Workers assemble cars at a workshop at Zhejiang Geely Holding Group.?[Beijing Review/CFP]

China has overtaken Japan as the world's second largest trading nation and is now the world's second largest manufacturer after the U.S. These actions secure China's international status as the world's factory. However, China's advantages in low labor costs have weakened compared to 10 years ago, and a large number of manufacturers are relocating to Southeast Asia. Also, Chinese manufacturing will face new challenges as developed countries accelerate reindustrialization programs. Pei Changhong, head of the Institute of Finance and Trade Economics at the Chinese Academy of Social Sciences (CASS), shares his views about the challenges and strategies for China's future industrial development.

Vietnam takes over China as Nike manufacturing base

China's competitive advantage of low labor costs has weakened compared to neighboring countries. According to Economist Intelligence Unit (EIU) data, China's labor costs increased nearly 4 times in 10 years. Labor costs per hour increased from 0.6 U.S. dollars in 2000 to 2.9 dollars in 2011, which equals 1.5 times Thailand's labor costs per hour, 2.5 times that of the Philippine's, and 3.5 times that of Indonesia. Moreover, increased land prices in China have translated into higher manufacturing resource costs.

The global manufacturing industry now is faced with two trends: drawing back to their own countries, or moving to lower costs production bases in Association of South East Asian Nations (ASEAN). Take Nike as an example. 40 percent of Nike's shoes sold globally in 2000 were made in China, and 13 percent were made in Vietnam. However, in 2009, China and Vietnam made the same percentage – 36 percent. And in 2010, Vietnam overtook China as the world's largest manufacturer for Nike.

Human resources still an absolute advantage

Nevertheless, China still has an advantage in human resources for the next decade. Labor costs in central and western regions in China are lower than the coastal areas. Labor supply attracts manufacturing investments to these regions. Also, improved quality of labors is a new competitive advantage for China.

Manufacturing backflow exists in the U.S., but appears to be limited to high technology involved in high-end industries. Furthermore, human capital levels in the U.S. are declining because low-income families don't receive higher education.

Updating to a new version of world's factory

Building new competitive advantages should help to give China new opportunities. Government should provide an environment which helps to cultivate human capital. For example, governments can increase education and training expenditures to lower residents' own educational expenses. And governments can establish labor market regulations to correctly forecast demands for labor skills and properly guide residents in choosing suitable human capital investments.

Enterprises should promote technology innovation and research to upgrade their products and build strong brands. Additionally, promoting e-business could also save on transaction costs. Finally, companies should build international distribution channels and enter foreign markets through merger and acquisition deals.

The author is head of the Institute of Finance and Trade Economics at the Chinese Academy of Social Sciences (CASS).

This article was first published in Chinese and translated by Yan Xiaoqing.