China has made substantial headway in manufacturing since the 1990s and has become a world's leading manufacturer, upgrading its industrial base and upping productivity. Seven of China's 22 industrial sectors are the largest in their field worldwide; 15 sectors ranked in the top three based on share of world output. Among developing countries, China has the largest share in all sectors except one. High-tech products account for more than 40 percent of China's manufacturing exports, offering a glimpse of China's intention to become a manufacturing hub of high-tech goods. U.S. economics consultancy Global Insight projected China would surpass U.S. to become the world's largest manufacturer in 2009, four years earlier than expected. Although the forecast hasn't yet been confirmed, China's progress in manufacturing has been widely recognized. Of course, China still has to grapple with some fundamental and entrenched problems that hinder the upgrading of its manufacturing. During the worst financial crisis since the Great Depression the vulnerabilities of China's manufacturing sector were exposed and new problems emerged. The following are problems facing China's manufacturing sector.

1. Low productivity

The rapid development of China's manufacturing is largely fed by its vast pool of cheap labor. The quality and competitiveness of China's manufacturing sector has grown slower than its scale. Compared with developed industrialized countries, China's productivity and value-added are still at a low level, which is a fundamental problem that China cannot avoid during its rapid development. The latest statistics show that China's manufacturing productivity is about 4.38 percent of that in the United State, 4.37 percent of Japan's and 5.56 percent of Germany's. China is also a distant follower after the developed countries in the complexity of manufactured goods.

The value-added ratio, a comprehensive measured to gauge whether an economy is cost effective, is only 26.23 percent in China – 22.99 percent, 22.12 percent and 11.69 percent lower than that of the United State, Japan and German respectively. China's value-added rate is even lower than developing countries in Latin America, the Caribbean, West Asia and Europe.

Based on rates of return, manufacturing of the United State, Japan and German is strongest. Despite a lower share in its economy, US manufacturing output still accounts for 16 percent of its gross domestic product and 72 percent of its exports. In comparison, profit margin and return on invested capital of China's manufacturing have edged downward in recent years. In October 2008, China's manufacturing profit growth slipped compared with the same period of the previous year. A slimmer profit margin heralds a slipping profitability and a worsening business, and may result in a scaling down of production.

The features of China's manufacturing can be summarized as "two highs and one low." The growth of manufacturing and its share in gross domestic product is high, but manufacturing value-added per capital is low.

2. Shortfall in R&D spending

China has been at the low end of the global production chain for a long time, because it lacks the ability to innovate and has little intellectual property, core technologies and patents. For instance, China's patent filings for integrated circuits, a core component for electronic products, only account for 1.74 percent of the world total. Japanese companies top the patent filings for integrated circuits in China with 43.5 percent, followed by the U.S. and South Korean companies at 15.8 percent and 13.9 percent. Domestic companies only account for 8 percent. A lack of innovation hampers a manufacturer’s ability to upgrade its products and compete globally.

Both in theory and practice, the development of a company relies heavily on technological innovation, which in turn depends on research and development. Although this is a cliché, research and development remains an unsolved issue for China's manufacturing. Chinese companies devote significantly less cash to research and development than the world average. Big international companies generally put 5 percent of sales into R&D – sometimes even 10 to 15 percent. The vast majority of Chinese companies, excepting tech giants such as Huawei Technologies, do not reach the 5 percent level. According to the China Enterprise Confederation, average R&D spending in China's top 500 manufacturing companies amounted to 1.88, 2.29, 2.41, 2.13, 1.95 and 2.03 percent of sales from 2005 to 2010 respectively. (See Table 2-11)

Table 2-11. Share of R&D spending as percent of sales revenue for China's top 500 companies and China's top 500 manufacturing companies
                                                                                                                                         (unit: %)

Source: 2005-2009 China's Top 500 Companies Report

The table above suggests that R&D's share as a percent of sales revenue peaked at 2.41 percent in 2006 and then leveled off at 2 percent after a slight decline, less than half of the multinational companies' 5 percent. This may explain why competitiveness of China's manufacturing has grown slower than its scale expansion. Many large Chinese companies still dream of expanding their companies by introducing new equipment instead of investing in research and development to develop new, proprietary technology. In fact, the meager R&D output not only puts a dent in a manufacturing company's innovation, it also makes the company reliant on assimilation and imitation of imported technology. According to international experience, acquisition and assimilation of a technology give catching-up countries an advantage, but also cost the company money to assimilate and adapt newly introduced technology to local conditions. China companies' expenditures on technology assimilation are backward compared with the global level, threatening the ability of China's manufacturing companies to enhance productivity and catch up with their foreign counterparts. This is an alarming situation facing China's manufacturing companies.

3. Is bigger better?

A company is like a human being; it may look healthy and robust, but when it gets sick, one sometimes discovers it is quite fragile. "Big company disease" is a major, entrenched headache that a company can encounter after a period of growth that undermines its health. A bloated organization, atrophied management, and talent drain are typical symptoms of "big company disease." When we look back, we will find many famous companies collapsed after they got too big. GM, for instance, the centenarian auto giant, was almost killed by the disease when its corporate structure swelled, its bureaucracy ballooned, its spirit of teamwork deteriorated and it became too slow to react to change. Big names such as Nokia and Toyota also fell victim to "big company disease" as their products became mired in quality woes.

