By JOHN ROSS

CHINA has recently emphasized a policy of international “production capacity cooperation.” The specific feature of this, as Gu Dawei at China’s National Development and Reform Commission (NDRC) put it, is: “Capacity cooperation means more than export of finished products, but also the transfer of the whole industrial chain to help other countries beef up their manufacturing capability.” This policy is not short term but economically rooted in China’s increasing participation in the latest stage of globalization. It is particularly applicable in manufacturing, due to China’s strength in global infrastructure industries such as power generation, transport, and construction.

John Ross is a senior research fellow at Chongyang Institute for Financial Studies, Renmin University of China. From 2000 to 2008 he was director of economic and business policy in the administration of Mayor of London Ken Livingstone. He previously served as adviser to several major international mining, finance and equipment manufacturing companies.

In one form of what might be termed “international production capacity cooperation” China’s companies undertake industrial projects in a particular host nation either by themselves or in cooperation with that country’s companies – current major examples are railway construction in preparation for Brazil’s 2016 Olympic Games and infrastructure in Kazakhstan. In an alternative/complementary variant China’s companies cooperate with another country’s companies to operate in third countries. For example Chinese and French companies now cooperate in power generation projects in other markets. Why this form of international cooperation has developed, and its significance, can best be understood in terms of the overall forces driving globalization and China’s position within it.

Since World War II the fundamental forces driving globalization mean that its economic forms keep deepening and changing. Initially, globalization was primarily in trade and then developed into foreign direct investment (FDI). But now creation of integrated global supply chains is spilling over into international production capacity cooperation, with China playing an increasing role in it.

The most fundamental driving force for globalization is the enormous productive advantage of division of labor operating not only domestically but also internationally. This is no new process. The opening sentence of the first chapter of the founding work of modern economics, Adam Smith’s The Wealth of Nations, clearly states : “The greatest improvement in the productive powers … has been the effect of the division of labor.”

Modern economic statistics confirm Smith’s analysis is as valid now as when written more than two centuries ago. Every major factual study confirms the positive correlation between the openness of an economy to trade and the rapidity of its economic growth. Domestically increasing division of labor, reflected in what are termed “intermediate products,” the inputs from one industry into another, is the most rapidly growing part of production.

Smith would recognize the process but its scale has naturally been magnified. Breznitz and Murphree’s excellent study of globalization Run of the Red Queen, accurately describe its latest stage: “In the last few decades, the world has witnessed a vast and accelerating increase in the fragmentation (also called decomposition, unbundling, or modularization) of productive activities. This means that the production of goods and services is no longer organized in vertically integrated hierarchical companies located in one country. Corporations increasingly break their activities into smaller, discrete modules and outsource or offshore them. This process of fragmentation has changed the international economic system, leading different regions to specialize in specific stages of production for particular industries.” China’s emphasis on “production capacity cooperation” relates to this process.

Globalization is therefore continuing to develop along the lines predicted by economic theory in increasing global division of labor. This is already highly developed in manufacturing. For example, the World Trade Organization found that in a typical “U.S. car,” only 37 percent of its value was added in the U.S. Of value added, 30 percent was from South Korea, 18 percent from Japan, eight percent from Germany,  four percent from Singapore and China’s Taiwan. Non-U.S. economies therefore contributed 63 percent of the value of a “U.S. car.”

China has long played a key role in supplying components for globalized production with world leading companies such as BYD in batteries and Wanxiang in automotive components. Other countries, for policy reasons and to create employment, wish such Chinese companies to manufacture within their own economies.

But the situation is even more acute in many economic sectors where different parts of the productive process necessarily must be located in the same place, or close to each other, for insuperable technical reasons or due to huge cost benefits. This frequently applies in infrastructure and heavy industry. For example, different parts of a power generating plant cannot be in different places, a railway cannot be separated geographically into track, overhead power supply, stations, marshalling yards etc., and a hydroelectric dam cannot be separated from the river that powers it.

In a significant number of such industries Chinese companies have a leading world position in terms of the combination of technological and cost advantages. This is aided by the unequalled size of China’s domestic fixed investment market. China’s annual fixed investment is now 40 percent higher than the U.S. In 2014, the latest available internationally comparable data, China’s fixed investment market was US $4.6 trillion compared to US $3.2 trillion in the U.S. This gives many sectors of China’s infrastructure companies, for example, unparalleled experience or expertise. But, for the technical or cost reasons outlined, trade cannot be an adequate means for many such leading Chinese companies to expand internationally.

“International production capacity cooperation” derives from the combination of this globalization process and China’s specific place in the international value chain. As China is a “high medium” income economy by international standards, China’s advantages are inevitably concentrated in “high medium” technological sectors. But other countries correspondingly possess advantages in other parts of the production chain. Advanced economies possess advantages in high technology fields – hence China’s companies are cooperating with French ones in power generation. Simultaneously, due to the rapidly increasing income of China’s population, China can no longer compete in sectors depending on very low wages. Therefore, Chinese shoe manufacturers, for example, are now using the expertise they previously acquired in China to finish products in Ethiopia, as advocated by one of China’s leading economists Justin Yifu Lin. Chinese infrastructure companies are active in numerous African countries. In both cases other parts of the production chain in these countries are filled by African companies. 

“International production capacity cooperation” therefore allows China’s companies to use their specific advantages in cooperation with different parts of the supply chain in other countries – to mutual advantage.