Further up the value chain

08. Jan 2019
  • China continues to move up the value chain;
  • China’s huge domestic market, established manufacturing base, and large pools of skilled labor make a ecosystem ripe for innovation;
  • China is taking the lead in new industries like electric cars, robotics and drones;
  • Trade tensions may arrest some export sales, but it will not stop China from innovating.

Upgrading: a long-term trend

With all the coverage of Made in China 2025, you would think the process of upgrading China’s manufacturing base had only just begun.

But China has been moving up the value chain for years, raising its share of global medium-to high-tech exports from 11% in 2005 to 20.3% in 20161, and dominating sectors like solar energy (photovoltaic) cells, LCD and LED products, and air conditioners. The hand of the government is undoubtedly prominent in this process: on the one hand, providing state subsidies and directed credit for upgrading firms while, on the other, withdrawing support for low-end manufacturers via tighter environmental regulations, higher minimum wages, and stricter control of export licenses.

Share of global medium-to high-tech exports (%), 2005-2016

Source: Bloomberg, CEIC, National Bureau of Statistics, November 11, 2018

China’s share of global exports (%), 2007 vs 2017

Source: Financial Times: China’s relentless export machine moves up the value chain, September 23, 2018

But government support is only one part of the story, because private companies are the ones driving the industrial upgrading trend. In part that is because they are embedded in an environment uniquely suited to innovation, for three main reasons:

  • A huge manufacturing ecosystem: Huge manufacturing hubs, including those in Guangdong, Fujian, and Zhejiang provinces, offer product developers the industrial capacity to develop ideas and bring them to market quickly, and at cheaper prices than in other international hubs.
  • A growing labor force of qualified workers: China had 4.7 million graduates in science, technology, engineering, and mathematics (STEM) subjects at the end of 20162, offering a workforce of people with the skills to develop and execute hi-tech products and services.
  • A large domestic market: China’s 1.3 billion population speaking a single dominant language constitutes a vast home market where new products have the potential to deliver huge revenues. 

R&D on the increase

And with this environment as a backdrop, Chinese companies are rapidly increasing R&D spending to develop future innovations, with the private sector in the lead – financing 83.2% of total R&D, compared to 16.8% from government sources, according to the OECD3.

In 2018, Chinese companies boosted R&D spending by 34% y-o-y in 2018, the fastest y-o-y increase seen globally.

And these investments mean China is taking the lead in many advanced manufacturing sectors, and three in particular stand out:

Estimated growth in R&D spending(YoY, %) 2018

Source: PwC: What the top innovators get right, November 2018

Electric vehicles

Elon Musk might dominate newsflow around electric vehicles (EV), but China is leading the world as both a production hub and a sales market.

China’s move into the EV industry began in 2009 with a multi-city policy experiment that supplied tax breaks to researchers and car makers, subsidies to EV buyers, and investment in critical infrastructure, like charging stations and production technology4.

Via this multi-year experiment, automakers in China developed the knowhow, capacity, and market infrastructure to support the roll-out of EV development. And that is one of the main reasons why Tesla, Volkswagen, BMW, and Ford have all ramped up China investments.

Importantly, the potential market for EVs in China is a major attractor. Rapid urbanization and government subsidy support are driving investments, but EV companies also see China as an important laboratory. The sheer size of the market offers huge potential data flows that can support the development of new technologies.

Electric cars: global production (’000s, 2017)

Source: ICCT Power Play white paper, May 2018

Global electric car sales (millions), 2018 (f)-2027 (f)

Source: Cairn Energy Research Advisors, September 1, 2018

Robotics

2016 marked a turning point for China’s robotics sector. In that year, total installed robots reached 340,000, overtaking the total installed in the US, and setting China up as the largest market for robots in the world.

China’s declining workforces, rising wages, and fierce competition for profits have pushed manufacturers to rapidly automate their operations.

But there’s still much room for growth because China only has 36 units per 10,000 workers, well behind the global average of 66, and 478 units per 10,000 workers in Korea, and 314 units in Japan5.

And China is seeing a massive increase of investment in robotics manufacturing capacity, with investments from not only domestic producers, but also major international manufacturers like ABB, Yaskawa, and Kawasaki, who are investing heavily in China.

China represents a double dividend for robotics manufacturers.

Firstly, it is a huge sales market that is growing rapidly and with big future growth prospects and, secondly, the market – with the world’s biggest amount of installed robots – is a huge potential source of data on operations that robot manufacturers can use to refine, develop, and improve their products. That is why Siemens has built its HQ for robot development in China.

Putting these factors together, the prospects for China’s development into a leader in robotics are looking very strong indeed, and that’s why industry bodies expect the supply of robotics systems from China to rise from 115,000 in 2017 to 210,000 by 2020, enough to take 40% of the global market6.

Installed robots: China, US, and Japan compared, 2015-2020 (f)

Source: International Federation of Robotics, September 2017

World supply of industrial robots, 2017-2020 (f)

Source: International Federation of Robotics, September 2017

Drones

Looking ahead, there are many industries where China will take the lead in the future, and the drone industry is one shining example of a high-tech industry that China dominates now.

DJI, a Shenzhen-based consumer drone manufacturer, has moved rapidly since its establishment in 2006 to grab an estimated 70%+ share of the global market at the end of 20177.

Based in the heart of Shenzhen, China’s innovation and manufacturing heartland, the company has rapidly brought innovative products to market and created a range of products including palm-sized models and drone swarms.

In part, DJI’s growth and that of the industry itself in China reflects the three key factors mentioned earlier – a well-integrated industrial base, a ready supply of qualified technicians, and a large domestic market.

Crucially, government support is a key catalyst, with China moving faster to allow drone testing sites and permit the use of drones for urban deliveries and civilian uses.

That is a key difference when compared internationally, and an important underlying factor why China is expected to continue dominating the global drone market in years to come.

Trade tariffs won’t stop innovation

Trade tensions do cloud the near-term outlook for China’s manufacturing sector, but looking long-term we remain confident that China’s industrial sector will still be able to not only grow but continue innovating and moving up the value chain, for four key reasons:

  • The US isn’t China’s only export market: other emerging markets, like those in Asia, the Middle East, Africa, as well as Japan and the European Union remain an important source of future growth.
  • The domestic market remains a huge prize: tariff headwinds will not dim the attraction of China’s fastgrowing domestic market, which represents a rich, proximate market with the potential for big revenues if you can get the right product into it.
  • Innovation doesn’t stop because of trade tariffs: China has an innovation advantage from its established manufacturing base, large market and qualified workforce, but it is also aggressively adapting its visa programs to attract more highly qualified workers, just at the time when the US is putting up restrictions.
  • Overseas companies still remain keen on China: regardless of trade tensions, overseas manufacturers are still expanding in China to access both domestic and regional markets. This influx of foreign capital, together with industry knowhow, means China is still well positioned to move up the value chain.

Inward FDI into China YTD (CNY billions), 2014-2018

Source: Bloomberg, November 1, 2018

The outlook for Chinese innovation

So while trade uncertainties muddy the short-term outlook, we are confident in the longer-term outlook for China to continue moving up the value chain and deliver innovations that will sustain growth over the next 10-15 years.

China has the right ingredients – a large domestic market, high-skilled workers, and its well-established industrial base – as well as necessary government support to develop new higher-value industries

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