In this episode of China Money Podcast, guest Ben Simpfendorfer discusses China’s manufacturing sector and its challenges to improve productivity.

Q: Your perspective of looking at the Chinese economy is unique. You suggested that we shouldn’t look at it as a whole. Rather, we should look at it as city clusters. Why?

A: China is going through a series of structural changes, with the population aging rapidly and the ability to invest increasingly limited. It’s important for the country to focus on productivity improvements. But these changes will come from particular parts of the country such as the city clusters, not from the central government itself.

This has been the case for the last few decades. Some of the most powerful reforms have come from regions or cities. An example would be the Pearl River Delta, cities like Guangzhou and Foshan, where they are building inter-rail links reducing the travel time to just 30 minutes, and that create wonderful network effects and reduced duplicating projects that has been a problem for many cities.

Q: With this different approach, how does this affect your outlook?

A: What we are looking for is not to track the monthly data and find the implications for the financial markets. We try to answer some of the most important structural questions that will determine the country’s medium-term outlook.

Will the private sector reclaim its role as China’s primary growth driver? Will there be growing investment into research and development to productivity gains to support medium term growth? These questions will be answered by the success or failure of these city clusters.

Q: So in your mind, will they succeed?

A: Some will. The Pearl River Delta clearly enjoys the economy of scale and network effects. In many respects, it is among the most significant emerging markets in its own right. The Yangzi River Delta and the city clusters around the Bohai region are other examples. These will succeed.

Others in the interior may struggle. They don’t have access to foreign markets, and perhaps competing with the wealthier regions for raw materials. So there is a bit more doubt in the outlook.

Q: With labor costs rising, China’s manufacturing sector is being threatened by other lower cost regions. What can China do to counter that?

A: China’s competitive edge is certainly being eroded. That said, China has some serious competitive advantages. Logistics, for example. China has efficient ports and efficient roads, as well as economies of scale. For the electronics sector, it’s about how much you can produce the product, but also about the suppliers surrounding yourself. It’s difficult for other countries to reproduce that.

So China will remain number one, though we will see some erosions of the margin. The implication of that is that China will pass on the higher production cost to the rest of the world. So higher prices at Wal-Mart or Costco. The era of cheap goods is over.

Our Guest Today:
Ben Simpfendorfer is managing director at Hong Kong-based consultancy, Silk Road Associates. He is the former chief China economist at the Royal Bank of Scotland and the former senior China economist at JPMorgan. He published the book The New Silk Road in 2009 on China’s economic relations with the Middle East.

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