Jan has more than 10 years of experience in industrial automation and manufacturing research. Jan is leading Interact Analysis’ APAC operations and is also research director for our industrial automation and robotics research.
Part 1 – What has been driving the recent growth in China’s manufacturing sector?
In this first of two analyst insights examining the China manufacturing sector, we explain the factors behind the resurgence in growth of the world’s second largest economy and manufacturing powerhouse.
In recent years, China’s economy has gone through significant changes; most notable is the slowdown in the country’s GDP growth since 2010. Real GDP growth decelerated from 10.6% in 2010 to 6.7% in 2016. At the same time, China’s economic structure also underwent a notable adjustment and change, with tertiary industries¹ gradually increasing share. These changes, coupled with the declining investment in fixed assets, led to an overall downturn in the manufacturing industry during this period.
However, after years of effort to cut overcapacity leading to a general restructuring of industry, manufacturing began to recover in the second half of 2016. Since then, impressive and encouraging results by the industry continue to be seen.
The recovery started with a significant rebound in demand for construction machinery – often regarded as a bellwether for the manufacturing industry in China. The construction machinery industry thrived during 2006-2011, with annual sales surging from 180,000 units to 440,000 – a CAGR of 19%, but then overheating in 2010-2011 following a government stimulus package estimated at 4 trillion yuan (~$570 billion). Between 2011 and 2015, sales slumped to a 10-year low of 120,000 units, but finally resumed growth again in 2016. Sales of excavators is a good example to illustrate the dramatic ups and downs of the construction machinery industry. It is predicted that the sales of excavators will rise more than 70% in 2017 and the outlook remains very positive going forward.
The initial uptick in construction demand provided evidence of an overall recovery for fixed asset investments, which triggered demand for energy, steel and chemical products. Heavy industries followed quickly afterwards including heavy machinery (e.g. mining machinery), metal processing and machine tools. Strong growth was observed in these industries towards the end of 2016 and continued into 2017. Since then, China has continued to experience high growth for manufacturing throughout 2017 and the outlook in general seems promising.
Is China’s Manufacturing Industry Entering a New Growth Cycle?
For those of us who have experienced the market ups and downs of the past few years, we are somewhat cautious about the future growth of China’s manufacturing industry. To understand the scope and longevity of this latest growth cycle we need to understand:
- What are the key drivers behind the current rapid growth of China’s manufacturing industry?
- Is this growth sustainable and what is the fundamental advantage for China’s manufacturing industry versus other regions?
We will address the first question here, with our second insight to be published very soon addressing the second one.
Industry upgrade and restructure has been discussed for many years; China has ambitions to move higher up the value-chain, transforming from low-end processors into high-end manufacturers with higher value-added products, generating higher profits and revenues. When this was first put forward by the Chinese government, many agreed that it was the right direction for China’s manufacturing industry, but how? Especially for a country with an industry of such enormous scale.
Yet this transformation is now occurring, and at a rapid pace. What has enabled the transformation to happen so quickly is a multitude of factors, including cutting of overcapacity, implementation of supply-side structural reforms, industry integration and consolidation, introduction of environmental policies, product quality upgrades, and improvements to production efficiency.
Traditional industries, such as coal, power generation, chemical production, pulp & paper production, metals production and cement production, were first impacted and suffered during this transformation. After several years of capacity investment and scale expansion before 2011, most of these industries saw the problem of overcapacity, which caused very low efficiency in capacity utilization and low profitability, followed by debt and employment problems.
Since 2015, supply-side reform efforts have been strengthened. Government intervention and market regulation have limited production and shut down some of the excess production capacity. In addition, consolidation and restructuring of enterprises in these traditional industries have taken place. From 2016 onwards, environmental policy has had a further impact on capacity cuts and industry consolidation. And enforcement of safety and environmental protection policies this year is even higher than in previous years. The supply has therefore been tightening, which has led to a rise in commodity prices in general this year. From a short-term perspective, it has been pushing up the overall cost of the industry, but in the long run, it will benefit enterprises that have already embraced these environmental protection policies.
