Manufacturing Upgrading and Policy

Implications in Chinese Industry

Loren Brandt
University of Toronto

The views expressed in this paper are the views of the author(s) and do not necessarily reflect the views
or policies of the Asian Development Bank (ADB), or its Board of Directors or the governments they
represent. ADB does not guarantee the source, originality, accuracy, completeness or reliability of any
statement, information, data, finding, interpretation, advice, opinion, or view presented, nor does it make
any representation concerning the same.
 Several Big Questions
• What’s driving productivity and upgrading
behaviour in Chinese mfg?
• What have been the experience and lessons
from other successful (and not so successful)
economies, including those in Asia, in
sustaining upgrading?
• What does China need to do to ensure
continued growth?
 What we all probably agree on:
Policy of domestic market and institutional
reform combined with economic openness

– Facilitated transfer of technology and know-how

– Increased competition
– Enabled reallocation of capital and labor
– Improved governance
 More Debatable?
• Rate of productivity growth
• Sources of productivity growth
– Continuing firms
– Creative destruction
• Heterogeneity across firms and sectors
• Role of upgrading through exporting and parallels with Japan,
Korea and Taiwan, versus the role of the domestic market
• Links between the two
• Exact channels of upgrading
• Contribution/costs of domestic policy
• Lessons from international experience
 Total Factor Productivity Growth in Industry

14.00%

12.00%

10.00%

8.00%

6.00%

4.00%

2.00%

0.00%
1999 2000 2001 2002 2003 2004 2005 2006 2007

Source: Brandt, Van Biesebroeck and Zhang, 2009

 The Dynamics of Productivity Growth

Time Contribution to
Period Productivity Growth

Continuing Net Entry

Firms
China 1998-2007 33% 67%
US 1977-1987 74% 26%

Source: Brandt, Van Biesebroeck and Zhang, 2009

Significant Heterogeneity Across Sectors

5
4 3 Sector-level Mfg TFP Growth, 1998-2007
Density
2
1
0

-.4 -.2 0 .2 .4
Average TFP Growth
Are Resources being Allocated to the Most Efficient Firms?
The Forgotten Domestic Economy

Role of Manufacture Goods Produced and Sold Domestically

1.2

0.8
% of Total Mfg

Share of Gross Output

0.6
Share of Value Added

0.4

0.2

0
1985 1990 1995 2000 2005 2007
Year
China and the Global Wheel
Loader Market
 Vehicle Sales in China
12

10

8
Sales (Million)

Annual Sales

0
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Year
Contestability in the Domestic Market?
• Rapid growth of size of domestic market
• From the perspective of domestic firms,
sources of competition come from:
– Imports
– FIEs (Foreign-invested enterprises)
• Imports typically serve the high-end, and so
the key is often output by FIEs sold to the
domestic market , i.e. FIEs total sales less
exports
Source: Calculations based on 1995 and 2004 Industrial Census, and UNCOMTRADE data.
Shares in the Domestic Market
Heterogeneity across Sectors
 Heterogeneity within Sectors
Three segments within each sector: low, medium, high

High
High End Wheel-Loader
High-End Excavator

Mid-Range Wheel-Loader
Increasing Mid-Range Excavator
Price Quality

Low-End Excavator
Low-end Wheel-Loader
Low

Low High
Sophistication

Increasing Price
 Shifting Center of Gravity in the Chinese Car Market

Passenger Car production in China, 2000 Passenger Car Production in China, 2007

350000 1200000

300000 1000000

250000
800000
200000 JVs JVs
600000
150000 Chinese Car Production Chinese Car Producers

400000
100000

50000 200000

0 0
 Implications for FIEs: Intense Pressures for
Localization
• Can occur in a variety of ways
• Speed determined by OEMs
• Often greater scope for cost reductions than by
improving productivity
• Increasingly supported by localization of design
and development
• Shift from PRD (public relations development) to
genuine RD (research and development)
Sourcing Patterns of Auto OEMs in China
(average percentage by ownership of Tier 1 suppliers)

100

90

80

70

60
JV/WOFE
50
Domestic
40 Overseas

30

20

10

0
Non-Chinese OEM Chinese OEM All

Source: Firms Interviews, 2006

 5-year plan of a major JV OEM in China (2006)

• Reduce production costs by 40% through

– Increase local sourcing for parts and components
to 90-95%
– Increase local sourcing of tools, die and other
capital equipment
– Invest heavily in local R&D/product development
capabilities, and require suppliers to do the same
 Leveraging Competencies?

Global Assembler Domestic Assembler Aftermarket

Distributor
Global Tier 1 Tier 1
(Global or Domestic)

Domestic Firm
Domestic Tier 2 Tier 2

Suppliers
Tier 3 Tier 3

Tier 2 position provides Tier 1 position provides Large economies of scale

opportunity for process and opportunity for functional and stable market, but
product upgrading, but Tier 1 upgrading, but competition is margins are small.
restricts functional upgrading. intense.
Product Upgrading in Braking Systems

Anti-Lock Braking System

Disc Brake

Drum Brake
Functional Upgrading in Braking Systems
 Multiple Channels of Capability Building for
Domestic Firms
• Through interactions with other firms
– JVs with MNCS
– OEM-Supplier relationships
• From capital equipment suppliers
• Own R&D expenditure and external
collaborations (Jefferson et. al., 2009)
• Overseas acquisitions/mergers within China
• International consultants
• Through the market for top mgmt and RD personnel
– Chery (top mgmt from MNC)
– Sanyi (RD personnel)
 What is probably true:
• Upgrading driven by domestic competition as
well as through participation in export market
• Linkages between FIEs and domestic firms
important
• Enormous amount of dynamism, but messy
• Heterogeneity at the sector and firm level that
we need to know more about in order to
know what works, and what doesn’t
 What is Driving Heterogeneity at the
Sector Level?
• Maturity of the technology and fit with China’s evolving
comparative advantage
• Explicit government policy relating to:
– Entry, M&A, and competition
– FDI and ODI
– Effective Tariff Protection
– R&D
– Standards, e.g. telecommunications
• Distortions (Hsieh and Klenow, 2010)
– Credit markets
– Labor market regulations
– Local protectionism
• Low TFP in tertiary sector, especially ICT sector, and logistics
 Average Tariff Protection, 1992-2007
80
60
40
20
0

1992 1997 2002 2007

year

output tariff Effective rate of protection

input tariff
Dispersion in Effective Rate of Protection

.025
.02
.015
.01
.005
0

-25 0 25 50 75 100
Effective rate of protection

1995 2002
1998 2007
 Literatures to Link Up with:
• Experiences of Japan, Korea, Taiwan, as well as Brazil and Chile
– Amsden (1989), Wade (1990), etc

• New perspectives on role of Industrial Policy

– Rodrick (2007), Dosi et. al. (2008)

• New empirical work on productivity dynamics and impact of

government policies and institutions
– Aghion et. al (2005), Acemoglu (2005), Arnold, Nicolleti, and Scarpetta
(2010), Bartelsman, Haltiwanger and Scarletta (2009a, 2009b)
 Agenda for the Report
• Document better the heterogeneity we
observe across firms and sectors
• Try to identify forces driving these differences
and see if we can link to existing policy
• Link up with a number of related literatures
• Lessons and policy recommendations?