Trading With a Low-Wage Tiger

When Robert Mao describes the fantastic manufacturing opportunities his company sees in China, he speaks with mixed feelings. "For the first time in the modern era," he marvels, "we have an inexhaustible reservoir of good, trainable labor." But Mao, who as president and CEO of Nortel Networks China has worked in the region for 20 years, also worries about what that means for China's neighbors. For the foreseeable future, he says, almost all new investment by Nortel suppliers will go to China and not to other Asian countries. So, too, he expects, will most major investments by other global manufacturers. "What can Taiwan, Malaysia and the Philippines do?" he asks. "They offer pretty much the same degree of technological sophistication as China but they are more expensive and lack the scale. What will they do?"

His concern is well-founded. In 2001, China absorbed 75 percent of all foreign direct investment into Asia's developing economies, a complete reversal of the ratio of 10 years ago. Indeed, almost all economies -- from Cambodia to the United States -- have by now lost some industrial activity to China. And with China's workers earning less than one-third as much as their counterparts in, say, Brazil or Thailand, with tens of millions of underemployed Chinese industrial workers waiting in the wings and with hundreds of millions of farmworkers lined up behind them, such losses are very likely to continue.

Press attention has mostly focused on the plight of the richest Asian nations -- particularly Japan, where think tanks and government agencies, recycling a phrase that Americans once used to use to describe their loss of manufacturing to Tokyo, report a "hollowing out" of the economy as manufacturing moves to China. Taiwan has also been in the news: Fear of China as an economic competitor recently edged toward panic following government approval of the first mainland investments by the country's gaudiest industrial success, the giant Taiwan Semiconductor Manufacturing Company.

But the economic stakes for developing nations are, relatively speaking, much higher. Mexico, Malaysia and Thailand -- and, to a lesser extent, South Africa, Poland and Brazil -- now find themselves competing with China for shares of the U.S. and European markets, and even for a place in their home markets, as well as for direct investment and capital. The effects can add up quickly. Mexican government figures show that in 2001, that country lost 5 percent of its manufacturing jobs, more than 580,000 positions, largely to China. More than 350 maquiladoras, many of which supplied parts to foreign companies, shut their doors as orders went to Chinese vendors instead; and the job loss was even worse among factories in Mexico that were directly owned and operated by multinationals. Among those that moved production from Mexico to China were Philips, Sanyo and Sony.

The same thing is happening in Southeast Asia. Singapore frets as Hitachi, Sanyo and Philips transfer high-tech work to China; Malaysia wrings its hands as Dell moves personal-computer production from Penang to Xiamen; and the Philippines watches helplessly as new foreign direct investment falls by half in a year while NEC, a longtime resident manufacturer, relocates a hard-drive plant to Shanghai and Toshiba moves PC production to Hangzhou. So strong and persistent is the investment slowdown in Southeast Asia that some academics are starting to connect the Asian financial crisis of 1997-1998 to the ascension of China.

The allure of China to the big manufacturers is not just its low wages, lack of unions and shocking absence of citizens' rights (Mexico looks downright Scandinavian by comparison). A recent survey of managers at Japanese multinationals showed that most believe China's workers are better-educated and harder-working than their counterparts in Southeast Asia. In addition, water and power are highly subsidized in China, and because Beijing will take from its people to give to industry, supplies are virtually guaranteed. China's currency, the yuan, is less volatile than, say, the peso. Perhaps most important, China's remarkably deep base of industrial supplies and services is unmatched in the developing world.

Jim Sacherman, senior vice president of Flextronics, a firm that manufactures electronic components and sells them to companies such as Cisco and Ericsson, says his staff recently identified more than 300 cable suppliers in Shenzhen, China. By contrast, they found only five in Guadalajara, Mexico, where Flextronics also operates factories. The longer China remains politically stable, Sacherman says, the harder it will be to stay away. "The fact is, our customers want us there, and the supply base is becoming so mature that you can basically buy anything you need," he says. "It's very much a snowball effect."

Scariest of all for most developing countries is the speed of China's technological advance. The Asian giant has quickly become not only the world's premier location for labor-intensive work but also a top choice for some of the most high-tech activities. The progress has been so swift that it has raised concern even in Washington. Last spring, the General Accounting Office reported that semiconductor production in China already had leaped to within a half-generation of the most advanced U.S.-based operations (contrary to U.S. policy, which calls for maintaining a two-generation lead).

