The Present and the Future of China’s Production-Capacity Cooperation with Foreign Countries

Zhang Mei

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The Present and the Future of China’s Production-Capacity Cooperation with Foreign Countries

Zhang Mei

Advancing China’s cooperation in production capacity with foreign countries has been elevated to a national strategy. Seen as an upgraded version of the previous “going global” strategy and an important way of implementing the Belt and Road Initiative, it has drawn a great deal of attention both at home and abroad. The focus now is on firmly seizing the opportunities, calmly tackling the various challenges and making solid steps in capacity cooperation.

Zhang Mei is Associate Research Fellow at the Department for World Economy and Development, China Institute of International Studies.

The significance of production-capacity cooperation

On the national level, cooperation in production capacity goes beyond the traditional mode of the international division of labor (such as international trade, investment and technology flow). It involves a transnational cooperation mode that covers the division of labor and cooperation in consumer markets and production factor markets. China’s cooperation in production capacity with the rest of the world follows the laws governing the international transfer of technology and helps deepen the integration of the global industrial chain, it is thus a good recipe for promoting a global economic recovery and the transformation and upgrading of the Chinese economy. Through international production capacity cooperation developing countries can achieve accelerated growth with relatively low costs, developed countries can access a bigger market, and China can boost the upgrading ofits industrial chains.

It is in line with the laws of international industrial transfer.

Industrial transfer and foreign production-capacity transfer are basic laws of international industrial development. The world has witnessed several large-scale industrial transfers. The first international industrial transfer saw the “world’s factory” move from the United Kingdom to the United States, propelling the United States to become the largest industrialized country. In the second transfer, the United States exported industries to Japan and the former Federal Republic of Germany which afterwards transferred industries to the four “Asian Tigers.” In the 1980s and 1990s, industries flew out from not only the developed countries, including the United States, Japan and Germany, but also from the Asian Tigers all of which were newly industrializing countries. Developing economies were the largest beneficiary in this process. China’s economic achievement over the 30-plus years of reform and opening-up can be attributed to the fact that it received international production capacity as it opened to the outside.

As economic globalization gathers momentum, it is necessary for China to follow the laws of international industrial development and conduct cooperation in production capacity with the rest of the word.

Since the financial crisis in 2008, industrial transfer is underway in two directions: the high-end chain has been flowing back to the developed countries in Europe and the United States, while the low-end chain has been moving towards regions with lower labor costs. Small- and mediumsized labor-intensive enterprises that are oriented toward exports and original manufacturing are shifting from China to Vietnam, Myanmar, India and other developing countries where labor and resources are cheaper. As economic globalization gathers momentum, it is necessary for China to follow the laws of international industrial development and conduct cooperation in production capacity with the rest of the word.

However, differences in national conditions and the changing times make it difficult for countries to indiscriminately copy other countries’modes of industrial transfer. China therefore is following a different path from those of the United States and Japan, choosing more diverse industries and regions for its industry transfer. In conducting cooperation in production capacity, China engages with a wide range of developing and developed countries in many areas such as infrastructure, equipment manufacturing, technology, financial services and free trade.

It can help promote the global economic recovery.

At present, the global economy is still undergoing profound adjustments and a recovery remains elusive. Cooperation in production capacity can address structural differences and mismatches in supply and demand, and stimulate the development of the real economy in different countries, thus boosting the global economic recovery.

In terms of the global industrial chain, developed countries as a whole are in the post-industrialization period. They boast high-end equipment and technology, but such equipment and products are fairly expensive. The developing countries enjoy rich natural resources and cheap labor but their industries and products are at the middle and lower levels of the value chain. Many developing countries are in the initial stages of industrialization and need large amounts of equipment. As the largest developing country in the middle period of industrialization, China has both technology and labor cost advantages. China’s cooperation with other parts of the world can push forward the integration of the whole industrial chain, encourage countries in different stages of development to leverage their own comparative advantages and boost global demand.

