Should manufacturers move inland to avoid processing trade restrictions?
By Andy Scott
SHANGHAI, Sept. 11 – China’s new policy restricting processing trade, which took effect nationwide August 23, will most heavily impact Guangdong province. The booming Chinese economy, which has grown at over 10 percent for the last 15 years, has been largely driven by processing trade factories located in South China and the Yangtze River Delta region, importing tax-deductible raw materials to manufacture finished products for export. Of the over 90,000 processing trade firms operating on the mainland, nearly 70,000 are located in Guangdong province according to the National Bureau of Statistics.
However, in its continued efforts to develop the central and western regions which have not profited from China’s economic surge, Beijing has stipulated that the new regulations will not affect enterprises operating in those regions.
With that in mind, we decided to take a look at central China, an area that includes the six provinces of Anhui, Henan, Hubei, Hunan, Jiangxi and Shanxi. It includes 30 airports, 12 inland ports, 460,000 kilometers of highway and approximately 15,000 kilometers of railway. Would it be better for processing trade manufacturers to move their operations inland, or look for other possibilities to dealing with Notice 44?
China’s main commercial centers on the coast, such as Beijing, Shanghai, the Pearl River Delta are getting more expensive. The cost of land and labor is increasing, a trend that shows no sign of changing. However, it is also true that for export-biased businesses, proximity to a port is a major advantage that going inland is going to start to eat into in terms of increased transportation costs. With China pushing manufacturers to move inland by a variety of incentive-based programs, the question becomes, is the trade-off worth it? Are the additional logistical costs of getting products out of central China and to a port worth the incentives and cheaper operating costs, that moving inland provides?
To get to the sea, inland manufacturers will have to turn to China’s road, rail, and inland waterway networks to transport their cargo to the coast. While transport infrastructure has grown rapidly in recent years, it still lags industrialized countries – capacity constraints exist and most of the infrastructure outside the developed eastern coast is not built to handle a modern transport industry.
According to a recent Jones Lang LaSalle study, China’s road network still handles the bulk (almost three quarters) of domestic cargo, compared to only 15 percent for rail. However, while the road system is relatively developed as compared to the freight rail system, roads remains much more expensive, with larger distances imposing far higher costs than rail or inland waterways (five times and 28 times higher respectively according to official China government sources).
Due to China’s expansive land mass, rail should be seen as the preferred mode of transport, however, as the Jones Lang LaSalle report points out, the rail infrastructure in China remains limited.
- the rail system can handle only around 30 percent of demand in the Yangtze corridor
- there is an absence of track in certain regions, particularly in the west
- a high proportion of the rail network is not double tracked, of 72,000 km of rail, only 24,000 km is dual tracked
- priority is given to coal/raw materials, followed by passengers over industrial goods
- passenger traffic often clogs rail capacity
- some routes require operators to book space as much as 6 weeks in advance
- damage rates are 2-3 times that of trucking
Companies looking to move away from the built-up coastal regions in order to avoid restrictions will have to contend with increased transportation time, logistical logjams and capacity issues should they rely on China’s road and rail networks. This could lead to additional transport costs of several hundred thousand dollars a year. A revealing figure when considering two other aspects: rail is a monopoly industry in China and fairly expensive as a result; and a premium on usage makes transportation a cost barrier to the inland regions. Moving to cities situated upstream on the Yangtze however, may prove beneficial and cost effective, and several key cities like Wuhan and Chongqing are already establishing themselves as emerging manufacturing hubs: Wuhan as the “Detroit of China,” and Chongqing, a historical industrial base, as the “Gateway to the West.”
A basic simple conclusion then is that foreign investors looking at export markets are still significantly better off staying in the coastal regions despite the new restrictions on processing trade. Obviously there are a lot of differences between types of international investors, for international commodities manufacturers such as Mittal Steel, who want to ensure their dominance over the global steel supply, moving into central China can be seen as a strategic investment in a region home to one of China’s largest steel manufacturers. In time, businesses supplying such industries may begin to enter the central China market. Yet for export-based businesses, central China, with its burden of increased transportation costs, still seems like a bridge too far until competition, a breaking of existing monopolies, and an increase in transportation infrastructure can start to bring those costs down. This would appear to be a longer goal target.