CEO Policy Recommendations for Emerging Economy Nations
Evolving to Advanced Manufacturing
China is today the world’s largest manufacturing economy and considered to be one of the most competitive nations in the world. Driven initially by its ability to deliver low-cost labour and materials, China quickly advanced across a number of other competitive drivers – including infrastructure, favourable policies, a large consumer base, and established supplier network – over the past 10-15 years and evolved its manufacturing capabilities from low-cost goods to more advanced products.
According to executives participating in the interviews and working sessions, China is at a crossroads as it works to maintain its cost advantage and core low-cost production base while also building the more complex capabilities that are required for advanced manufacturing. Executives also said that the economic growth momentum that China gained by opening markets and enacting reforms has weakened, and that China needs breakthroughs to spur a new round of economic growth.
Many executives agreed that China’s 12th Five-Year Plan and its focus on seven strategic emerging industries (e.g. energy saving and environmental protection, new generations of IT technology, biotechnology, high-end equipment manufacturing, new energy, new materials, new energy vehicles), as well as many of China’s current policies, are moving in the right direction and are important actions to revitalize the economy. In addition, they said that the strategic directions from the World Bank China 2030 report3 provide useful insights regarding the path forward for China as it seeks to maintain and expand its presence as one of the most competitive countries in the world.
However, executives cited concerns with a number of policy areas where improvements would further advance China’s competitiveness: promotion of innovation; reforms to local politics and bureaucracy; and regulations related to environment and health. And while executives generally applauded the speed at which policy is enacted, they said that implementation lags behind and noted that improvements could be made in terms of execution. They also believed that policy-makers could be more forward-thinking and strategic in making long-term resource distribution and environmental plans. Executives expressed significant concern with energy and environmental challenges in China, ranging from the cost of energy to China’s ability to provide clean and sustainable sources of energy.
Executives believed that the following set of recommendations would enable China’s pursuit of more advanced manufacturing capabilities.
Develop a basis of differentiation beyond low cost by transforming to high-end manufacturing
Almost all of the executives recommended that China move from low-cost, labour intensive manufacturing to high-end, technologically advanced manufacturing. They agreed that China cannot abandon its core competency in low-cost manufacturing, but advised policy-makers to find another basis of differentiation, such as technology and innovation.
To facilitate the move to high-end manufacturing, executives believed there is an urgent need to redefine the role of state-owned enterprises. An independent Chinese study has found that if all the government’s grants and hidden subsidies were taken away, the state-owned enterprises would lose money, which represents a drain on resources in China and impacts China’s competitiveness.4 This redefinition would require a broad set of policy activities: deregulating many key sectors; marketizing the transfer pricing of goods and services along entire supply chains; and introducing more real competition in sectors that remain protected for and dominated by state-owned enterprises and “national champions”.
Executives also suggested that policy-makers guide and encourage enterprises to explore modularized mass customization to meet the diverse needs of customers. Modularized mass customization could merge China’s capabilities in mass production with innovations required to deliver customized, differentiated products domestically and globally.
Executives also believed that China is well-positioned to pursue intelligent manufacturing, which involves the development and implementation of artificial intelligence in production processes. Executives said that the government should increase the planned support for intelligent manufacturing to promote China’s transition to make, use and sell more intelligent manufacturing equipment.
Many expressed that China’s low-cost edge is fading as it loses ground on a cost basis to new low-cost manufacturing destinations such as Vietnam. Monetary policy was a noted concern. Additionally, executives said that China would be challenged on a wage basis, as the government recently proposed increasing the average wages of Chinese labour by over 80% by 2015. This would effectively reduce China’s competitiveness in labour-intensive sectors, making the move towards more advanced manufacturing even more imperative.
To serve as a catalyst for China’s transformation to high-end manufacturing, executives recommended the following:
- Develop an industry-led strategic transformation plan that is focused on the industrial development of technological innovation and differentiation.
- Enact policies and strategies that bring in capital and technology-intensive industries from developed countries.
- Promote indigenous innovations, including original and integrative innovation, as well as improve on innovations imported from other countries, by encouraging local governments to set up venture funds, innovation awards and stock exchanges for innovation companies.
- Develop programmes that support and fund entrepreneurship.
- Shift from large-scale manufacturing to mass customization, which includes end-to-end modularization.
- Promote the system integration and application of intelligent manufacturing as well as support the R&D and innovation of core intelligent measurement and control devices.
Develop an energy efficient, sustainable manufacturing environment
Executives predicted that environmentally friendly and energy efficient manufacturing will be the requirement for all nations in the future. Current manufacturing conditions in China are seen as damaging to the environment, energy intensive, and not aligned with this vision. Executives also said that Chinese policy-makers must consider how the country would like to position itself with respect to energy costs, and make changes now to remain attractive for manufacturing sites in the future. Making current investments in the energy industry can help to reduce environmental pollution now and positively impact China’s future trajectory.