It is worth noting that inadequate investment in infrastructure and industries is the common challenge facing developing and developed economies. The rapid urbanization in developing countries requires more robust demand. While for some developed countries with aging infrastructure, it is urgent to improve infrastructure to boost investmentand growth. Conducting production-capacity cooperation in this field can link supply and demand and stimulate demand, thus tapping new potential and injecting new momentum into the global economy. By carrying out production capacity cooperation with the rest of the world, China hopes to integrate its manufacturing capacity, and the advanced technologies and managerial expertise of developed countries with the demands of developing countries. In this way, China’s industries can be upgraded the economic growth of developing countries be promoted, the whole industrial chain developed, South-South and North-South cooperation advanced and inclusive development facilitated.

Chinese President Xi Jinping and Saudi King Salman jointly inaugurated a joint-venture refinery in Riyadh, Jan.20, 2016.

It can benefit China’s economic structural adjustment.

As labor and financing costs are rising and resource constraints are mounting, changes have taken place in China’s comparative cost advantage. China is losing its traditional industrial competitiveness and finds it hard torely on the traditional mode of foreign trade in which China imports large amounts of raw materials and exports general consumer goods. The Chinese economy has entered a new normal in which the economy has shifted gear from a high-speed to medium-speed growth rate and the main objective is to adjust the economic structure and absorb its excess capacity. In carrying out production-capacity cooperation, the going out of equipment capacity can facilitate the transformation and upgrading of foreign trade and shift general product exports to industrial exports so as to advance economic structural adjustment.

Over the past 30 years of industrialization, China has become one of the top countries for manufacturing capacity and technical standards. China now has much surplus capacity and many competitive industries. In 2014, the value of China’s equipment manufacturing exceeded 20 trillion yuan and its exports amounted to 2.1 trillion yuan, accounting for one-third of the global total, making China the largest exporter in the world. China also produces the most iron and steel, cement and automobiles, and its output of machine tools accounted for 38 percent of the global total in 2014, its ships 41 percent and its electricity generation equipment 60 percent. In the field of high-speed railways, China has developed its own core technology with independent intellectual property rights in railway construction, high-speed trains and train control. China, with 16,000 kilometers of high-speed rail and another 10,000 kilometers under construction, both of which are the longest in the world, has more complete technology and lower construction costs than any other country. Conducting cooperation in the abovementioned surplus capacity and competitive industries will help China both maintain medium-speed growth and move up the value chain. It will also ease the saturation in the domestic market and transform the surplus capacity into effective capacity. It also presents new opportunities for businesses to allocate resources. By participating in international market competition, Chinese companies can improve their overall quality and core competitiveness and speed up China’s transition from being a big manufacturer to a strong manufacturer.

The progress China has made in its production-capacity cooperation with the rest of the world

In recent years, China has simultaneously engaged in capacity production bilaterally and multilaterally from Central Asia, Southeast Asia and Africa to Latin America and Europe. China has signed framework agreements or memorandums of understanding with 15 countries on different continents including Kazakhstan, Brazil, Malaysia and Ethiopia and is has undertaken consultations with 33 countries in this regard. On the multilateral level, China intends to synergize with the Junker Plan, which is aimed at reinvigorating the European Union economy by investing in infrastructure. A China-EU joint investment fund is being established. China-African Union cooperation in the Three Networks and industrialization is in the making and a China-Africa railway cooperation plan has been mapped out. And China, Japan and the Republic of Korea reached consensus in their sixth trilateral meeting (which had been suspended for three years). Besides, China is stepping up its cooperation in manufacturing and services with other countries in the international market.

China’s cooperation with other developing countries is booming.

