Originally appeared in the China Business Guide 2009

Published by the China Economic Review

by Bill Dodson

1. What is your outlook for manufacturers heading into 2009?
Manufacturers will be dealing in an even more dynamic global economic environment than in 2008. Though commodities traders are betting that economic recession in many Western countries will lead to less use of resources such as metals and oil – forcing prices for raw materials to two-year lows – it remains to be seen just when Western economies will move into recession and consumers reduce their buying patterns. China’s domestic market, however, will weather the global economic downtown, becoming more attractive to foreign producers that need to make up for slower demand globally by investing more in China.

Manufacturers in the renewable energies and food processing industries will see growth in the China domestic market. The Central Government will continue promote the renewable energies industry through subsidies and tax incentives. Meanwhile, recent crises involving domestic foodstuffs producers will bring tighter regulation and inspection routines, and a heightened awareness  of and opportunity for international brands.

2. What are some of their most pressing challenges?
Reducing the cost of operations will be of paramount importance to Western manufacturers that want to sell into the Chinese market. The bulk of Chinese manufacturers across industries are speeding up the value curve to capture markets in China that even five years ago would have seemed a wild dream to everyone. Meanwhile, Western companies are struggling with rising wages, constrained talent pools, requirements from home offices and increased competition from other Western companies and from domestic producers. Western companies will need to reduce their costs to levels domestic rivals are used to operating at while maintaining quality levels that make their international brands valuable to Chinese buyers.

3. Which government policies had the biggest impact on foreign manufacturers in China in 2008?
The new Enterprise Income Tax law and the new Labor Law implemented at the beginning of 2008 made investing in China as an export base less appealing than in the past. Now, mostly foreign investors that want to sell into the Chinese domestic market find it economically viable to invest in China from a taxation point of view. Also, companies “grandfathered” by the implementation find themselves racing to use up their tax treatments before 2010, when all preferential treatments for traditional manufacturing sectors will be phased out.

The new Labor Law made it difficult for all enterprises in China to fire under-performing employees without great penalty. Labor Law interpretation also exposes companies to greater to possible litigation from former staff. The new Labor Law increases costs to companies by forcing businesses to maintain staff that under perform. In leaner times, when companies need to survive downturns in business, costs of maintaining and firing under-performing or excess staff will be onerous.

4. What kind of regulation do you expect to see in the near future?
China national policy will tighten in the areas where industry and living standards meet: that means greater regulation and enforcement of environmental standards, and food and drug administration. Huge and deadly pollution and food scandals have embarrassed national and local governments in China into action lest they lose “the mandate of Heaven” – the permission of the people to administer their country.

In particular, the Central Government will continue to put greater attention to industries that are heavy water polluters along the east coast; Central and Western provinces are still open to such polluting businesses, as they are still starved for investment. Air pollution regulation will continue to be an issue as power generation from coal will predominate for the foreseeable future.

Food scandals will force a reorganization of government agencies such as the Food and Drug Administration and the Administration of Quality Supervision, Inspection and Quarantine (AQSIQ), bureaus that have direct responsibility for the testing, certification and enforcement of food quality in China. Stricter qualifications will be put in place for ensuring food safety and local government leaders will be held to more transparent requirements for food-related incidents.

5. Will the global economic crisis affect Beijing’s long-term plan for manufacturers?
The downtown in the global economy has accelerated Beijing’s long-term to move from low-margin manufacturing to higher value production and services. The loss of consumer markets abroad as well as a stronger currency compounded by increased material costs and rising salaries have all conspired to put exporters in traditional industries under great strain. The global downturn will accelerate the decline of traditional exporters in China by three to five years.

6. How did the industrial zone landscape change in 2008? What’s to come in 2009?
With the new Enterprise Income Tax law Economic Development Zones (EDZs) along the east coast had fewer tools with which to attract foreign investors. EDZs countered the loss by promoting the geographic and economic comparative advantages they each have with a mix of local city and county tax advantages. Meanwhile, EDZs in central and west China still have the nationally approved tax treatments as incentive to lure investors to their nascent regions.

7. Are low-end manufacturers leaving China for lower-cost destinations?
For almost two years now low-end manufacturers have been moving to southeast Asian countries and central China to reduce their costs of manufacturing. The cost of operating along the eastern seaboard with such slim margins has made production along the coast unaffordable for all but the most resourceful or well-captialized. However, many southeast Asian countries – such as Vietnam – will continue to suffer from hyper-inflation or political instability; while central China has the challenge of an immature production and logistics infrastructure that will continue to make life difficult for export-driven companies.

Copyright William R. Dodson, 2009