Many Southeast Asian governments are left dusting off their sightseeing brochures from the 1980s, when yen-toting Japanese vacationers were one of the main props for the region's economies. Malaysian Prime Minister Mahathir Mohamad, who for 20 years has been an outspoken proponent of state-led industrialization, recently spoke in Tokyo of his hope for an "influx of Chinese tourists."

For now there may be little else the semi-industrialized countries can do. In July, Mexican Secretary of Economy Luis Ernesto Derbez said his country would register a complaint against China before the World Trade Organization (WTO), but few other countries appear willing to join the effort. India, long one of China's main critics on trade issues, has actually moved closer to Beijing over the last year. And the Southeast Asian nations have been quiet for reasons running the gamut from the pro-China tilt among the ethnic-Chinese industrial elites in Singapore and the Philippines to the unwieldiness of the Association of Southeast Asian Nations, the forum where these countries have traditionally coordinated trade policy. By all indications, the Southeast Asian nations intend to take much the same passive stance toward China that most of them once took toward Japan. During the many years when Japanese multinationals dominated the region's trade, Tokyo imagined itself as the lead goose in a V-formation; if all the other geese followed along, the thinking went, everyone would get to the same pond together. The governments of Southeast Asia seem eager to convince themselves that the only thing now changing is the lead goose.

Malaysia's Mahathir may have provided the best explanation for the region's diffident mood in his Tokyo speech, which seemed to come down to a weighing of risks. China may be a fearsome economic competitor for Malaysia, he implied, but it would be an even more fearsome political foe, especially in the struggle he sees unfolding between China and the Western industrial nations. To illustrate the dangers he sees for his people, Mahathir resorted to an old proverb, saying, "We all know that when two elephants fight, the grass and the animals underneath will get trampled."

Yet if the chances of concerted action by the semi-industrialized nations are slim, the chances of a helpful WTO response are even slimmer. The WTO is simply not designed to decide on the legality of subsidies provided to manufacturers by the central or provincial governments of China, or of any other nation. For years, global corporations and developing countries worked in tandem to deny the organization such power. Both groups feared that the definition of "subsidy" would be extended to include such factors as, say, a poor country's lack of environmental rules -- and this would allow protectionists in Europe and America to keep out other countries' products.

Such concerns made sense in the 1980s, when the WTO was conceived, a time when most midsized nations still had national industries to project and defend. Trade today, however, is a very different beast. Most cross-border movement of manufactured goods now takes place within global companies, and national economies are increasingly shaped by the self-fulfilling consensus among these global corporations that the Philippines, for instance, is the place to package semiconductors, that Thailand is good for sophisticated automobile components and that Mexico is best for the assembly of heavy products headed to the U.S. market. No one has yet designed a model for achieving national economic development in this new industrial landscape.

At a recent press conference, Derbez announced that Mexico will soon start demanding new concessions from manufacturers that wish to operate in the country. "What we have to say to them is, 'Well, I brought you in, so you have to help me develop Mexican industry. More than that, I want you to help me develop Mexican technology,'" he said, following pretty much the same script that China began to use more than a decade ago. But that approach, too, is unpromising in today's changed global economy. In 1990, China was dealing with a haphazard array of foreign firms largely unfamiliar with overseas production; Mexico now faces consolidated global industrial networks that see little reason to accede to the demands of any one country.

Today it is the global companies that are making the demands -- that host countries devalue their currencies, subsidize electricity for businesses, lower corporate taxes, hold down wages. And so much for the promise that opening their doors to free trade would one day drive wages in these countries higher, that it would induce investors to upgrade plants and equipment, that their economies would actually develop.

Sooner or later, the nations now watching their economic hopes drain away to China are likely to conclude that the real culprit isn't Beijing but Washington, which labored so mightily to create this global economic structure. Indeed, with the inept steel tariffs and fat-filled farm bill that the Bush administration pushed through in 2002 -- scoring domestic political points by raising new barriers to the U.S. import market -- free trade is already looking to many like an elaborate game of bait and switch. As Mexican economist Rogelio Romero de la O says, "People in the street don't even know where China is. But they do know NAFTA and the United States, and these will be very good targets when someone decides to make trade into a political issue."