The majority of developing countries are in the initial stage of industrialization in which their weak industrial foundation compels them to rely on imports. They are eager to pursue all-round cooperation with China, as they have great demand for construction equipment. China has a relatively complete industrial system and cost-effective equipment in the middle of the global industrial chain and therefore can meet this demand. Their cooperation is advancing smoothly as China conducts targeted cooperation with other developing countries based on their different national conditions and actual needs. Kazakhstan is a pivot country for China in its cooperation with Central Asia. The first 25 early harvest projects are valued at about $23 billion and the 42 projects designated recently total about $30billion. In August 2015, the two countries signed a production-capacity agreement. Their cooperation can be used as a model for cooperation with other countries and sets a good example for China’s competitive production capacity to expand into other markets. Kazakh Prime Minister Karim Masimo said, “The production-capacity cooperation between China and Kazakhstan has got off to a good start. It fully demonstrates that the new model of win-win cooperation promises broad prospects and can serve as a guide for other regions.”

Many places in Southeast Asia have witnessed fruitful results in their cooperation with China in production capacity. In October 2015, a groundbreaking ceremony was held for the first-stage coal-fired power plant in Hengshun Zhongsheng Industrial Park in Indonesia. As an important project in production-capacity cooperation between China and Indonesia, the industrial park will not only create jobs but also improve the local economy and speed up Indonesia’s economic transformation. In the same month, Chinese enterprises won the contract for the Jakarta-Bandung rail project and will work together with their Indonesian counterparts on the project. It is a breakthrough for Chinese high-speed railways going abroad and it is the single largest cooperation project between China and Indonesia. In December 2014, China and Thailand signed a MOU on rail cooperation for the co-construction of Thailand’s first standard gauge railway. After nearly a whole year of negotiations, a ground-breaking ceremony was held on December 19th, 2015. Chinese technology, standards, and equipment will be used. In November 2015, a cascade power station in Laos on the Nam Ou River, the only one of its kind along the river, which was constructed by a Chinese enterprise, started to generate power four months ahead of schedule. As a key project in Lao’s national energy strategy, this power station is expected to promote imports of electrical equipment from China worth 310 million yuan. This will help lead to “going out” of Chinese enterprises in electrical design, supervision, construction and equipment manufacturing. A ground-breaking ceremony for a China-Laos railway was held in December. The railway will extend for 418 km, more than 60 percent of which will be bridges and tunnels. It is designedfor speeds of up to 160 km/h and is projected to be open in 2020.

China has been actively taking part in infrastructure cooperation with Africa on multinational and trans-regional as well as bilateral levels. In November 2014, China and Nigeria signed a coastal railway contract valued at $11.97 billion. The construction of the railway has directly created 50,000 jobs and, indirectly, 150,000 jobs. During its operation, 20,000 to 30,000 stable jobs will be created. In January 2015, China and African Union signed an MoU of to cooperate on major infrastructure networks and industrialization process in Africa. The light rail constructed by the China Railway Group Limited in Addis Ababa began operating in September 2015. As the first modern light railway in Africa, it is effectively improving the lives of the city’s residents and helping to drive the economic growth of the whole city. The 760 km-long Ethiopia-Djibouti railway is expected to begin operations in the first half of 2016. The 480km-long Nairobi-Mombasa railway in Nigeria and the Kariba South power station extension project in Zimbabwe will, once completed, also strengthen the internal driving force of the African economy.

Production-capacity cooperation between China and Latin America is kicking off as the Twin Ocean Railroad Connection project—a tunnel connecting the Pacific and the Atlantic coasts—and the ultra high-voltage direct current (UHVDC) transmission project of the Belo Monte power station, are opening up logistical, power and information passageways. China, Brazil and Peru announced in May 2015 they would conduct a basic feasibility study on the Twin Ocean Railroad Connection that will connect Brazil’s Atlantic port of Porto do A?u with Peru’s Pacific port of Puerto Ilo. The transcontinental railway will go a long way in driving Latin American economic growth. In the same month, China and Chile agreed to carry out feasibility study on a Chilean transcontinental tunnel as soon as possible. The project, also known as the Aconcagua Bi-Oceanic Corridor, aims to connect Chile and Argentina through the Andes by building a 205 km railway and a 52 km tunnel to substantially reduce the time spent traveling between the two countries. The UHVDC transmission project of the Belo Monte powerstation extends over 2,000 km through most of Brazil. China’s State Grid Corp was awarded a contract in 2014 for a Belo Monte UHVDC line, which became a model for China-Brazil production-capacity cooperation. The Chinese company was a awarded a contract to build and operate a second transmission line for Belo Mont power station in 2015, which will result in about 3 billion yuan of electrical equipment exports for China. China also announced it would set up a special fund of $30 billion for China-Latin America cooperation in production capacity to ensure that the cooperation in production and equipment manufacturing advances smoothly.

