Foreign trade expansion has played a key role in spurring China’s economic growth since its economic liberalization in 1978. Initially, exports were concentrated in labour-intensive industries such as tex- tiles. In the 1990s, however, high-tech electronics exports became the most dynamic part of export growth. Between 1980 and 2000, electronics exports have grown by an average annual rate of 43 percent, almost three times as fast as total exports. In 2000, electronics exports were 28 percent of total exports. As a result, China has turned into one of the main traders of electronics prod- ucts, with a 4.5 percent share of global electronics exports in 2000.

China’s rapidly expanding export of electronics prod- ucts has instilled in many Western political and business leaders a growing fear that the country is turning into an economic superpower that is competitive not only in labour-intensive industries, but also in high-tech industries. This fear has been fuelled by the fact that in recent years several Chinese electronics ”œchampions” have successfully penetrated overseas markets and turned into global com- petitors. In consumer electronics, Haier has surged to become the world’s fourth-largest manufacturer of large household appliances. In the computer industry, Lenovo has made its name by purchasing IBM’s PC unit and becom- ing the first Chinese company to sponsor the Olympic Games. In the telecommunications equipment sector, Huawei and ZTE have emerged as plausible competitors to global leaders such as Cisco and Nortel.

China’s emergence as a global player in the electronics industry is often attributed to its proactive policy of stimu- lating inflows of capital and technology. To court foreign direct investment, for example, China has introduced tariff exemptions for imported materials used in the processing of exported goods. To induce technology transfer, China often grants foreign firms privileged access to the Chinese domes- tic market in exchange for the transfer of know-how to Chinese counterparts.

Recent studies seem to indicate that China’s proactive policies have been successful. Two leading American academics have provided empirical evidence that China’s exports indeed have become more sophisticated than one would expect from its level of development. Harvard University’s Dani Rodrik finds, for instance, that China’s exports are generally imported by countries with income levels three times higher than that of China. While China had a GDP per capita of US$4,726 in 2003, it exported the type of goods generally associated with countries with an income level of US$13,575. Rodrik concludes that ”œChina has managed to latch on to advanced, high productivity products that one would not normally expect a poor, labor abundant country like China to produce, let alone export.” Yale University’s Professor Peter Schott reaches a similar conclusion, saying that ”œChina’s export bundle increas- ingly overlaps with that of more devel- oped countries, rendering it more sophisticated than countries with sim- ilar endowments.”

A closer look at China’s electronics import and production data, however, shows that the rising sophistication of China’s exports does not mirror its electronics companies’ technological upgrading. China imports highly com- plex electronics components from abroad and uses low-skilled workers to assemble them in export goods. As such, the production activities of elec- tronics firms in China generally remain relatively unsophisticated.

In recent decades, non-Chinese (for- eign) electronics companies have relocated their assembly plants from other East Asian countries to China, thus turning China into a global assembly platform for electronics products such as computers, telecom- munications equipment and consumer electronics. These firms continue to rely on other East Asian countries as the primary source for their electronics components, which are now assem- bled in China. Once the assembly is completed, they export the final goods to Western countries. These trends are clearly reflected in China’s electronics trade (figure 1). In 2000, China had an electronics trade surplus of US$51.4 billion, largely due to the export of electronics final products to the United States, Canada, Japan and Western Europe. At the same time, China had electronics trade deficits with many Asian countries such as South Korea, Taiwan and the members of the Association of Southeast Asian Nations (ASEAN), largely due to the import of electronics components from these trade partners.

A large portion of the components that China imports from other East Asian countries are semiconductors and integrated circuits " that is, the most complex components in elec- tronics products. Indeed, as can be seen in table 1, China’s trade deficit in electronics components is almost entirely driven by the import of com- plex ”œactive components” such as semiconductors and integrated cir- cuits. The trade deficit in the less com- plex ”œpassive components” such as capacitors, resistors and printed circuit boards is much smaller.

Since China imports complex elec- tronics components, the value-added of electronics products manufacture domestically remains limited. Indeed, Nicholas Lardy from the Institute of International Economics estimates that the amount of value-added created in China’s electronics industry is as low as 15 percent of the value of exported electronic products. Most of the work performed in the electronics industry continues to be the low-skilled assem- bly of high-tech components brought in from the rest of East Asia.

