Domestic Flying Geese: Industrial Transfer and Delayed Policy Diffusion in China

06/20/2017

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Yuen Yuen An

Abstract
This study illuminates the important yet under-studied phenomenon of industrial transfer in China: the migration of capital and investment from wealthy coastal areas into poorer central and western provinces, beginning in the 2000s. By 2015, the value of domestic investment in five central provinces alone was 2.5 times that of foreign investment throughout China. Compared to the original “flying geese” model of tiered production in Asia, China’s experience is distinct in three ways: (1) industrial transfer occurred domestically, rather than across nations; (2) subnational transfer followed cross-national transfer; and (3) industrial migration is accompanied by a delayed replication of government policies. While coastal locales today resolve to expel low-end industries, inland governments cannot afford to be selective and have recently adopted aggressive investment promotion tactics that coastal cities abandoned years ago. Policy diffusion is delayed as policy adoption depends on economic conditions, which varies widely across China and changes over time. Keywords: Industrial transfer; flying geese model; delayed policy diffusion; industrial policy; domestic investment; regional development China’s stock market meltdown gripped headline news around the world in the summer of 2015. Its impact reverberated across the globe, putting a dent on stock markets in Asia, Europe, and America. While the causes of the panic are complex and multiple, one of the deepest fears behind the sell-off is the impression that export-manufacturing—the engine of China’s hyper-growth over the past three decades—has hit the doldrums. Manufacturing output fell worryingly to a 3-year low in 2015 and continued to shrink in 2016. While the aggregate picture appears bleak, it must be stressed that only a thin geographic slice of China—concentrated in the coastal cities—makes up the factory of the world. In 2006 the five coastal provinces of Guangdong, Jiangsu, Zhejiang, Shanghai, and Shandong accounted for 76 percent of the value of total exports. Undoubtedly, manufacturing has taken a hit in coastal China. Factor and labor costs are rapidly rising, eroding profits and competitiveness among export manufacturers. This dire situation, reflected in gloomy statistics and media reports, fanned worries about the weakening of the entire Chinese economy. The ongoing hype about the manufacturing crisis on the coast, however, has obscured discussion in both scholarly and popular literature of a significant new trend: the migration of capital and investment from wealthy coastal areas into poorer central and western provinces, beginning in the early 2000s. This phenomenon is termed “industrial transfer” (chanye zhuanyi 产业转移) in Chinese, which is much harder to define and quantify than industrial output because transfer (or relocation) is dynamic and multifaceted. Nevertheless, official statistics on “domestic investment” (shengwai zijin 省外资 金), a relatively new terminology, indicates a steady surge of investment from the coastal to inland regions. To illustrate, in 2008, the combined value of domestic investment that flowed into five central provinces of Jiangxi, Henan, Hunan, Hubei, and Anhui was 836 billion Yuan. In 2015, seven years later, it ballooned to 3,760 billion Yuan. This was 2.5 times the amount of foreign direct investment (FDI) that flowed into China in the same year. Furthermore, this comparison only includes domestic investment in five central provinces, excluding the Western provinces and industrial transfer within the coastal region. Despite the fact that domestic investors are assuming an economic role as formidable as that of foreign investors in the earlier decades,7 it has received scant mention in the scholarly literature. The purpose of this research report is to lay a macro-historical foundation for further empirical investigation into the trend of industrial transfer. I address a few basic questions: What were the historical processes leading up to industrial transfer today? Why did this pattern emerge only in the early 2000s but not earlier? What are the economic and regulatory forces that have accelerated industrial transfer? What are the implications of industrial transfer for the reshaping of China’s national competitive advantage? Addressing these questions will help us see the big, evolving picture of China’s economy and enable us to identify micro-level questions for study. From a comparative perspective, China’s industrial transfer is unique in that it manifests a domestic version of the “flying geese” model. Coined by Japanese economist Akamatsu, the term “flying geese” refers to a tiered system of development in Asia. Like the lead goose in a V-shaped formation, Japan was the first to launch late industrialization and hence the most advanced economy in the region. It occupied the highest end of the regional supply chain, while other nations took on lower-level production. In exchange, lead economies transferred capital and technology to laggard economies, thereby assisting them in the process of industrial catch-up. In other words, the flying goose model describes a division of labor that can generate mutual benefits among unevenly endowed nations. China’s experience departs from the original theory of flying geese in three significant ways. First, China displays a pattern of differentiated production and industrial transfer across sub-national regions within a nation, rather than across nations within a region. This occurs because China’s vast size renders it more like a continent than a country. Compared to other countries in East Asia, such as Japan and South Korea, China is many times larger and displays far wider sub-national inequality. This calls for a rethinking of Michael Porter’s classic theory of national competitive advantage. In his influential book, The Competitive Advantage of Nations, Porter names four factors that affect national competitiveness in the global market: endowed factors, home demand for products and services, structure of supporting industries, and structure of domestic enterprises. Treating nations as homogeneous, Porter’s theory completely ignores regional economic relations. For large countries like China, promoting regional complementarity and niches—in addition to competition—is key to national competitive advantage. Second, in China, cross-national and sub-national transfer of industries are sequentially linked. Following market liberalization in 1978, scores of factories from East Asia, especially Hong Kong and Taiwan, moved to China’s coastal areas to exploit the region’s competitive advantage in low-cost, labor-intensive, export-oriented manufacturing, which fueled rapid industrialization and trade expansion on the coast. But while coastal provinces grew wealthier by leaps and bounds, central and western provinces lagged behind by several orders of magnitude. By the 2000s, the coastal cities switched roles from recipient to investor, bringing opportunities of late industrialization to laggard provinces. Third, departing from the original flying geese model, which highlighted only the transfer of capital and technology, China is now experiencing a transfer of government policies and practices, in addition to capital, across regions. While coastal locales today can afford to pick winners and resolve to expel low-end industries, inland governments have little choice but to welcome virtually all investment projects, regardless of quality. Interestingly, the latter has also belatedly adopted aggressive investment promotion tactics that were earlier practiced but abandoned on the coast ten to twenty years ago. In other words, within China, we see a delay in the diffusion of government practices across regions. This lagged pattern has not been picked up in the existing literature on policy diffusion, which assumes that any experiment, once proven successful, can be replicated across the country simultaneously. My study, on the other hand, reveals that the replication of government practices and experiments is dependent upon economic conditions, which varies across regions and changes over the course of development. Strategies that worked on the coast did not work in the interior during the 1980s and 1990s, as inland governments simply could not compete against coastal cities in attracting foreign investment. It was not until the mid-2000s, when coastal investors turned inward, that interior regions received a new lease of growth opportunity. Therefore, future studies of policy diffusion must take into account the effects of economic conditions, as well as sequence and timing, on policy replication. What works in one region may not work in other regions until a later point in time. The rest of my discussion proceeds as follows. The first section traces the evolution of cross-national industrial transfer from East Asia to coastal China in the 1980s and 1990s to domestic industrial transfer from the 2000s onward. The next two sections zoom in respectively on cost and regulatory pressures that push traditional manufacturers to relocate from the coast. The third section simultaneously reveals delayed institutional changes that have occurred within local governments in the interior, as well as different levels of selectivity and policies made with regard to evicting low-end industries. Finally, I conclude with the implications of industrial transfer for the remaking of China’s competitive advantage and suggestions for future firm-level research on industrial transfer.
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