Dapeng CHEN: Research Fellow at the Chinese Academy of Macroeconomic Research. His research interests cover corporate finance, international finance, Belt and Road Initiative and free trade agreements.

With the largest manufacturing capacity and output, China is famed as the “World Factory” and is becoming an innovation-driven manufacturing power. Since 2010, the size of China’s manufacturing value added has ranked first in the world for 12 consecutive years, accounting for roughly 30% in the global total. China has the largest output of more than 40% of the 500 major industrial products. Moreover, as a shining point of high-quality development, high-tech manufacturing grows faster than the overall industrial sector, accounting for more than 15% in 2020. It took China several decades to achieve the level of industrialization that developed countries went through for centuries. How did China become the “World Factory”? This essay aims to unlock three important aspects of the secrets, which provide insights for the high-quality development of the manufacturing sector.

First, China fully utilizes and actively cultivates “dynamic comparative advantages”. At the beginning of the reform and opening-up, China took advantage of its low costs of labor and land as well as quality infrastructure to attract foreign investment and established international competitiveness in labor-intensive and certain capital-intensive industries. It’s worth noted that China’s opening up is characterized by a “progressive” process, with “pilot zones” set up to test and experiment new policies in order to promote openness while addressing potential risks. As a pioneer of attracting foreign investment, the Pearl River Delta area, where Guangzhou and Shenzhen locate, utilized an amount of US$ 20 billion  foreign capital during 1980-1993, of which manufacturing sector accounted for 70% with a majority in labor-intensive light industries such as electronics, garments, toys, metal and plastic products. The Pearl River Delta became a manufacturing base for Hong Kong, forming a “front shop, back factory” pattern. At the same time, China constantly cultivates new and dynamic comparative advantages by learning and innovating, which promotes industrial upgrading to attain higher status in the value-added hierarchy. Domestic companies keep learning from foreign-invested companies by joining their supply chains. For example, JMPT, a leading manufacturer of automotive components, was only a producer of toys and decorating candles when it was first set up. In 1988, when Volkswagen established production lines to assemble Santana cars in Shanghai and searched for local suppliers of automotive components, JMPT seized the opportunity to join the Santana supply chain. JMPT imported Germany-made equipment and machines to produce bumpers, with technological support from German experts. By 1997, JMPT had successfully transformed to a leading supplier of bumpers for Volkswagen, BMW, GM and Mercedes-Benz. During the process, domestic companies not only got access to advanced technologies and global market, but also developed new management philosophies and brand awareness.

Second, China establishes a policy framework where the government and the market join forces to promote business. On the one hand, market mechanisms are fully respected with fair competition and innovation-driven growth, which leads to the compatibility of top-down planning and incentives of market entities. China has steadily promoted the transformation of the state-owned sector and activated the vitality of the private sector, deepening the factor market reforms and removing all kinds of obstacles that lead to misallocation of resources. During the process, the spirit of entrepreneurship has been emphasized. The encouragement and protection of entrepreneurs, especially in the private sector, enhanced their motivations to enlarge investment, optimize operations and explore global markets. On the other hand, the government plays a supportive and instructive role in constructing reliable infrastructure, promoting industrial synergies, regulating market behaviors and controlling potential risks. For example, Chinese government invested heavily and pre-emptively in infrastructure and basic industries, as the slogan goes “first build roads to gain fortunes”. Since the founding of the People’s Republic of China in 1949, infrastructure and basic industries were regarded as the leading priority of national economic recovery. With the reform and opening up, infrastructure and basic industrial systems have been continuously improved, laying solid foundation for the fast growth of manufacturing industries. According to the Bureau of Statistics, from 1979 to 2007, investment in basic industries and infrastructure accounted for 38.4% of the total social investment during the same period, with an average annual growth rate of 19.9%, 4.2 percentage points higher than the average annual GDP growth rate. At the same time, the government endeavored to address all sorts of market inefficiencies and promote high-quality development of manufacturing industries, utilizing the institutional advantage of “accomplishing important missions with united powers”. For example, the foreign investment in manufacturing was the result of both market forces and government guidance. As a matter of fact, during 1979-1984, foreign investment in Guangzhou and Shenzhen was concentrated in hotels, tourism and entertainment facilities. These industries delivered fast and remarkable returns to foreign investors with relatively low requirements for capital investment and technological innovations. In 1986, the State Council announced “22 rules to attract foreign investment”, aiming to improve the business environment for manufacturing enterprises. Since 1992, Guangdong developed ambitions to boost manufacturing and endeavor to surpass “Four Asian Tigers” (The Republic of Korea, Singapore, Chinese regions of Taiwan and Hong Kong) in twenty years. Only then did foreign investors, mainly from Hong Kong, start to invest heavily in export-oriented factories in mainland China. Another example is that government-guaranteed loans provided JMPT with necessary funds to purchase German equipment when the firm decided to produce bumpers for Volkswagen. What’s more, China has maintained the stability of its economic and financial system through prudent macro-control measures. The government successfully mitigated risks associated with several shocks, both domestic and abroad, such as the bankruptcy waves of small SOEs in the 1990s, the pressure from banks’ non-performing loans around 2000, the negative impact of the 1998 Asian Financial Crisis and the 2008 Global Financial Crisis, which ensured the steady and healthy development of the manufacturing industry.

Third, China has pro-manufacturing endowments and a relatively favorable international environment. Abundant high-quality labor force is vital to China’s manufacturing boom. Since the reform and opening up, a large number of labors were released from the agricultural sector in the rural area into the manufacturing sector in towns and cities. Such “demographic dividend” means low labor cost for manufacturing enterprises. And labor force was of high quality, thanks to a set of actions to improve people’s health and education since 1949. As of 1982, life expectancy reached 68 years from 35 years in 1949 and illiteracy rate was reduced to 22.8% from 80%. Since the reform and opening up, the quality of labor force has been further improved, with “demographic dividend” transforming into “human resources dividend”. Moreover, public ownership of land facilitates the fast conversion of land usage, for example, from farming and residential land to manufacturing sites, which promotes efficient allocation of land resources. Moreover, for a long time, the prices of industrial land are significantly lower than that of residential and commercial land. Local governments compete with each other to attract investments with discounted land prices, reducing the land costs of manufacturing enterprises. At the same time, China enjoys a favorable international environment. The emergence of new technologies represented by information technology increases the degree of modularity in the production process, which means that different production links can now be completed at different locations before all these modules are integrated into final goods and delivered to end consumers. It enables vertical division of labor in the global supply chain and global value chain, helping China to fully take advantage of its low factor costs and dominate the manufacturing links. The deepening of globalization also provides an opportunity for China’s merging into the global market. After World War II, a series of bilateral and multilateral free trade agreements (FTAs) went into force, reducing the barriers of international trade and investment. With commitments to open its own market, Chinese manufactured goods found their way into the global market and “Made in China” became a symbol of “fine quality with bargain prices”.

Looking forward, with a new round of industrial revolution unfolding, China is sparing no efforts in seizing the new opportunity and optimizing the policy framework for restructuring the manufacturing sector. The experience of China’s manufacturing development may also provide useful insights for other emerging economies in the new era.