Fool's Mountain: Blogging for China

The following is a translation of an op-ed published published in China Review News.

May 27, 2010 – Opinion: the Foxconn Incident is a Reflection of the Growing Pains Associated with China’s Traditional Mode of Development

The recent spate of suicides at Foxconn in China has brought unprecedented attention to this major international manufacturing subcontractor of electronics equipments.  While the causes of these suicides are inevitably complex,  the incidents are a general reflection of the stress the traditional mode of development has wrought on China’s society and provide a warning that change must be brought about soon.

Foxconn employs some 80,000 in Mainland China.  In 2008, it exported products worth some U.S. $ 55.6 billion, representing about 3.9% of all exports from China.  Foxconn has ranked among the top 200 exporters in Mainland China for each of the last seven years.

Offering low cost, high quality electronics assembly manufacturing services, Foxconn has attracted clients from Nokia to Apple, who has come to rely on Foxconn to supply many of their most important products. Leveraging low-coast, reliable labor, Foxconn imports crucial components from abroad and assemble these components into products for export.  Foxconn’s operation represent in miniature the development model of Mainland China for the last several decades.

As “the factory of the world,” China has become a major export platform used by most multinational corporations. Labor added export such as those from Foxconn represent some 50% of all China’s export. While such exports have enabled China to become a major economy, it has also produced contentious trade surplus while placing China at the lowest rung in the global trade value chain.

Consider the experience of global best-seller iPad. Foxconn is the biggest supplier of the iPad. According to global market supply intelligence research iSuppli, the average cost of assembly in China of each iPad is about U.S. $11.2.  Given that the lowest priced version of the iPad cost U.S. $499, one can see that the assembly cost  is minuscule when compared to the overall value of iPad. For comparison, the component cost of each  iPad is estimated to be U.S. $219.35, still less than 1/2 of the total value Apple extracts from the end customer. The most costly component in the iPad is iPad’s much-raved 9.7 inch touch screen, supplied by Korean manufacturer LG, costing Apple some U.S. $95 per screen.

From the iPad example, one can see multinational branded companies such as Apple reaps by far the biggest share of the profit. Manufacturers of innovative products such as LG also reap a decent amount of profit. The profit made by operations in China, by comparison, is minuscule. To add insult to injury, in providing such low-cost services, China has to sustain the indignation of taking the blame for its trade surplus. Because of the thin profit margins inherent in Chinese operations, the only way for these operations to make a decent profit is through cost control. Under such circumstances, it is not surprising that employees feel stress, high demands are placed on laborers, and pay and benefits are reduced to the lowest amount possible.

Subcontracting, export-led economy can increase industrial activities but not create new brands or new technology; it can increase GDP and trade surplus but not generate wealth; it can create jobs but not generate substantive increases in incomes and standards of lives for the working people.  The present model of economic development has brought on resource deficiency and trade frictions. The recent global financial crisis has also has shown that this model of development is unstable, and make us too dependent on foreign markets.

The rash of suicides represent only the tip of ice berg in terms of the ravages the current mode of development has brought onto the Chinese society. It is time for change – fast. Last year, China overtook Germany as the largest exporting economy.  This year, China is set to overtake Japan as the second largest economy. But if Germany has Mercedes-Benz, BMW, and Japan has Toyota, Sony, what does China have? Where are the world-class brands and companies?

When China first reformed and opened up, China’s economy was still in a very backward state.  It made sense then to focus on economic growth as a top priority. But while growth did make China strong in many ways, it has also caused China to build a huge trade surplus as well as gigantic foreign reserve.

Internally, while the single minded leap toward economic development has pulled many out of poverty, it has also created traumatic stress and shock throughout society. Today’s pace of change is not sustainable. There is a fundamental disconnect between people’s ever growing expectation of increasing material wealth and what can be sustainably provided by our economy.

Today, China’s economic growth is still based on a “demand-driven model” and not an “innovation-driven model.” Our economy consumes a lot of resources, but creates little in terms of technological innovation. Our growth may be a strength of our economy, but it has given the laborers little.  Between 1993-2007, the share of earnings by laborers as a percentage of GDP dropped from 49.49% to 39.74%.  That drop was worse between 2000-2008, when earnings dropped 11.7% as a percentage of GDP.

In order to improve the situation, we need to change the model of economic development. And the key change to pursue is to increase our own ability to innovate. Our ability to improve the mixture of our industrial production depends on our ability to innovate. Our abilities to improve the way we industrialize, to develop technological and scientific know-how, and to grow emerging industries depend on our ability to innovate. Our abilities to build defensible brands and to become more competitive in the global marketplace also depend on our ability to innovate.

This is not to say change will be easy.  But it is only through such changes that we as a society can climb out of the predicament  that the Foxconn incidents symbolize. As Commentator Li of Shen Zhen News Broadcast has observed, “we hope Foxconn will take appropriate measures to rectify immediate dangers facing its employees, take this opportunity to transform its work environment, improvement management, and raise the bar of development for everyone going forward.”

We should emphasize that embarking on this new model of development going forward depends on growing our ability to innovate – including the ability to develop indigenous technological innovations. A key ingredient to doing that is to strengthen the creation, protection and enforcement of intellectual property. The central government has set 2020 as the date China becomes an innovation-based economy. There is not a lot of time left, but much to accomplish.