Surge in Exports From China Gives a Jolt to Global Industry
The Wall Street Journal - October 10, 2002

By KARBY LEGGETT and PETER WONACOTT

When Philips Electronics NV began prospecting for opportunities in China in the early 1980s, the Dutch company adopted the hot strategy of the time: produce and sell locally to the Chinese market.

Back then, China was seen as a land of unlimited demand, and Philips dreamed of Chinese consumers snapping up its radios and electric irons by the millions. But it soon turned out that one of the big reasons Philips and other foreign companies loved China -- its low wages -- also meant that few Chinese workers could afford to buy the stuff they were making.

So Philips and a host of other foreign manufacturers hit on a new strategy: Keep the factories in China, but export most of the goods to the U.S. and elsewhere. Philips now operates 23 factories in China and exports nearly two-thirds of the roughly $5 billion in goods those plants produce each year.

Today, there are few things in the global marketplace that aren't made in China. Many foreign manufacturers find they must either produce in China or expand their purchases from China. The country has become the world's factory floor, with an output so massive and wide-ranging that it exerts deflationary pressure around the globe on everything from textiles to TVs, mobile phones to mushrooms. "China's rise as a manufacturing base is going to have the same kind of impact on the world that the industrialization of the U.S. had, perhaps even bigger," says Andy Xie, an economist with Morgan Stanley in Hong Kong.

Half of China's exports, which totaled $266.2 billion in 2001 and are on track to surpass that this year, now come from foreign manufacturers or their joint ventures in China. China is the world's fourth-largest industrial base, in terms of value of goods produced, behind the U.S., Japan and Germany. These days, China makes more than 50% of the cameras sold world-wide, 30% of the air conditioners and televisions, 25% of the washing machines, and nearly 20% of the refrigerators. A private Chinese company, Guangdong Galanz Enterprise Group Co., now accounts for 40% of all microwave ovens sold in Europe. The city of Wenzhou, in eastern China, sells 70% of the world's metal cigarette lighters.

China's entry into the World Trade Organization late last year accelerated the trend toward exports. By forcing down trade tariffs, WTO membership cuts production costs and removes obstacles to selling overseas. That is drawing more investment into China, funding new factories and leaving industry after industry groaning with overcapacity.

What's more, as the Chinese government relaxes its export rules, a new generation of nimble Chinese companies -- particularly private enterprises -- is beginning to focus on overseas sales as well. (The investment boom also is reviving an old economic nemesis: a real-estate bust. Please see article.)

China's growth as a production base has followed a consistent pattern: A new product is introduced, usually by a foreign company. Within months, numerous local Chinese manufacturers also start cranking it out. Prices slide and producers, both foreign and Chinese, start looking for new markets, increasingly overseas.

Helping drive this competitive cycle is the flood of foreign investment into China -- more than $600 billion during the past two decades -- and the introduction of modern manufacturing techniques. Foreign technology has powered productivity gains across the economy, and a nationwide entrepreneurial zeal has sprouted from the shambles of central planning. Low wages have slowed China's transition to a consumption-driven economy, but the pool of cheap labor remains deep, allowing companies to control costs and often to cut them dramatically.

Some of the foreign companies that have expanded their focus from the local Chinese market to exports include: General Electric Co., Toshiba Corp. of Japan, Siemens AG of Germany, Samsung Electronics Co. of South Korea and personal-computer maker Acer Inc. of Taiwan. General Motors Corp. is exporting family wagons from its $1.5 billion joint-venture factory in Shanghai to the Philippines and says it may also begin exporting minivans it makes in China to other areas in Asia.

Foreign investment in China is on pace to hit a record $50 billion this year. Motorola Inc. says its total investment in China will reach $10 billion within four years, up from $3.7 billion now. Toshiba is building one of the world's biggest laptop factories outside Hangzhou, with output next year projected at 750,000 units and growing to 2.4 million in 2004. The bulk of that is destined for export.

Feeling Effects

The U.S., the world's biggest market, feels the effects more than most. Since May, America's monthly imports from China have consistently outstripped those from Japan. After decades of exporting mostly low-end products, such as textiles and toys, China has moved into more sophisticated goods, such as computers and DVD players. In July, exports to the U.S. of China-made electronic products hit $1.2 billion, up 12.5% from the month before. China's high-tech exports to the U.S. are now growing faster than any other category of Chinese export, up 47% in the first seven months of this year from a year earlier.

Exports from China to the U.S. affect most industries. Televisions and audio equipment rose at a 13% annualized rate between 1998 and 2001 to $6 billion in 2001; tools and hardware were up at a 23% annual rate to more than $1.5 billion in 2001; sporting goods rose at a 16% rate to $2 billion. And as imports from China are rising, U.S. retail prices in many of these categories are falling. TV-set prices have declined on average by 9% each year since 1998, according to Labor Department data; tool prices have fallen 1% each year on average; sports-equipment prices have dropped at a 3% annual rate.

To be sure, other big changes in the global economy are driving prices down. The North American Free Trade Agreement and European economic integration have boosted the flow of goods around the world. Gains in technology have spurred productivity, helping damp prices. The slowdown in the U.S. economy has added to the global glut of goods. But China's export juggernaut is a leading source of deflationary pressure.