Executives’ perception is that current Chinese enterprises are weak in green design capabilities and have large gaps in energy-saving product development and safety. Executives urged policy-makers to establish and optimize the technical specifications, standards and regulation system of green manufacturing; encourage enterprises to focus on the development of technology and equipment that can enhance the energy efficiency and resource utilization of traditional industries; and consider how to leverage the country’s scale in its progress towards green development.
Executives cited the United States as a good example of where energy cost and availability provide a significant competitive advantage, pointing out that some manufacturing companies are thinking about moving production back to the US, based on the affordability and availability of energy.
To address the energy challenge, executives made the following recommendations:
- Create specially designated funds that support energy consumption optimization and sustainability.
- Enhance the policy efforts in promoting energy conservation, emission reduction, environmental protection and clean production.
- Accelerate the R&D in alternative supplies of green energy.
Improve intellectual property protection polices for both domestic and foreign manufacturers doing business in China
Not surprisingly, intellectual property protection was cited by both Chinese and non-Chinese executives as a critical need to continue the country’s manufacturing industry growth. Executives said that policy-makers need to foster a “fair-play” environment to facilitate the long-term development of the Chinese market. Some Chinese executives believed that the lack of intellectual property protection has caused China’s position to weaken relative to its key competitors, especially in a market that often requires joint ventures or strategic partnerships as a cost for foreign companies to operate in China.
Many executives were clear in their perspectives that the concern with intellectual property protection in China does not lie in lack of policy. Their concerns were primarily founded on lack of enforcement of those existing intellectual property protection laws as well as the current business culture and mindset regarding intellectual property. One business leader explained that legacy institutions tend to undervalue individual contributions, heavily favour seniority, and lack a risk-tolerant culture necessary to spur innovation. As a result, intellectual property (and other intangibles, such as services) is often undervalued. Most executives broadly believed this does not align with the values and priorities of manufacturing companies in the global market.
Still, China is viewed as having stronger intellectual property protection laws when compared to emerging low-cost countries such as Vietnam, Thailand and Indonesia. As a result, some executives said that China has the opportunity to make improvements in the enforcement of its laws and provide a strategic advantage for manufacturers operating in the region. Doing so, and given the other competitive drivers China delivers, would positively impact China’s journey to advanced manufacturing.
In 2012, China announced a 10-year campaign to cultivate 10,000 talented individuals in scientific and technological fields. The programme aims to support 100 scientists annually who have made breakthroughs in leading fields
and have the potential to
become “world-class scientists”.5
Continue efforts in developing a highly talented workforce
Many executives saw China’s abundance of engineers and scientists as a critical component of the country’s current and future competitive capabilities. Executives also applauded China’s various policies regarding talent development, such as the “1,000 Talents” and “10,000 Talents” programmes. And although executives support the current direction of these policies and see the increase in college enrolments, expansion of graduate programmes and coverage of vocational education as positive signs, they are concerned about the pursuit of superior talent. China’s ability to develop and retain top talent is crucial to the country’s transition in the value chain from low-end, low-cost manufacturing to high value-added, technologically driven manufacturing. To facilitate this transition, executives recommended the following:
- Expand and continue programmes similar to 10,000 Talents which help to recruit and cultivate innovative, talented employees.
- Improve incentive mechanisms to cultivate technical leaders.
- Promote and deepen the cooperation between enterprises and academic institutions.
Create policies and programmes to improve innovation capabilities and operational excellence
Executives had mixed perspectives about China’s progress in the transformation from a low-cost manufacturing destination to a hub for manufacturing innovation. However, executives broadly agreed that operational excellence and the ability to innovate are critical for China to advance beyond its current success. They also said that policy-makers play a key role in creating an environment that facilitates a variety of innovation: technology, product, process and management practices.
Regarding operational excellence, executives suggested that increasing management transparency and promoting social progress would universally benefit enterprises in China. For example, one executive proposed that if companies were required to disclose on a monthly basis products that do not meet quality standards, the quality of life for the Chinese population would improve, the global markets would open further, and certain industry and business costs would actually decrease.
Executives said there is also a critical need to curtail market-distorting relationships between local governments and key local industries. For example, limiting subsidies and promoting more professional and commercial management, establishing technology neutrality for key regulators and state investors, and promoting transparency in the reporting and analysis of business results for manufacturers would improve overall competitiveness for the country.
China is seen as lagging behind developed countries in the synergies among the manufacturing industry chain, R&D systems and innovation processes. To improve in this area, executives recommended that businesses and policy-makers develop programmes that enhance organization and integration of downstream and upstream businesses in the industrial chain. Additionally, executives wanted to see increased attention to operational excellence at the business level, with evaluation of internal processes such as product and service innovation, cost control, human resources, risk management, and financing to improve China’s manufacturing competitiveness.