A second reason why we should not worry about the rising sophistica- tion of China’s exports is that foreign firms are at the core of the electronics manufacture in that country. Chinese electronics companies heavily rely on technology and complex components provided by foreign firms. According to MIT’s Edward Steinfeld, Chinese comput- er giant Lenovo, for example, does not produce all of its complex components itself: it has teamed up with Microsoft to develop a tablet PC, incorporates IBM storage technology in its own storage products, employs IBM voice-recognition software in its pocket computers and uses Intel Pentium processors.Foreign enterprises also play an important and growing part in China’s electronics processing trade. Gaulier, Lemoine and Ünal-Kesenci find that in 2002, 76 percent of the value of China’s high-tech exports was con- ducted by firms with at least 25 per cent foreign ownership. On the import side, the share of foreign-invested enterprises was 67 percent.

The fact that the bulk of China’s electronics processing trade is handled by foreign enterprises provides a sec- ond piece of evidence against the hypothesis that Chinese firms are upgrading technologically. Indeed, the high foreign ownership share has hampered the dissemination of tech- nology to Chinese companies.

It is often overlooked that the domi- nant foreign players operating in China’s electronics processing trade are not Western and Japanese firms, but rather Taiwanese firms. In 2002, Taiwanese companies produced 47 per- cent of their value of electronic hard- ware in China. They are currently responsible for 60 percent of China’s electronics exports and they also play a dominant role in global electronics hardware production. In 2002, Taiwanese companies’ share of global production was 75 percent for mother- boards, 61 percent for notebook PCs, 61 percent for LCD monitors and 51 percent for CRT monitors (table 2).

This raises an impor- tant question: given that Taiwanese firms are such dominant players in the global production of elec- tronics hardware, should we fear the growing competitiveness of Taiwanese firms more than we should that of Chinese firms? To answer this question, we need to take into account the recent outsourc- ing trends in the global electronics industry. In the 1990s, the profit mar- gins that could be earned from manu- facturing electronics products were declining rapidly. As a result, leading electronics firms such as IBM, Apple, Cisco, Motorola and Dell decided to focus on their core competencies of design, marketing and supply chain management, while outsourcing their manufacturing capacity to specialized contract manufacturing firms.

They outsourced circuit board printing and final product assembly, pri- marily to globally operating North American contract manufacturing firms such as Celestica, Flextronics, Sanmina- SCI and Solectron. The production of notebook computers, however, was almost entirely outsourced to Taiwanese contract manufacturers such as Quanta, Compal, Hon Hai and Asustek. As a result, Taiwanese electronics companies now produce most of their output for leading Western and Japanese electron- ics firms, and only a limited share of their output for their own-brand prod- ucts. In 2003, 91 percent of the value of all electronics hardware produced by Taiwanese firms was manufactured for globally branded electronics multina- tionals such as HP/Compaq, Dell, Sony, Apple and IBM. Only 9 percent was for own-brand products, such as Acer and BenQ (figure 2).

There is evidence that many Chinese ”œchampions” conduct similar subcontracting work for leading Western electronics firms. Fortune mag- azine’s Jonathan Sprague, for example, identified that 98 percent of the refrig- erators that Haier sold to the US market in 2002 were subcontracted work for lead firms such as Electrolux, General Electric, Maytag and Whirlpool.

These examples indicate that even the ”œchampion” Taiwanese and Chinese electronics companies only represent a limited competitive threat against Western and Japanese electronics com- panies. In fact, a strong partnership and division of labour has emerged between Western and Japanese firms on the one hand, and Chinese and Taiwanese firms, on the other. Western and Japanese firms act as the designers and architects of electronics products, Taiwanese firms are the middlemen responsible for the hardware production and assembly, and China is the preferred location of assem- bly. The higher-value, proprietary aspects of the electronics products con- tinue to be controlled by Western and Japanese firms, and as long as that remains the case, the competitive threat of Taiwanese and Chinese companies will be limited.

Once all the evidence is taken into account, it becomes apparent that China’s trade and production patterns conform to standard trade predictions. China has a comparative advantage in the low-skilled, labour-intensive stages of production, while Western countries and Japan have a comparative advan- tage in the high-skilled, capital-intensive stages of production. In addition, Japanese and Western lead firms con- tinue to dominate the electronics industry. We should therefore continue to see our trade relations with China in that light, and we should tone down the rhetoric about China becoming a high-tech competitor.

At the same time, there is a great need for Western governments to con- tinue their efforts to provide an insti- tutional environment that is ripe for innovation, so that we can remain on the world technology frontier. This includes immigration policies that attract high-skilled workers, education policies to improve our education sys- tem, especially in the fields of mathe- matics and engineering, and general policies to upgrade our technological infrastructure.

 

This article draws from a pres- entation given at the conference ”œLe Québec face au géant chinois,” organized by CERIUM and HEC Montréal on March 17, 2006.