In its production-capacity cooperation with other developing countries, China gives full consideration to resources endowment, support capacity and market conditions of the host country based on equality and mutual benefits to make sure that the projects meet actual local needs. With regard to less developed countries, China is ready to translate their strengths, including natural resources and labor, into independent development capacity in light of their specific features and development potential, which has been wellreceived by the host countries.

Positive progress has been registered in China’s production cooperation with developed countries.

In the 12th Five-Year Plan period (2011-15), China has made rapid progress in its high-speed railway, nuclear power, UHV technologies. The experience and low cost of Chinese technologies can match the demand of developed countries for upgraded infrastructure, thus providing opportunities for production capacity cooperation. At the same time, the third-party cooperation between China and developed countries is becoming a new model of capacity cooperation.

Cooperation in high-speed railways and nuclear power plants with developed countries has got off to a good start.

The 315-billion euro Junker Plan initiated in November 2014 is designed for investment in infrastructure development. In his visit toEurope in June 2015, Premier Li Keqiang took it as a priority to promote cooperation in production capacity with European countries. China and the European Union decided to synergize the former’s Belt and Road Initiative and the latter’s investment plan and set up a joint investment fund. The European Union proposed supporting the development of transport and energy networks. China and the European Union reached consensus on the participation of Chinese businesses in the pan-European transport network, China-EU land-sea express line and new Eurasia Land Bridge.

Zonergy 900 MW solar power plant, located in Bahawalpur of eastern Pakistan's Punjab Province, is being developed.

The United Kingdom is faced with aging infrastructure. The UK Prime Minister David Cameron said the United Kingdom welcomed China’s investment in the country’s proposed new high-speed railway network (HS2), civil nuclear energy, aviation and telecommunications. Breakthroughs were made in China-UK production-capacity cooperation during President Xi Jinping’ visit to the United Kingdom in October 2015, when it was confirmed they would jointly construct the Hinkley Point C nuclear powerstation. This is the first time China and a developed country have conducted cooperation in major strategic industries and their cooperation will act as a role model for China and developed countries to work together in production capacity.

A Chinese consortium led by China Railway Corporation signed an agreement with XpressWest for a joint venture to build a 370-km highspeed railway in the United States. The project is China’s first high speed rail project in cooperation with the United States and one of the major infrastructure projects in China-US economic cooperation. Therefore, it is of special significance for China. China Railway Rolling Stock Corporation broke ground in the same month for its manufacturing and assembly factory in Springfield, Massachusetts, symbolizing the transition of China’s highend equipment from product exports to capital and technology exports and from product cooperation to all-round cooperation in products, technology, services and management.

China has embarked on exploring third-party cooperation with developed countries.

Third-party cooperation with developed countries means that China’s middle-end equipment and developed countries’ advanced technology and core equipment are used to explore third-party markets, which covers not only developing countries but also some developed countries that are pushing forward re-industrialization and need improved infrastructure.

China and France already have examples to follow in third-party cooperation. As early as 2007, China General Nuclear Power Corporation (CGN) and EDF signed a global partnership agreement on cooperation in investing in power stations at home and abroad, expanding technical cooperation and jointly developing new technology. They laid out clear cooperation principles. China and France reached consensus on third-party cooperation during Premier Li Keqiang’s visit to Europe in June 2015. In their joint statement on third-party cooperation, the two sides agreed to deepen production-capacity cooperation in aviation, aerospace, high-speed railways, as well as energy cooperation in nuclear power, oil, gas and hydroelectric power. The two countries agreed to improve the added value of these industries and products, push the bilateral cooperation up the industrial chains, explore third-party markets and establish a joint fund to finance industrial investment and production-capacity cooperation in thirdparty markets. The agreement between China and France will likely stimulate the cooperation enthusiasm of more developed countries.

