 20-percent annual increase in labor costs as forcing China to transition to greater levels of automation and innovation in manufacturing, as had happened before in Japan. He sees China moving up the value chain for manufacturing activities, with focus shifting to growth in quality, versus the past preoccupation with quantity growth.

In any case, the prognosis is for wider opportunities for our own manufacturing industries in the face of these expected long-term changes in China’s manufacturing sector. If we play our cards right, we can yet resume the industrialization that we missed in the last two decades, largely because China had swept the rug from under us and other similarly placed countries at the time. And with this would come our long-awaited breakout into sustained economic dynamism.

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