A Blog by Jonathan Low


Jan 2, 2015

Say Goodbye to Made in China? Chinese Government Encourages Its Firms to Outsource

Turnaround is fair play. Long the locus of other nation's low cost competitive dreams, China has decided that there's money to be made not just by doing the rest of the world's dirty work, but by sending some of its own production overseas. 

The Chinese government has begun to support and even encourage producers in certain industries to outsource production to other, lower cost countries.

While there is an element of 'man bites dog' in this development, the reality is that technology has changed the nature of competition. Chinese companies are realizing that to attain the quality and cost advantages they need to become global brands, they may be better off sending production to places like South Africa where the economic and political returns on providing investment and  jobs is greater than it is at home.

Chinese experience in other parts of Africa, where resentment of a 'Chinese-first' management style has led to discontent and even violence suggests that they have some learning to do about being a good business partner.

The country is keen on figuring this out because as it becomes more deeply integrated into the global economy, pressures at home as well as opportunities abroad are evolving in ways that make the wide, wide world a lot more enticing. JL

Adam Minter reports in Bloomberg:

China is keen to see its flagship firms become internationally competitive -- so much so, that it's willing to encourage forays abroad. Bankrolling such overseas expansions is a signal that China wants better returns -- in the form of profit and political influence -- on its considerable foreign exchange reserves
These are not the best of times to be one of China's massive, state-owned steel mills. The domestic economy is slowing, competition is increasing, and there's widespread disgust and impatience with the smog pouring out of their stacks. In short, their lucrative business model for the past three decades is slowly dying. So what’s a manager of a Chinese steel mill to do?
One surprisingly popular option is to bid China goodbye. In November, Hebei Iron & Steel Co Ltd, a provincial-owned company and China’s largest steelmaker by production, announced that it was moving 5 million tons of its annual production -- roughly 11 percent of the 45 million tons of steel it makes every year -- to South Africa. According to press reports, it won’t be going abroad alone. By 2023, Hebei Province -- China’s most polluted province -- plans to export 20 million tons of steel, 30 million tons of cement and 10 million weight boxes of glass capacity (a weight box equals roughly 50 kilograms) to points still not named.
At first glance, the export of excess industrial capacity wouldn’t appear to make much business sense. As Bloomberg News noted two weeks ago, Hebei Iron & Steel’s South African mill will be “equivalent to two-thirds of that nation’s output last year, and a third of continental Africa’s.” In other words, it's not clear there's much demand in these new locales for the Chinese steel giant's plentiful wares. Why, then, are they doing it?
The officials in Hebei Province who oversee the company may have felt they had no choice. First, they undoubtedly faced political pressure to reduce their environmental impact in China: reducing production of steel, cement and glass -- all highly polluting industries, especially in developing countries -- will have a direct impact on Xi Jinping’s pollution goals. (Starting in Hebei will have the added benefit of cleaning up polluted, neighboring Beijing.)
Second, Hebei may simply be at a loss as to how to scale back businesses that they recognize have become massively bloated. Officials in China’s construction-related industries clearly have too much capacity and too little demand. Back in September, I attended a speech in Beijing where a Vice-President of the China Iron & Steel Association announced that Chinese steel production capacity had grown by 200 million tons since the end of 2012, to reach 1.1 billion tons total. Much of that capacity isn’t used -- China is projected to manufacture around 750 million tons of steel this year.
The effect on domestic Chinese steel prices has been devastating. Consider the price in Shanghai for steel reinforcing bar (rebar), a key component to building everything from subways to residential high-rises: it's fallen twenty-nine percent this year. That drop was largely precipitated by China’s economic slowdown (and the slowest growth rate since 1990).
So where is the steel going in the absence of a strong domestic market? During the first 11 months of 2014, China exported 86 million tons of steel (almost equal to total U.S. production in 2013), up 47 percent over the same period in 2013. But the export market is hardly a sustainable bet in the long-term, especially at a time when the United States and other importing countries are erecting anti-dumping duties on Chinese steel.
For a company looking for growth over the long-term, and significant capital to invest, that really only leaves one choice: go global. In fact, the Chinese government has had a “go global” policy since the 1990s, whereby companies are encouraged to set up subsidiaries abroad, for the purpose of extracting raw materials and energy and -- to a lesser extent -- manufacture. But unlike in the past, when going global had served as a nice long-term goal, today's “going global” strategy has taken on urgency.
Indeed, on Wednesday, China’s ruling State Council announced that China will further promote “going global” by Chinese firms, including with financial assistance. As described by the State Council, the goals are two-fold. First, China is keen to see its flagship firms become internationally competitive -- so much so, that it's obviously willing to encourage even quixotic forays abroad. Second, bankrolling such overseas expansions is a signal that China wants better returns -- in the form of profit and political influence -- on its considerable foreign exchange reserves. Though Hebei Iron & Steel announced its South African plans two months before the State Council's announcement, it’s all but certain that it's benefiting from the promised subsidies.
Will it work? In the short-term, just by virtue of adding so much unneeded capacity to South Africa’s steel trade, Hebei Iron & Steel will likely create a smaller version of the saturated market that’s hurting it in Hebei. But just as China’s domestic steelmakers turned to exports when local markets weren’t generating sufficient demand, Hebei Iron & Steel will likely count on using its newly-built modern South African mill to meet demand in emerging Africa. To be sure, it’s hardly a safe bet. But so long as China appears incapable of fostering a climate in which companies want to invest, it might just be the best one available -- and one that other Chinese companies are also likely to soon embrace.


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