China and the United States have also started to explore third-party cooperation. In September 2015, China Machinery Engineering Corporation and General Electric Company signed an MoU in Beijing on cooperation in clean energy projects in Africa. They selected the Kipeto wind power project in Kenya as a pilot and plan to invest $327 million to build sixty 1.7-megawatt wind power stations with 102-megawatt installed capacity in Kipeto in Kenya’s Rift Valley.

The opportunities and challenges of cooperation in production capacity

Chinese capital, equipment and technology are increasingly welcome by other countries, particularly developing ones. The years to come will witness a global boom in infrastructure investment, as adjustment of the global industrial structure speeds up, developing countries advance industrialization and urbanization, and developed countries push forward “re-industrialization.” This will bring about unprecedented opportunities for China to engage in industrial transfer and production-capacity cooperation.

The developing countries with a total population of 6 billion have great demands for infrastructure construction and equipment, as they are in the midst of industrialization and urbanization. While developed countries, with the dual-goal of upgrading their aging infrastructure and reviving their economies, have successively put forward plans for large-scale infrastructure development. Deepening regional economic integration has further stimulated enormous demand for infrastructure connectivity in manyregions. It is projected that the global infrastructure investment will reach $57 trillion by 2030.

Taking high-speed railways as an example, it is predicted that China will have invested over $800 billion in overseas high-speed railways by 2020, which will bring about a $7 trillion market created by other industries. As a latecomer, China has mature technology, experience and strong capacity in equipment manufacturing. China’s cost-effective high-speed railway technology suits the demands of different markets, and it has attracted nearly 30 countries.

Shipping is another example. Indonesia expects to require almost 4,000 vessels of different kinds over the next decade. It welcomes foreign businesses to build vessels given its own limited capacity. China has the technology, capital and cost-effectiveness to help meet the demand.

Such demand in the Southeast Asian countries can offer precious opportunities for China.

Power generation is another sector where China has the necessary technology and experience. Power shortages or incomplete grids in many developing countries mean they have great demand to increase their power generation and distribution capabilities. From 2011 to 2035, global power investment is projected to reach $17 trillion, three-fifths of which will be used in countries that are not members of the Organization of Economic Cooperation and Development (OECD). For example, sub-Sahara Africa needs $300 billion to realize universal access to power by 2030. In both developing and developed countries, new energy and nuclear power promise broad prospects. Australia is rich in sunshine but has no solar panel companies. Given that wind and solar power account for only 1 percent of the country’s energy, the Australian government plans to increase the share of power generated by clean energy to 20 percent by 2020. The world is expected to invest $1.5 trillion in nuclear power plants. China is building the largest nuclear power projects, and Chinese nuclear power companies are being favored by many countries as their technology is among the safest but least expensive. China’s increasingly mature nuclear power technology,equipment, production capacity and services as well as coal-fired power, hydrogen power, transmission and transformation equipment, wind power, photovoltaic (PV) equipment manufacturing and technology rank among the best in the world, giving China large-scale production capacity and strong competitiveness.

But as cooperation in production capacity deepens there are also mounting challenges and risks.

First, fiercer international competition. Such technology and capital intensive industries as high-speed railways and nuclear power are the priority in China’s industrial transition and also traditional “battlefields”for developed countries. In the high-speed railway market, China, Japan and some European Union countries are the main players. A consortium led by the Chinese businesses in partnership with Indian companies, after sever competition with the German and French companies, won the bid to conduct a feasibility study on the high-speed railway between New Delhi and Mumbai. Japan set up international high-speed railway association to overcome the lack of coordination among the Japanese companies in order to promote its high-speed railway technology abroad. From the Jakarta-Bandung railway to Singapore-Malaysia railway, Japan has been keen to promote its high-speed railway technology in Southeast Asia.

