Photographer: Qilai Shen/Bloomberg

Sock City Playbook Copied as China Moves Up Value Chain

  • 'You can hear the footsteps' as Chinese competitors close in
  • Instead of Zhuji sock city, think the Wuxi photovoltaic hub

China is turning to an old formula to challenge the world in higher value-added manufacturing, posing an increasing threat to developed-nation competitors already forced to cope with a slowing global economy.

The template: clusters, or the concentration of multiple producers of the same type of product and their suppliers in one location. The advantages include creating a pool of specialized labor, strengthening competitiveness through the spread of new ideas and developments across rivals in one place, and economies of scale.

Clusters along the eastern seaboard helped China become the global leader in low-end manufacturing, such as with the sock city of Zhuji in eastern Jiangsu province to a shoe hub in Wenzhou in Zhejiang.

Now, new zones for more sophisticated products are gaining scale, from photovoltaic panels in Wuxi in Jiangsu to a pharmaceutical, biotechnology and medical hub in Shanghai, and a computer, semiconductor and information technology agglomeration in Chengdu in the western province of Sichuan. More is to come as President Xi Jinping’s "Made in China 2025" blueprint envisions global competitiveness within a decade in 10 industries from machine tools and robots to advanced railway equipment and medical devices.

Exports of high-technology products are rising

"Chinese competitors are coming and I think you can hear the footsteps," said Dante Rutstrom, a Shanghai-based senior executive at Eastman Chemical, which makes specialty chemicals and fibers that are used in everything from car tires and windscreens to medical devices. "It would be a huge mistake to underestimate the current state of innovation abilities in China."

Supply Chain

Already, the emergence of more advanced industrial clusters in China is helping spur the production of components at home instead of in other parts of Asia, according to HSBC Holdings Plc. The share of imported components in China’s exports has fallen from a peak of 60 percent in the mid-1990s to around 35 percent today, says Herald van der Linde, HSBC’s head of equity strategy in Hong Kong.

"The growth of advanced industrial clusters is at the center of China’s growing dominance across supply chains," said van der Linde. "Contrary to what many people believe, China is actually gaining competitiveness. We might underestimate the threat of this."

Almost 800 companies with total sales of about 10 billion yuan ($1.57 billion) have gathered in just one of at least three photovoltaic parks in Wuxi, according to the province’s official newspaper. The city has vowed to expedite the development of "strategic new industries" by stepping up policy support to help them expand 15 percent this year, according to it’s annual government work report. Photovoltaic cells enable the conversion of sunlight into electricity.

‘Aiming Higher’

"China is aiming higher in manufacturing upgrading," said Zhu Haibin, chief China economist at JPMorgan Chase & Co. in Hong Kong, referring to products including mobile phones and mechanical equipment. "In some areas we are already competing directly with South Korea, Taiwan and southern European countries such as Spain."

The progress China is making was reflected in October’s trade numbers, which showed exports of capital intensive, high-technology products recorded a double-digit rise even as overall shipments declined from a year earlier. Mobile phones rose 11.9 percent and integrated circuits 11.2 percent, according to Mizuho Securities Asia Ltd., while shipments of labor-intensive goods like garments and footwear fell.

The 2025 blueprint for manufacturing indicates "Made in China" will increasingly be "Innovated in China," says Citigroup Inc.

Low Cost

"China manufacturers are often viewed as low-cost industrial suppliers, but lacking in innovation and R&D prowess," wrote analysts led by Jason Sun in a recent report. "This view is increasingly dated. China in fact leads all emerging markets in both competitiveness and innovation."

China’s shift up the value chain is bad news for economies from Malaysia and Singapore in Southeast Asia to Taiwan and South Korea in the Northeast, says Chua Hak Bin, an economist at Bank of America Merrill Lynch in Singapore. Companies from industries including auto components in Thailand to hard disk drive makers in Malaysia are likely to feel more competitive pressure from China as clusters in higher valued-added industries gain momentum, said van der Linde at HSBC.

Fair Warning

It’s not like foreign competitors weren’t given ample warning. China stopped trying to hold on to many lower value-added industries just before the global financial crisis, instead prioritizing higher technology, said Perry Wong, managing director, research, at the Milken Institute in Santa Monica, California.

"Ten years ago they were already planning a huge upgrading," said Wong. "Foreign firms in China should have seen it coming around 2009 to 2010 or even earlier."

Overseas acquisitions also are spurring a more systematic transfer of know-how and expertise to China, according to AT Kearney Inc. In Germany alone, Chinese companies acquired 12 small- and medium-sized, highly specialized companies within the past two years, the advisory firm says.

Still, there’s no guarantee China will have the same success in industries like energy-saving vehicles and medical devices as it had in low-end ones from sneakers to socks.

While clusters are the birthplaces of successful innovation, top-down, policy-driven approaches to spurring it have largely failed, the McKinsey Global Institute wrote in a July report.

"The entrepreneurial culture, academic and business ecosystems, and the critical mass of talent that created Silicon Valley cannot be conjured by policy action," it said.

China has invested substantially in advanced manufacturing for 15 years and achieved notable success in sectors from telecommunications to high-speed rail and wind power, says Scott Kennedy, director of the Project on Chinese Business and Political Economy at the Center for Strategic & International Studies in Washington. But it has struggled to compete in industries from semiconductors, passenger cars and fiber optics to commercial aircraft, he said.

Mixed Record

"The overall record is highly mixed," he said. "China’s domestic environment for innovation is still quite poor, and they have a long way to go to turn it around."

China’s manufacturing sector is now in a serious slowdown because of dynamics including rapid wage gains and an aging population, said Xiao Geng, professor of finance and public policy at the University of Hong Kong.

"While the competitiveness of Chinese industry has been improving rapidly, the same is true of competitors from South Korea to Taiwan and Germany," he said. "China’s companies and governments, both central and local, need to work very hard to improve its current competitive position."

For foreign companies bracing for a new wave of competition from China, there is a silver lining. The leadership’s vision for restructuring the economy features boosting the role of consumption, one reason why wages have been climbing.

For foreign companies like Eastman Chemical, that could prove a boon.

"It’s an opportunity to go after the consumer and get our share of that growth," said Rutstrom. "Let the best technology win."

— With assistance by Enda Curran, and Kevin Hamlin

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