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Machinery Sector: F - Eu-C &: 1. Summary of Sector Developments
Machinery Sector: F - Eu-C &: 1. Summary of Sector Developments
INVESTMENT RELATIONS
PERSPECTIVE
OF
EU-CHINA
TRADE
&
1. Summary of sector developments During the last decade, trade and investment relations with China have been of increasing importance to European machinery manufacturers as a major export market, a production base or as a location generating more and more visible competitors. We focus on the mechanical engineering sector: which is the leading sub-group within the total EU-25 engineering sector accounting for nearly two thirds of the total EU-25 engineering production output. It includes power-generating equipment (31% EU output) and the much bigger sub-segment of non-electrical machinery (63% EU output) for many different industries (Note: 2004 figures). For electrical machinery as a whole, the EU-25 recorded a trade deficit of USD 45.7 billion in 2004. The biggest contributors to this deficit were office machinery, computers as well as radio, televisions and communication equipment. It is likely that EU-25s deficit with respect to electrical machinery will continue to widen in the next 5-10 years. This sub-sector is not a focus of the study. In 2004 EU-15 held 38% of the world trade in mechanical engineering equipment, while China accounted for only 6%, however with on average 18% growth from 2001 to 2005. The last decade has seen significant investments in this sector as China has broadened its industrial base. A significant shift has occurred away from the dominance of state owned enterprises (SOEs) to private domestic companies and foreign invested enterprises (FIEs). This trend has been driven by SOE reform and foreign direct investment (FDI). Another trend is the reduction of dependence on imports through import substitution. Chinas policy towards FDI has encouraged export-orientated foreign investments, especially through Special Economic Zones (SEZs). Consequently, a large proportion of Chinas surging machinery trade is generated by foreign-invested firms. Power generating equipment- is a restricted industrial sector requiring foreign companies to set up Joint Ventures (JV) as opposed to Wholly Foreign-owned Enterprises (WFOE). Foreigninvested companies (FIE) in this sector tend to be larger than non-electrical machinery producers. Since 2001 China has made substantial investments in the power-generating industry. Overinvestment in inefficient small power generation plants was countered with investment restrictions in 2004. Between 1996 and 2005, China maintained a trade deficit of power-generating equipment with the world, 21% of which could be attributed to EU-25 in 2004. This deficit is slowly reducing and can be expected to achieve a faster turn-around into a surplus than for non-electrical machinery. Meanwhile, Chinas average annual exports of power-generating equipment have soared. In March 2006, FIEs made up 18% of all companies operating in the Chinese powergenerating equipment sector and constituted 33% of the total Chinese industry sales. Both importers and Chinese manufacturers which have also built up substantial manufacturing capacities of power-generating equipment have been doing well. Nevertheless, 29% of the sub-sector suffered losses in 2005, up from 22% in 2004. Compared with the output productivity of employees in SOEs in 2005 and 2006e, FIEs is over 70% higher, and that of private Chinese companies is over 40% higher. Despite this fact SOEs have the highest profits rates in 2006 due the nature of these pillar industries which have economies of scale and are supported by direct and indirect government subsidies and technology transfer. However, SOEs have much lower return on investment (ROI) than both FIEs and private Chinese companies. The non-electrical machinery sub-sector, where private Chinese companies dominate more than in the power-generating equipment segment, has also seen significant SOE reform. In 2006, FIEs made up 17% of the total number of companies with a share of 28% of the industrys sales value. They are either larger and/ or more productive than their Chinese counterparts. As with the power-generating equipment industry, FIEs in the non-electrical machinery segment are far ahead with respect to their output productivity. Here as well, China is still dependant on imports. Nonetheless, Chinas exports of non-electrical machinery are
growing fast (average of 33% annually from 2000 to 2004). The trade deficit here is likely to remain beyond 2010 before it turns into a surplus. Chinese manufacturers are already establishing a strong foothold in the world market for lowand medium-tech machinery. They are not yet advanced enough to supply high-precision, high-tech machinery but China is a leading supplier in mass-scale production of lower valueadded machines and components. The main driver for Chinas export growth in both sub-sectors is the cut-throat competition in the domestic market, caused by excessive capital investment. Despite almost all input factors of production becoming more expensive, prices for machinery and equipment have on average dropped. 15% of machinery companies producing in China made losses in 2005 (31% of these companies were FIEs). Some 23% of all machinery companies were unprofitable in March 2006. Despite this SOEs are to some extent sheltered through government support. For both sub-sectors it is likely that the average SOE in China would make a loss if they had not received government subsidies. A cycle has emerged during the last 5-10 years as described in Figure 1. SOEs and other Chinese operators make capital investments and upgrade production facilities, partly with the help of subsidies and other support from state and especially local governments. FIEs also invest in local manufacturing. Foreign technology pours into the country via foreign direct investments, via technological partnerships or via imitation. Domestic production capacity increases and improves. Overinvestment/ competition and a lack of real cost accounting (subsidized industry) results in downward spiralling of prices despite a parallel increase in costs of industry inputs. The price pressure is augmented with the development of sales in less developed regions of China (rural areas), which call for cheaper products. Chinese companies continue to advance their technical quality through a combination of R&D, technology transfers and copying or adapting foreign innovations. The market position of foreign companies is therefore seriously threatened and we should expect their profits to fall, or that they potentially leave the market. A broadened installed capacity in an already overcrowded domestic market leads to increased export volumes, with the added advantage that Chinese companies experience better margins through export. As competition in export markets increases (e.g. Southeast Asia) the cycle requires renewal with the opening up of more advanced markets for Chinese products. This is likely to result in increased technology pressure on Chinese companies and further exploitation of foreign-owned IPRs. European investors are increasingly compromised by market access obstacles, investment restrictions, loss of IPRs and through competition with subsidized competitors. Many rules, regulations and practices are not fully implemented by authorities as the Chinese government favours import substitution. Note: there is growing concern amongst European operators that Chinese exports to third markets are supported by government incentives to host countries (e.g. barter deals for oil).
