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Opinion: the Foxconn Incident is a Reflection of the Growing Pains Associated with China’s Traditional Mode of Development

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.

SourcedFrom Sourced from: Fool’s Mountain: Blogging for China

  1. May 30th, 2010 at 15:35 | #1

    Here is an interesting piece from ESWN that there may be individual complicated cause of each suicide.

    Here is a piece from the China Daily on how improvements in the social environment may help

    While Foxconn plans a planned 20% wage hike, according to this piece from the financial times labor activists had been asking for a 50 % raise:

    Foxconn pays its workers according to China’s legal minimum wage, but most make at least double that through constant overtime. Labour activists have been asking for a 50 per cent pay rise. The base monthly salary at the Longhua plant is Rmb950 ($140) but staff said they made almost Rmb2,000 a month including overtime.

    Of course, all these issues aside, we may also have the issue of abuse by Taiwanese companies of Mainland workers. According to this piece of Corpwatch, Taiwanese companies are especially brutal to workers in Central America, where Taiwan manages to keep some diplomatic influence.

    “Taiwanese manufacturers have one of the worst reputations in the world regarding the treatment of workers. They can be quite vicious,” said Charles Kernaghan, executive director of the National Labor Committee, based in New York.

    Kernaghan and others say the abuses include obligatory overtime, physical violence, union busting and pregnancy tests as a condition for employment.

    To be sure, Taiwanese firms are following in the footsteps of many U.S.- owned maquiladoras, which also take advantage of low wages, tax breaks and lax government enforcement of labor and environmental laws. But U.S. factories tend to be less abusive because they are under constant scrutiny by nongovernmental organizations and liberal politicians at home. In Taiwan, there is little public awareness of the problem.

    “There are civil society groups that are attempting to impose an enforcement mechanism,” said Teresa Casertano, field representative for Central America for the AFL-CIO Solidarity Center in Washington, D.C. “But the Taiwanese government is not sensitive to that.”

    Taiwan’s Ministry of Foreign Affairs is steadfast in its support of its overseas investors and rejects the implication that Taiwanese businesspeople have a poor labor rights record. Instead, ministry officials say the nation’s policy to win diplomatic support abroad has only benefits.

    “(Our companies) bring much-needed jobs and economic development to these countries,” said spokeswoman Katherine Chang.

    “Development, aid, investment. It’s the Holy Trinity of Taiwan diplomacy,” said George Nee of the Asia Pacific Labor Update, a labor rights watchdog group in Taiwan. “After encouraging these businesses to go overseas and subsidizing them to do so, the(Taiwanese) government is hardly going to turn around and slap them on the hand for exploiting labor laws.”

    That view is shared by Nien Hsing vice chairman John Chen, who says his company remains one of the largest investors in Central America — employing more than 13,000 people in Nicaragua alone. He dismissed U.S. labor activists who criticize Taiwanese as puppets of those who want to protect U.S. business interests.

    “They spread vicious lies and rumors about Taiwan’s offshore manufacturers in an attempt to protect American-made goods,” he said. “That is their motivation.” But some Taiwanese politicians disagree.

    Independent legislator Shih Ming-teh, a senior member on the parliamentary committee for foreign affairs, is organizing a hearing next month to rally support for legislation that would hold companies more accountable for labor abuses committed locally and abroad. He says Taiwan will pay dearly for ignoring a call-to-arms from Western critics who perceive the globalized economy as unfettered exploitation of developing countries.

    “In the long run, this will shame Taiwan’s international image and will cause a lot of trouble,” he said. “This is not an issue that will go away. It’s time to take action or pay the price.”

  2. Rhan
    May 31st, 2010 at 18:21 | #2

    A KPMG consultant told me that Japanese and Korean investor often seek his opinion how to reduce tax, while Taiwanese investor tutor him what is the “best” way to do it. He felt tremendous stress when dealing with Taiwanese.

    Hualon the textile producer owe banks and supplier many millions, they use to employ more than 10k workers, and hence government becomes hesitated to take action against them. Hualon don’t contribute much profit (tax) to the invested country, their transfer pricing strategy (trick) move all the profit to HK.

    Taiwanese investors have very bad reputation here in Malaysia.

