Workers in blue overalls and caps work in near-silence in a 24,000 square-meter clean-room in Shanghai’s Zhangjiang High-Tech Park. They are manufacturing assistants, or MAs, who work for Semiconductor Manufacturing International Corporation, better known as SMIC.
The workers are stationed at SMIC’s “mega-fab” in Pudong. Down the street are suitably high-tech neighbors like Lenovo, SAP and the maglev train to Shanghai’s international airport.
One of the products those blue-suited MAs are making are 0.18 micrometer memory chips. These are commonly embedded in identity or security cards to turn those documents into “smart cards.” A client for this product is STMicroelectronics, a European electronics giant with net revenues of US$10 billion last year.
In the cleanroom, workers wheel components for the memory chips from station to station on trolleys. Once the silicon wafers are etched, stripped and layered with aluminum, they are shipped to Malaysia to be assembled and tested.
The Malaysian government embeds these chips in the MyKad, the national identity card issued to every Malaysian over the age of 12. The MyKad can be used to store digitized photos and thumbprints of the cardholder, to hold credit for use on toll roads and more.
The transaction between SMIC and STMicro illustrates one part of the trade in intermediate goods between China, Southeast Asia and East Asia that was valued at US$655 billion in 2005, according to the Asian Development Bank (ADB). Economists have long noted that multinationals operating in the region are increasingly fragmenting their supply chains across countries, picking sites that offer the best advantages for certain stages of production.
Andy Weber, managing director of logistics firm Kuehne + Nagel in Asia, says the electronics sector is a prime example of fragmented supply chains. “China is well known as one of the fastest-growing manufacturing hubs for electronic components and finished articles,” he said.
A working paper published by Judith Dean, K.C. Fung and Zhi Wang attempted to quantify the degree of geographical fragmentation in Chinese trade.
The paper, published last January, found that more than a third of the value of China’s exports to the world consisted of imported intermediate goods.
“Imported intermediate inputs made up 35.9 cents of every dollar’s worth of Chinese exports to the world in 2002,” it said. According to the paper, nearly 60% of imported inputs came from Japan, Taiwan, South Korea and Southeast Asia.
Yet, even with supply chains split across national boundaries, the task of tracking products and their components is proving to be difficult. Companies without the financial muscle to build their own customized tracking systems may find a paucity of ready-made systems that are up to the task.
“I don’t think anybody, quite frankly, is tracking raw materials to finished goods, from a commercial goods standpoint,” said Dan Entac, CEO of Tradelink Technologies, a company that provides electronic tracking and inventory services.
“Even in supply chains, we handle 100 to 150 supply chains, let’s say, each one of them is slightly customized.”
Unlike semiconductor manufacturing, the apparel industry does not require high-tech processes and tools. However, it’s another example of the close trade links between China and Southeast Asia. Some shoe manufacturing, for example, has migrated from China to Vietnam because of lower costs – a textbook case of fragmentation – but China still has the edge in sectors like garment making.
According to Entac, apparel manufacturers consider two critical factors in setting up a manufacturing base: The cost of labor and the availability of raw materials. China has an abundant supply of both, giving it strong advantages over Southeast Asian challengers.
The Xinjiang region and Shandong and Henan provinces are the top producers of domestic cotton, accounting for nearly 4 million tons of the commodity in 2006, according to the US Department of Agriculture. This helped make China the world’s top cotton producer, ahead of the US, India and Pakistan.
China’s population and widespread rural-urban migration ensure that the supply of workers, too, is plentiful. According to research by Global Demographics, a consultancy, the proportion of China’s population living in urban areas rose from 32% in 1997 to 45% 10 years later. The total number of urban dwellers therefore rose from 398 million in 1997 to 582 million in 2007.
In recent years, however, the cost of labor has increased. The labor contract law, which came into effect this year, is emblematic of China’s rising labor costs. It discourages short-term contracts and makes it more difficult for employers to hire and fire workers in a variety of ways.
But China’s early lead has allowed it to stay ahead despite rising labor costs. For example, the scale of operations here and the relatively large supply of labor (Vietnam’s entire population, for example, is around 80 million – less than 14% of China’s urban population) means it can meet even large orders quickly. Speed is of the essence in the garment industry, with some retailers boasting of three-day supply-chains from the factory to store shelves worldwide, Entac said.
“The reason why China is still successful today is that [its manufacturers] can do ‘turns,’” he said. “That is, they can do quantities that a Bangladesh or Cambodia company cannot. You can get as much as you want, as quickly as you want, and you can get the inventory out of China.”
Process of evolution
China’s ability to stay ahead in the garment business may hint at a changing role in the trade triangle it shares with the region and the rich world, which consumes most of its exports. According to Brad Setser, a fellow at the Council on Foreign Relations in New York, the share of components being created in the country may be rising.
Setser says that in 2004, China’s trade surplus with the US and Europe was growing without a corresponding increase in its trade deficit with Asian countries, excluding Japan. This contributed to an increase in its current account balance, causing it to add more than US$100 billion a year to its trade surplus.
The reason for this disconnect, he suggests, is that China is producing more components and so importing fewer intermediate goods for final assembly.
“Something shifted,” he said. “A fair amount of anecdotal evidence suggests that what shifted was the capacity of mainland Chinese supply chains.”
If Setser’s inference is right, some of China’s Asian suppliers may be in trouble. Countries like Vietnam will likely benefit as they occupy the lower rungs of the value chain vacated by China, but others, like Thailand or Malaysia, may suffer.
“The high degree of complementarity between some of the component producers and China, with each specializing in a different stage of the supply chain, is likely to come under pressure,” he said.
The ADB, in its next annual outlook report for the region, is investigating the hypothesis that China’s supply chains have deepened to include more component manufacturing. Ted James, one of the economists working on the report, says if the hypothesis held up, it wouldn’t necessarily benefit China. While reducing intermediate goods would lower imports it would also expose the country to the vagaries of the final consumer – the G3 economies of the US, EU and Japan. Any downturn there would have a greater effect on China’s own economic wellbeing.
“China would take more of the full brunt of the blow in the drop in demand. [A G3 downturn] would affect not only China’s final assembly goods, but also all the producers who supply those final assembly goods. So the value-added at risk would be much higher,” James said.