China Ramps Up

It's adding massive factory capacity in tech-intensive industries such as autos and electronics

The automotive world barely noticed, but a little bit of Chinese economic history transpired in late June at the Xinsha Port in Guangzhou. In a dockside ceremony replete with costumed dragon dancers, Honda Motor Corp. (HMC ) executives and Chinese officials celebrated the country's first full-scale export of cars made in China: 150 Jazz compacts bound for Europe. Guangzhou officials, who believe their booming city of 6.7 million is destined to become the nation's top auto hub, were thrilled. "From now on, high-quality autos made in Guangzhou will be shipped to more and more markets around the world," says Lin Yuanhe, the city's executive vice-mayor.

Officials in Changchun, Tianjin, Wuhan, and Shanghai are just as car-crazy. The mainland is in the grip of a massive capacity ramp-up by both global auto makers and rising domestic outfits, from Chery Automobile to Shanghai Automotive Industry Corp. Plenty have plans to export China-made vehicles some day. "Where will these cars go but to international markets?" asks Hai Wen, deputy director of the China Center for Economic Research in Beijing.

Get ready for the next industrial leap. For years, China has been the cheap assembly shop for the world's shoes, clothing, and microwave ovens. Now, it is laying the groundwork to become a global power in much more sophisticated, technology-intensive industries that also demand tons of capital. Billions of dollars are flowing into auto, steel, chemical, and high-tech electronics plants. Driving this massive spending push is voracious domestic demand for all manner of goods as well as a big shift by multinationals to manufacture in China. As a result, China is rapidly becoming more self-sufficient in key materials and components, and setting the stage to be a major exporter of high-end products. Here's where:


By 2008, Chinese passenger car capacity could reach 8.7 million vehicles annually -- double the number of expected buyers. Quality is increasing. At Honda's new $82 million export plant in Guangzhou, you'll see the same efficiency as at plants in Nagoya, Japan, or East Liberty, Ohio. Honda can crank out 50,000 1.2- and 1.4-liter versions of the Jazz compact, and there's plenty of unused land for expansion. At another jointly managed plant, where the Accord is produced, Honda officials were surprised to learn from in-house quality tests that the China-made version of the car is superior to the U.S.-manufactured model. The day is coming, declares Honda Senior Managing Director for China, Atsuyoshi Hyogo, when the Japanese auto maker "will use China as one of our export production bases" for global markets.


For the first time ever, the Chinese steel industry became a net exporter in 2004, and shipments of rolled steel vaulted 54% during the first half of this year. Asian steelmakers such as South Korea's INI Steel Co. and Tokyo Steel Manufacturing Co. have announced price cuts in response.

It's too early to tell whether China will become a major exporter. With investment in construction and highways soaring, China's needs for steel remain high. But even if China simply manages to satisfy its own steel needs, that has big implications. In stainless steel, for example, China has quadrupled its capacity since 2000. That has allowed the country to shrink its imports from 65% five years ago to 40% last year -- a worrying sign for big global steelmakers.


The same thing is going on in petrochemicals. China has 50 projects under way involving at least $1 billion in investment -- compared with just one in the U.S. today. Outside Shanghai, 5,600 workers are building a chemical complex a half-mile long for Germany's BASF and its Chinese partners in record time. Six other so-called crackers, built by Sinopec and other chemical companies, are expected to come on stream by 2010 -- an expansion that would push up China's annual ethylene capacity by 25% annually. China will still need to import the stuff, but it will be able to supply half of its needs in 2008, compared to one-third now.


China's chip industry is still in its infancy, but it is expanding rapidly. Consumer-electronics and telecom-equipment manufacturers are major buyers. Some 22 new silicon wafer fabrication plants are expected to be built by 2008. Fueled by this expansion, China's chip-design industry has grown nearly fivefold, to 450 companies, during the past five years. While China's fabs are still a generation or two behind those in the U.S., Taiwan, Japan, and Europe, they're good enough for chips in appliances and other consumer gear.


By any measure, China is a consumer-electronics giant. It's the leading producer of color TVs, cell phones, desktop PCs, and DVD players. Now the industry also is poised to dominate in high-end products. That means China also may emerge as a global innovator. The country boasts more than 350 million mobile-phone users -- the most in the world -- and will likely overtake the U.S. in broadband households this year. Beijing also aims to convert to digital TV faster than in the U.S. and Europe. This makes China a crucial test market for new electronics technologies and products of the future, and it means China will help shape global standards as well.

The impact on world prices? "Chinese factories will drag down the profitability of global industries," predicts UBS Securities Asia Ltd. (UBS ) analyst Joe Zhang. If history is a guide, China's exports also will surge. UBS predicts China's global trade surplus will quadruple this year, to $126 billion. That's on par with Japan, an economy almost three times as big. The Washington (D.C.)-based National Association of Manufacturers forecasts China's sensitive surplus with the U.S. will leap 35%, to $220 billion, this year.

That means as China charges into these more sophisticated industries, a whole new strata of Western industries will likely face a crossroads. They will have to move even more forcefully into higher-tech, higher-value materials and products -- or buy from China like everyone else.

By Brian Bremner and Pete Engardio, with Michael Arndt in Chicago

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