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Manufacturing in China - Foreign Investment Downtrend

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PostPosted: Tue Aug 08, 2006 6:24 pm    Post subject: Manufacturing in China - Foreign Investment Downtrend Reply with quote

Foreign investment in Chinese manufacturing sector experienced a downtrend, according to the Wall Street Journal.

We also saw this trend due to the following factors

1. Appreciation of Chinese currency (major factor)
2. Rise of costs of labor in China
3. Inability of allowing foreign companies to take over or merge Chinese companies
4. Competition from lower cost countries such as Vietnam

See the Wall Street Journal article below

China Loses Some Allure
As a Manufacturing Hub
Foreign Investment
Falls as Rapid Growth
Pushes Costs Higher
August 7, 2006; Page A4

BEIJING -- Foreign investment in China's manufacturing sector has started to slowly decline after years of strong gains, suggesting the country is losing some of its luster as a base for inexpensive production.

China has for years been one of the world's biggest recipients of foreign direct investment, money that has helped turn the country into the world's factory floor. Yet China's take of direct investment dropped slightly in 2005, excluding a series of one-time deals in the financial sector. After a 12% plunge in June, the figure is down a further 0.5% for the first half of 2006. Given that China's economy is continuing to expand at a rate of about 10% annually, the size of foreign investment as a proportion of the whole economy is shrinking even faster.

Total investment coming into the country remains huge -- roughly $60 billion a year -- a testament to how China has been able to diversify its industrial base and keep attracting new money. But even a flattening in the trend is striking, given the reputation China has developed as an irresistible magnet for foreign companies' money.

Many factors are at work. At this point, much of the manufacturing that can be profitably shifted to China has already moved, while the lowest-end production is starting to migrate away to less-expensive locations. And while multinationals' interest in China is broader than just export-driven manufacturing, the difficulty of buying domestic companies and the limits on foreign participation in service businesses are keeping those channels from becoming big new drivers of investment.

"China should think about how the country is going to position itself for the next 10 years," says Xiang Bing, dean of the Cheung Kong Graduate School of Business. "Multinational corporations won't put all their eggs in one basket. There are incentives for diversification."

Government officials say they aren't worried by a modest drop in investment, but acknowledge that some foreign companies are starting to look elsewhere as wages and land prices have risen. "It is possible that the costs for some foreign investors have increased," says Zheng Jingping, spokesman for the National Bureau of Statistics. "Other countries are also stepping up their efforts to attract foreign investment."

Foreign investment in Southeast Asian nations such as Malaysia and Indonesia is starting to pick up after languishing for years in the wake of the regional financial crisis of 1997-98. Even once-closed Vietnam has become a new hot spot for manufacturing, as it can offer even less-expensive conditions than China.

No one is predicting an exodus from China, as the country's huge domestic market and high-quality infrastructure continue to attract many businesses. But some entrepreneurs, like Wang Lih-hwa of Taiwan, have begun shifting operations abroad in search of more competitive prices. Ms. Wang and her husband, who run a food-ingredients business, opened a factory in the southern province of Guangdong in 1995.

At the time, the move helped them cut production costs by 50% from the level in Taiwan. But steadily rising wages have since eroded that advantage. So in 2004, she and her husband opened a factory in Vietnam, and it now accounts for 60% of the company's output. Ms. Wang expects average costs in their Vietnam operation this year to be at least 35% lower than in China, thanks chiefly to inexpensive labor and rent. "It was time for us to consider a new spot outside China to protect our company and maintain our slender profits," Ms. Wang says.

Taiwanese companies, which were among the first to recognize and exploit China's advantages in low-cost manufacturing, are now putting much of their new investment in other Asian countries. Thanks to big projects from the likes of petrochemical company Formosa Plastics Group and contract shoemaker Yue Yuen Industrial (Holdings) Ltd., the Taiwanese are now the biggest foreign investors in Vietnam.

In a way, China has become a victim of its own success. So much of the Asian electronics industry has already relocated to China that there is little left to move. And for other big investors, there are limits to how much more they can realistically put in.

Total investment from Japan, South Korea and Taiwan -- a group that has collectively been a bigger investor in China than either the U.S. or the European Union -- dropped 6.5% in 2005 and has plunged 31% in the first half of this year. Foreign direct investment into China from the U.S. has fallen every year since 2003, according to Chinese statistics. (Figures for foreign direct investment measure money that goes into building or buying businesses, not purchasing stocks or bonds.)

At this point, many Japanese companies have "more or less completed" their major manufacturing investments in China, says Tomoharu Washio, a Tokyo-based researcher at the Japan External Trade Organization. For instance, Honda Motor Co. in 2004 started investing to double its car-making capacity in China, but plans to complete the program this year. With the Japanese economy reviving, many companies are now focusing on adding to higher-end production capacity in their home market, Mr. Washio says.

Yet, stagnation or a small decline in foreign direct investment isn't necessarily bad news for China. At a time when the biggest worry is that the economy could be growing too fast and authorities are trying to slow down domestic investment, a reduction in foreign inflows is probably welcome. Less foreign investment could also trim the external imbalances that created pressure on China to push up the value of its currency, the yuan.

It wouldn't be hard for the government to attract even more foreign investment -- if its leaders really wanted to. A hint of investors' appetite for China was given by the recent sale of stakes in the major state-owned banks to overseas institutions, a program that drew an additional $12.1 billion in direct investment in 2005. But those landmark deals are unlikely to be repeated, and authorities are keeping limits on foreign investment in other key service sectors and have shown reluctance to approve some major acquisitions.

Optimists see in all this a welcome stimulus for Chinese companies to move out of low-cost production. "You don't want to be a place that can only attract low-end industries," says Nicholas Kwan, an economist with Standard Chartered Bank in Hong Kong. For foreign investment, he says, "Increasingly, the quality matters more than the quantity."
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