Figure 1
1. Capital investments (+subsidies) European/ international technology transfer
In summary, the Chinese competitive strengths are characterized by: -Low cost production -Subsidised operations -Cheap IP acquisition -Protected markets -Government support in export markets
4) Imports are assumed to grow by an average annual rate of 15% for the years 2006 to 2010 (compared to 27% from 2001 to 2006e). Increased competition induces Chinese companies to move up the value chain by upgrading their technology and increasing exports. 5) Export push if domestic market too competitive. All scenarios consider stable exchange rate and macro-economic/ political conditions Outcomes: Exports from China to the world markets in this scenario are set to grow 34% on average per year from 2006 to 2010. Strong competition in the Chinese market drives domestic producers to adopt more professional export strategies. Export value expected to almost reach the value of imported machinery in 2010. The market share of imported machinery in the Chinese machinery consumption of nonelectrical machinery would then decrease to 27% by 2010, down from the current level of 32%.
- China: Low-cost production - Competition: catalyst for innovation - Fostered environmental policy Threats - No level playing field for EU firms in China: Chinese companies supported by govt. policy, e.g. subsidies, technology transfer, favourable govt. procurement rules - IPR infringements - Chinese producers incl. foreign-invested companies need to push excess production into exports (3rd country markets)
(partnerships/ technology transfers and other techniques) - Government support for import substitution, esp. to the benefit of SOEs or local champions Threats - Too much competition in own low-tech segment, makes profit margins fall - Prices for production factors (e.g. wages, land) rise fast in China, making imports from EU relatively cheaper - Enforcement of WTO agreements, falling import quotas - Reverse of rules discriminating foreign competitors
1. Administrative costs associated with delays following all manner of protectionism 2. Loss of revenue because of subsidized markets (approx 10% sales price) 3. Loss of IP investment and from this market share (most significant long term impact)
5. Policy recommendations by priority
Improve protection and enforcement of Intellectual Property Rights (IPR) Eliminate industrial policies that discriminate goods of foreign origin in the Chinese market
Note 1: 1)Implicit and explicit measures adopted by the Chinese government to ward off foreign competition in key domestic industries such as technology transfer and local content rules for certain types of machinery are not in line with the WTO agreements and should therefore be terminated. 2) China signed the Agreement on Subsidies and Countervailing Measures (SCM) However, this agreement does not affect the local governments subsidies to state-owned enterprises, which accounts for the vast majority of the official subsidies.
Note 2: Often there are explicit or implicit local content rules on compulsory technology transfers as a precondition for the Chinese government accepting the bid of a foreign firm. The latter is a serious threat for EU machinery industry as their long-term competitiveness is entirely dependent on their technological edge.
Note 3: Chinese state banks are one of the major tools used to subsidise state-owned enterprises.
If the aforementioned issues could be resolved/ improved, EU-25 machinery companies could engage in business in China without fear of losing competitiveness due to market obstacles
Improve the financing options for small and medium enterprises (SMEs) in Europe to provide enough capital to participate fully in an economic upswing Liberalizing labour markets Making taxes more consistent and transparent, lower taxes Supporting innovation/ education
Leverage cost benefit of China market within global operations Foster innovation, research & development especially energy efficiency and renewable. (High probability of losing IP in China. Issue will be to lose it at a time when it is less important.) Streamline costs, increase efficiency Operators need realistic assessment of their products market potential and risk in China Identify and compare alternative investment locations in Asia
60%
% of responses
European ccompanies surveyed expect competition from their Chinese counterparts to increase in the next five years. Todays average response rate of 2.6 places the competition of Chinese enterprises at a level of some to moderate significance. This perception increases to 3.5 indicating that companies expect local enterprises to pose an increased and significant threat in the next five years.
* DISCLAIMER
Please note that that the executive summaries of several sectors of the study on the future opportunities and challenges of EU-China Trade and Investment relations of DG Trade being carried out for the European Commission are preliminary results. Therefore, the Commission accepts no responsibility or liability whatsoever with regard to the information in the summaries or for any losses or damage resulting from the information being quoted or used in any other manner.