All these efforts have led to hard won achievements for traditional industries, resulting in improvements in capacity utilization and profitability.
Alongside these efforts for traditional industries, industry structure adjustment is taking place. The share of Fixed Asset Investment (FAI)² in China’s manufacturing industries reflects this change. In 2007, FAI mainly flowed to labor and capital-intensive industries, such as basic metal production, chemicals, processing of petroleum and textile, whilst in 2015, multi-industry machinery and dedicated machinery, metal products and non-metallic product industries now account for much larger shares of total FAI than eight years ago, while that of petroleum processing, chemicals and basic metal production industries shrank significantly.
You could argue that most of the above are a result of government intervention; however, if one looks at certain emerging industries in China and how they’ve been through their own transformation, another part to the story can be seen. Take electronics manufacturing as an example, where China is now the world’s second largest consumer electronics market and the largest telecom equipment market. Compared to traditional industries, this industry has been facing another problem that is impacting its profit margin: rising labor costs in China. As the world’s biggest manufacturing base, China had been enjoying its high demographic dividend and relying on low labor costs until 2011 (note: the National Bureau of Statistics announced that the number of available workers declined by 3.45 million in 2012, which was the first time this has happened in China; the country’s “demographic dividend” that it enjoyed in recent decades, which kept wages low and saving rates high, is diminishing gradually). Wage costs rose to a level where many small and medium-sized companies, which already had very slim margins, could not afford the wage cost increases anymore and had to shut down factories.
To change or to die, manufacturers in the electronics manufacturing industry have been forced to take measures to move up the value chain:
- Despite the low margins, they’re still willing to invest in automation to combat increasing labor costs. This may not necessarily be for brand new production lines, but instead just the upgrade of even one part of an existing production process.
- This has clearly impacted the industrial robot market. Whilst automotive used to be the dominant end-market for robots, penetration in the electronics industry – especially the 3C (consumer, computing and communications) industries – is growing rapidly due to the requirement for automation from this industry. Improvement in efficiency has become the key rather than cost.
- Increasing R&D investment, seizing opportunities to upgrade and increase their products’ added value. Gradually, transforming from a pure product or component supplier into a solution provider.
- Focusing on the local Chinese market initially to become a leading player, then expanding to other business areas or overseas. A successful company in China that won through the intense competition in its own electronic industry is likely to find its products accepted by users in other parts of the world. This was not always the case.
We’re seeing similar trends in other industry sectors such as dedicated machinery, textiles, transportation, and new energy. Doing all the above has helped many companies to build a strong brand in the local China market and several of these large Chinese companies have started to gain good penetration into the global market.
Now that we have provided some perspective around the first of our earlier questions, our next article (which will be released shortly) will attempt to answer the second question: is this growth sustainable and what is the fundamental advantage of China’s manufacturing industry versus other regions?
¹ Primary industry - agriculture (including farming, forestry, animal husbandry and fishery). Secondary industry - industry (including mining and quarrying, manufacturing, production and supply of electricity, water and gas) and construction. Tertiary industry - all other industries not included in primary or secondary industry. ² Fixed Assets Investment (FAI) - Amount of investment in fixed assets refers to the volume of activities in construction and purchases of fixed assets in monetary terms. It is a comprehensive indicator which shows the size, pace, proportional relations and use orientation of the investment in fixed assets. According to China’s current management system, the investment in fixed assets in the whole country is classified into the following four parts: investment in capital construction, investment in innovation, investment in real estate development and other investment in fixed assets. ³ This analysis is extracted from our Manufacturing Industry Output Tracker. We create estimates, aggregates and forecasts from this source data. For China data, National Bureau of Statistics of China, and the China Industrial Yearbook is our primary source.
The above analysis is taken from a new Interact Analysis report – “Manufacturing Industry Output Tracker” – which will be publishing shortly.