Unfortunately, some Chinese companies have developed early cases of "big company disease." For example, Sichuan TV maker Changhong Electric Co. caught the disease after being spoiled by rapid growth and suffering from top-down planning. Kelong is another good example in case. Xu Tiefeng, president of Kelong, said the sales of Kelong have kept rising in the recent years, but tell-tale signs of "big company disease" began to set in at the company: the growth rate slowed down and profitability declined. Lenovo Group, also a victim of "big company disease," was hard hit during the financial crisis and dropped out of the list of the world's top 500 companies. Why have so many not-so-big Chinese companies been troubled by "big-company disease" before they become a heavyweight? This is a question that the companies who hope to become a household name worldwide need to think about.

4. Energy-intensive projects rear their ugly head

Behind China's amazing manufacturing development is the undeniable fact that China still heavily depends on coal as a source of power. Despite its low energy efficiency, China's appetite for the dirty fossil fuel keeps growing. Statistically, China can be called a super manufacturer, but Chinese companies, which are big but not strong, have consumed massive amounts of energy and emitted pollution at unprecedented levels. A lot of energy-intensive, polluting industries have moved to China. The Chinese government announced in its 12th Five-Year Plan that it would reduce energy consumption by 20 percent and cut total pollutant emission by 19 percent before 2010. According to a national economic census, revised energy consumption fell 2.74, 5.04 and 5.20 percent in the three years from 2006 to 2008. Unrevised energy consumption for 2009 fell 3.61 percent. China had achieved a 16.59 percent reduction in its energy consumption for the period ending July 2010, still 3.41 percent short of the 20 percent target.

Since the autumn of 2008, some provinces had restarted energy-guzzling projects to fight the financial crisis and support economic growth. According to data from the Ministry of Industry and Information Technology, a breath-taking industrial expansion has led to a serious overcapacity since 2009. In the first five months of 2009, some steel mines revved up output without getting approval from authorities; investment in the cement sector surged by 78.6 percent during the period, leading to a total of over 200 production lines and an additional output of 200 million tons; the shipbuilding sector was beset with an idle production of 16 million deadweight tons, equivalent to one fourth of the total capacity; the total fixed investment asset in shipping industry jumped 55.5 percent in the first five months of 2009. Zhu Hongren, spokesman for the Ministry of Industry and Information Technology warned that the overcapacity resulting from the blind expansion may wreak great damage on the manufacturing sector as a whole. China reduced energy use by only 3.61 percent due to rebounding energy guzzlers in 2009, below the 5 percent reduction rate in 2007 and 2008 and even below the five-year period target of 4 percent. Even worse, for the same reason, energy consumption actually went up, not down in the first quarter of 2010, making it tougher to meet the five-year target.

Currently, it is really difficult to ensure economic growth while meeting targets for energy conservation as China embarks on an industrialization and urbanization drive. Moreover, the rebound in energy-intensive projects only adds to Chinese companies' difficulties in pursuing green development.

5. Rising labor cost

As a matter of fact, manufacturing costs in China are rising faster than manufacturing development. The China Enterprise Survey System recently conducted a survey on the difficulties facing Chinese companies' development. They found 70.5 percent of the companies who participated in the survey mentioned labor costs as a major difficulty, while 66.3 percent of the companies called rising prices of energy and raw materials as a significant problem. Among three key factors that impact the cost of manufacturing– labor, raw materials and fuel- labor cost has always been an issue that Chinese companies have to deal with. The labor law promulgated in 2008 imposed a strict minimum wage standard, making production more costly.

A vast pool of cheap labor has been a boon to China's manufacturing capabilities, but that advantage cannot sustain the development of China's economy anymore. A report by US consultancy firm Jassin O'Rourke said China's labor costs are higher than seven other Asian countries. The hourly pay in China's costal industrial provinces is $1.08, and $0.55-0.80 in China's inland. India ranks seventh at $0.51. The lowest labor costs are in Bangladesh, where an average hour of labor costs a mere $0.22, five times lower than in China's richest coastal areas. Since 2010, rising wages have driven up manufacturing costs. Jiangsu Province led wage hikes at the beginning of 2010, followed by Ningxia, Jilin, Shanxi, Shanghai, Zhejiang, Fujian, Guangdong, Tianjin and Beijing, all of which lifted the minimum wage by 10 to 20 percent. Currently, Shanghai has the highest minimum wage in China, at 1,120 yuan per month, and Guangdong pays the highest hourly wage at 9.9 yuan per hour. Foxconn and Honda have raised the wage of workers in their plants in China's costal provinces by 10 to 20 percent since May 2010. The national average wage standard will increase at a double-digit pace in 2011 due to labor shortages and workers' growing awareness of labor rights, a report forecast.

This is not a company problem, but rather an industry problem. China's wages have remained low for a long time, growing slower than the economy and company profits. The share of national income that is paid out in wages has been on a downward trajectory since the start of the Reform and Opening Policy in 1978. The prosperity of China's economy has come at the cost of benefits for workers, who have been paid a meager wage. However, wage inflation will impose a burden on manufacturers who operate at a lower margin, cutting into their profits. As a result, it makes sense for Chinese companies to move away from reliance on cheap labor towards a higher-value growth model.

Summary	Report on Top 500 Manufacturers of China in 2010
Chapter I.	Scale and Distribution Features
Chapter II.	Performance Features
Chapter III.	Industrial Structure and Distribution
Chapter IV.	Regional Distribution
Chapter V.	Ownership Distribution
Chapter VI.	R&D Expenditure