Meanwhile, countries are cautious when making decisions on nuclear power, as it is a sensitive technology and requires long-term cooperation between the exporter and the importer. France and Russia are strong in nuclear power with rich overseas experience. They are sparing no efforts to expand into other markets. There is a long way to go for China’s nuclear power to go global.

Second, project halts or setbacks caused by political and economic risks. Some countries enjoy good geographical positions with rich resources, cheap production factors and enormous markets, but complicated political factors, including rampant extremist forces, the combination of tribal and ethnic problems, and severe party struggles which often lead to political instability and poor safety. Some countries have weak rules, unenforceablelaws and highly uncertain economic policies. Infrastructure development as part and parcel of China’s cooperation in production capacity involves big investments and long periods before any returns are seen, thus they are prone to be halted or disturbed by political and/or economic problems. In 2014, a Chinese consortium’s successful bid for a Mexican high-speed railway project was canceled by the Mexican government after a Mexican bidder alleged the bidding process was unfair. Infrastructure projects undertaken by China in Southeast Asian countries have also suffered setbacks. The Thai constitutional court ruled in March 2014, an infrastructure project approved by parliament was unconstitutional. As a result, the core “rice for high-speed rail” program was suspended.

Third, differences in domestic laws, environmental protection and labor lead to obstacles to businesses that operate locally. Countries in Latin America, Central Asia and Southeast Asia differ in production-capacity laws, environmental philosophy and worker protection. In terms of procurement, some countries request that key spare parts be procured locally and technical standards follow the EU and US standards. Infrastructure projects are also often subject to environmental and social assessments, local suggestions, the approvals from governments at all levels and the strict supervision of international organizations. As to the protection of labor rights and interests, the constitutions of some countries grant workers the right to strike, forbid salary reductions, impose harsh terms on overtime, and give higher compensation to workers that are fired. These rules are severe constraints and tests for the strength of Chinese production capacity. If Chinese companies rush abroad without doing sufficient research, they will be plagued by delays in production-capacity cooperation, leading to business losses and giving China a bad image.

Fourth, false negative public opinions may cause disturbances to smooth cooperation. Some countries or blocs will create obstacles or “l(fā)ead” public opinion by exaggerating, playing up or even distorting the normal problems arising in cooperation, as they are worried that China’s influence will rise with the implementation of cooperation projects. Takethe cooperation between China and Thailand on a high-speed railway, for example. Thai media followed the process intensively with some arguing that Japan’s offer was lower than China’s. But what the Export and Import Bank of China offers is loans in dollars whose ratio is higher than those in yen.

Meanwhile, some Western media have deliberately hyped up possible environmental and social risks from China’s investing in Latin American infrastructure. The Observer in the United Kingdom, for example, argued that the Twin Ocean Railroad Connection project cuts through much of the Amazon rainforest and will undoubtedly threaten the rainforest and the aboriginal tribes there. Such reports worsened local perceptions of the cooperation project, forcing the host government to hesitate in its decisionmaking.

Conclusion

As the Chinese economy is transitioning from an exporter of products to an industrial exporter, expanding production capacity cooperation with other countries is not only in keeping with the trend of global industrial development, it also contributes to the greater integration of the Chinese economy into the global economy at a higher level. In some key countries with strong will and favorable conditions, production capacity cooperation has begun to take shape. China’s capacity cooperation with other countries has got off to a good start, with major projects, represented by its highspeed railway and energy technologies, being carried out worldwide. In the future, China will give full play to its advantages in industry, technology and managerial expertise, starting with such areas as project selection, fund guarantees, institutional establishment, and local operations. While making efforts to enrich cooperation, China will have to deal with all kinds of, and give priority to both economic and social benefits after the projects are completed, so as to make sustained progress in our cooperation in production capacity with other countries.