  3. June 1st, 2010 at 00:19 | #3

    Great translation, Allen.

    1. Regarding the iPad example, do you know how the various value-add are counted in the balance of trade? For example, is the LG screen counted in the U.S. import numbers from China?

    If so, then I feel all these talks about the trade imbalance is not only lame but utterly immoral.

    2. In the U.S., the media is so used to reporting labor vs. corporate America as a zero sum game. I think innovations can still be achieved even while wages are low – on both the workers wellbeing and manufacturer’s competitiveness. I like the op-ed a lot. It’s not a whiny session about poor working conditions, but one with solutions:

    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.

  4. June 1st, 2010 at 09:52 | #4

    @YinYang #3,

    Yes the whole cost of the iPad get counted (i.e. including LG’s $95 screen) even though China only adds a small minuscule amount of the overall cost of the iPad, with the most going to multinational companies or other countries.

    According to this WSJ article earlier this year:

    China imports a huge quantity of parts from places like Japan and South Korea, but when those components are assembled into finished goods and shipped to the U.S., all the pieces count as Chinese exports, inflating the U.S. trade imbalance with its most polarizing trade partner.

    A study by the Sloan Foundation in 2007, for example, found that only $4 of an iPod that costs $150 to produce is made in China, even though the final assembly and export occurs in China. The remaining $146 represents parts imported to China. If only the value added by manufacturers in China were counted, the real U.S.-China trade deficit would be as much as 30% lower than last year’s gap of at $226.8 billion, according to a number of economists.

    At the same time, the U.S. trade deficit with Japan would have been 25% higher than the $44.8 billion reported last year, because many goods that China and others export to the U.S. contain parts purchased in Japan.

    The current method of calculating trade data is a headache for senior trade officials like Mr. Lamy. “It makes everything appear more volatile,” he said recently in Brussels. “That creates a political problem.”

    I think the 30% lower figure can still overvalue the trade imbalance. The way we count trade imbalance, the only time we get it correct is if China imports all components from the U.S. and only U.S. companies are involved in the distribution chain. However when multiparties, such when Korean or Japanese or European companies are involved, then it is way off. In the case of the iPad, that $95 LG screen is counted in the U.S. as a trade deficit to China. For companies like HP that does manufacturing in China, the profit from those operations are also counted as trade deficit to China even though it is American companies that reap the profits. Go figure.

    See this piece from UCLA:

    Overcounting China exports: Many of China’s exports are actually produced by foreign-invested firms in China, among them many American companies, who then ship these products back to the U.S. for sale. In fact, in recent years, the majority of China’s exports, nearly 60% by value, have been produced by foreign-invested enterprise[10] but have been counted as Chinese exports, thus helping to drive up China’s export figures, even though the reality is that U.S. firms are selling to U.S. consumers. For example, Apple’s iPod is conceived, patented, and designed in the U.S., but is assembled in China by a Taiwanese firm using component parts from different parts of the world. China, however, only receives $3.70 from the wholesale price of $224. Most of the profits flow back to Apple even though the item is labeled “Made in China”[11] and gets counted as a Chinese export. Typically, about 20% of revenues from each mobile phone, and 30% from each computer made in China are returned to the original investors or patent owners in the U.S. and other countries.[12]

    Undercounting U.S. sales: Conversely, due to the same method of calculating exports, the sale of goods and service to the Chinese by U.S. foreign affiliates operating in China are not counted as U.S. exports to China. This figure totaled $86.5 billion in 2005 (latest available) and was 70% larger than U.S. exports in the same year.[13] If these figures were counted as U.S. “exports”, then the total amount of U.S. sales to China would look quite different and the trade imbalance would not be quite so large. Thus are the U.S.-exports side of the numbers in this bilateral trade relationship somewhat misleading and not reflective of the actual balance of commerce. If anything, the primary means by which U.S. firms sell goods services in China is via their foreign affiliates and not via exports, but this is almost never accounted for in the trade debate. Until a better more nuanced method of calculating becomes available, American politicians and citizens alike will have the opportunity to continue to use these somewhat inaccurate numbers to suit their own political ends.

  5. June 1st, 2010 at 15:39 | #5

    @Allen, #4,

    Wow, this overcounting of China exports is really making me sick to my stomach!

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