Maryjo Cohen, president of National Presto Industries, a manufacturer of pressure cookers, griddles and other kitchen appliances, feels China's deflationary forces firsthand at her office in Eau Claire, Wis. Between 1998 and 2001, total U.S. imports of household cooking appliances from China more than doubled to $640 million. In the process, retail prices for National Presto griddles have dropped to $29.99 from $49.99 in just three years. To keep costs low, Ms. Cohen decided last year to shut down plants in Mississippi and New Mexico and expand production in China. "We've had these plants for a very long time," she says. "It really hurts to say goodbye to them."

Boon for Consumers

Though the flood of cheap Chinese imports has translated into some lost jobs for U.S. workers who compete against Chinese manufacturers, it has been a boon for American consumers. Amatsia Salomon, who operates a New York limousine service, spent $48 at Home Depot on a combination ceiling fan and light fixture made in China. Mr. Salomon, 63 years old, says: "Years ago, we would say, 'Made in China, we don't want to buy it, because it's very cheap quality.' " Then he adds, "Today, this looks good ... and it's inexpensive."

In Japan, China's low-price exports are reinforcing deflation that has plagued Japan in recent years. Matsutake mushrooms, prized for their delicate aroma, used to be considered such a luxury that they appeared only in minuscule quantities in Japan, either sliced in soup or cooked in rice. But matsutake mushrooms grown in China under contract with Japanese companies for export cost a tenth of the price of Japanese-grown mushrooms and account for almost two-thirds of the matsutake mushrooms sold in Tokyo's biggest wholesale markets.

Competitive prices also forced Xerox and its Asian joint venture, Fuji Xerox Co., to refocus their energies on China's export market. In the mid-1980s, Xerox set up a factory in Shanghai to produce low-end photocopiers for sale in China. But it soon realized it had overestimated the market's potential and began exporting the machines. So attractive was the export market that in 1995 Fuji Xerox set up a new export-only factory in Shenzhen and struck deals to manufacture laser printers for giants such as International Business Machines Corp., Dell Corp. and Apple Computer Inc.

The auto industry is one of the best examples of the growing focus on new export industries. Honda Motor Co. is setting up the country's first export-focused auto factory as a joint venture with Guangzhou Auto Corp. and Dongfeng Motor Corp., China's second-largest auto maker. Nissan Motor Co. announced last month that it plans to spend about $1 billion to buy a 50% stake in Dongfeng Motor and begin mass production of a wide range of cars and trucks. The Japanese company said recently that the joint venture could be exporting in one to two years.

Ford Motor Co. announced last month that it plans to boost it purchases of auto parts in China to as much as $1 billion annually starting in mid-2003. GM has already purchased more than $1 billion in Chinese spare parts in the past five years, and says it plans to increase that figure in the years ahead.

Some of those orders are expected to go to Delphi Corp., GM's former parts unit, and Visteon Corp., Ford's former parts supplier, which both have huge operations in China. Delphi, since setting up in China in 1993, has invested about $400 million in nine joint ventures and two wholly owned operations making everything from car radios to air-conditioning systems and catalytic converters. Though it now exports about a third of what it produces in China, Delphi says it plans to raise that to 50%.

A rising player in auto parts is China-based Asian Strategic Investments Corp., a U.S.-funded investment company headed by former Wall Street banker Jack Perkowski. In the past decade, Asimco has acquired and revamped 15 auto-parts plants across China that now bid for manufacturing business around the world through Internet auctions. They often win contracts from U.S. auto-parts companies desperate to pare costs. Though exports accounted for just 20% of Asimco's $200 million in sales last year, Mr. Perkowski is convinced that will expand, as more auto-parts companies shift low-margin production to China and car manufacturers themselves buy parts from China to save money.

Spigot of Supply

For large U.S. retailers such as Target Corp. and Wal-Mart Stores Inc., China has become a huge spigot of supply. Wal-Mart has been buying goods in China to stock its stores for more than 20 years. About $10 billion in Chinese-made merchandise makes it to Wal-Mart stores every year, either directly from manufacturers in China or from other suppliers that tap sources in the country. In February, Wal-Mart set up a new independent sourcing unit, based in the southern city of Shenzhen, to buy directly from Chinese factories, with most of the goods going to the U.S., executives say.

General Electric, which posted sales in the local market of $1.6 billion last year, expects purchases from China -- both parts and finished goods -- to hit $5 billion annually within the next three years. The goods include GE-brand refrigerators made by independent Chinese manufacturers, and parts for GE's gas-turbine engines, used to generate electricity.

Philips has witnessed the unfolding of this massive factory floor since the company made the switch from local to overseas targets. Of 23 factories it operates, six are wholly owned and 17 are joint ventures.

The company still pursues the local market, where competition has forced Philips to adjust its strategy. Several years ago, David Chang, the 54-year-old head of Philips's China operations, was strolling through an electronics exhibition in Shenzhen when he was shocked by yet another round of price cuts in color TV sets. Growing numbers of these sets also were being exported. The result was a new partnership Philips formed with a major competitor, TCL Ltd., one of China's biggest TV makers, mainly for domestic sales.

But Philips still seeks to wring more exports from its China interests. Last month, the company broke ground on a $77 million factory that will make module displays, or screens, for notebook computers, monitors and televisions. The majority of the displays will be exported overseas -- inside a Philips electronics product. If the factory is successful, Philips says it may set up other such display plants in China and gradually shift the industry away from South Korea, where the screens are now made.

Ultimately, Philips says the goal is to turn China into a global supply base from which the company's products will be exported around the world. Last year, 20% of everything Philips made world-wide came from China, and executives say the figure is rising quickly. Several products, such as the drivers for CD and DVD players, are now made only in China.

-- Jon E. Hilsenrath and Miho Inada contributed to this article.