Use the scale of the Chinese market to promote the adoption of advanced technologies
Plans outlined under China’s 12th Five-Year Plan, particularly in the area of electric vehicles and supporting infrastructure investments, position the country well in terms of having the capabilities to drive mass adoption of electric vehicles on a global scale.
The electric vehicle related policies and trend bode well for domestic manufacturers and those foreign manufacturers looking to grow in China. It is expected that 5 million electric or plug-in hybrid vehicles will be on the road in China by 2020. Furthermore, annual production capacity is estimated to be 2 million cars by the same year. These volumes and demand create an attractive destination for both local production (from a cost perspective) and regional sales for both foreign and domestic manufacturers.
As Chinese automotive manufacturers work to establish local brands, they have a unique opportunity to introduce new innovative technologies in their local markets. Over time, if adopted on a mass scale within China, these manufacturers have the potential of becoming world leaders in introducing the same innovations in other global markets – thereby helping China’s evolution to high-technology manufacturing.
Executives said that the automotive opportunities related to electric vehicles could also be easily applied to other high-technology sectors that align with China’s 12th Five-Year Plan, including information technology and energy. As wages continue to rise and consumers desire more complex (and expensive) goods and services, demand for these advanced products and the rate of adoption will continue to rise. Executives believe policy-makers will play a role in the widespread adoption of new technologies.
Develop incentives that attract and improve the application of research and development investments in China
The Chinese government has recently set a series of objectives for industrial development, proposals for independent innovation, and urged large manufacturers to invest research and development dollars in China for up to 3% of sales.6 Executives stated that some Chinese companies are effectively leveraging this: for example, some companies are investing in original technology by providing capital, market opportunities, sales channels, management resources and consulting services to smaller companies, and then benefitting from the innovations or discoveries generated by their investment.
On the other hand, according to executives in the working sessions, some Chinese companies are not effectively abiding by the intent of the policy. Some manufacturing companies may not have rigorous or specific objectives focused on maximizing or measuring the value of R&D investments. For example, some companies utilize R&D funds to acquire prototypes and conduct peripheral testing, but spend little on core technology or true innovation. This is another case where the implementation and enforcement of the policy is the greatest concern for executives in advancing China’s manufacturing competitiveness.
There is evidence that some foreign-operated research and development facilities are successful in China, which demonstrates that certain kinds of innovation are strong. For executives and policy-makers alike, the first step is to understand the factors that drive success in foreign-operated R&D centres and leverage these competitive advantages in other locations, as well as foster a business and cultural environment that encourages risk-taking and an innovative mentality among its employees.
To learn from and expand on the R&D facility successes, executives recommended the following activities:
- Develop incentives such as pre-tax deductions, 150% deduction rates, and depreciation for R&D equipment that work to attract multinational corporation investments to establish global research and development centres in China.
- Increase investments in technology, build up the public platform for the R&D of generic technologies, and build on the strengths of existing programmes, like the National High-Tech Research and Development Program and the National Basic Research Program.
- Enact and consummate laws and regulations that are advanced in terms of promoting technology innovation.
- Provide greater support to key enterprises, leading enterprises and backbone enterprises.
Develop more favourable corporate tax policies
Executives participating in the discussions expressed concerns with tax policy in China and said the government should consider additional ways of reducing the burden on enterprises.
To address this need, executives outlined the following recommendations:
- Develop tax incentives for sectors deemed strategic (e.g. high-tech firms). Example incentives include a tax-free window for the first two years after becoming profitable and 15% thereafter, duty-free import of equipment for national key projects, or accelerated depreciation for R&D instruments and equipment.
- Attract businesses to set up advanced manufacturing operations and provide various incentives for land, building, facilities, etc.
- Develop stable tax policies that favour the long-term development of enterprises.
Leverage fiscal policy to encourage the development of the Chinese manufacturing industry
Executives broadly agreed that China’s financial institutions could do more to encourage the development of the manufacturing sector. They generally believed that there is a crucial need to reform and restructure capital markets, equity investment funds, and banks. As one business leader indicated, capital resources are often directed towards the less productive sectors of the economy, while small and medium-sized enterprises (SMEs) and entrepreneurial companies are often underserved. Although some progress has been made, more changes are required to foster the deep reform of channels for capital that are needed for real market players. To make steady progress towards financial reform, executives recommended developing a multi-level capital market, accelerating the internationalization of the renminbi, encouraging the economic development of non-public sectors, and promoting private investment.
Additional recommendations offered by executives include government-backed bonds for corporations with significant scale and competitiveness, foreign currency exchange rules, and financing for merger and acquisition activities that target foreign research institutions and corporations.
Finally, executives broadly agreed that fiscal policy in China must provide long-term financing for creative and innovative new industries and their research and development components. In providing this recommendation, executives were clear in saying that fiscal policies should support research and development activities as well as education and training programmes that deliver a highly skilled workforce capable of driving innovation.