The Asian Chemical Industry at the Crossroads
Hiromasa Yonekura (President, Sumitomo Chemical Co., Ltd.)
Presentation made on November 5, 2003 for Societe de Chimie Industrielle luncheon at The Yale Club in New York. Posted here with permission.
In this paper, I would like to discuss: i) a broad overview of some of the key economic and industrial trends in the region; ii) the challenges that the Japanese business and industry is faced with; and iii) the strategies that Japanese companies have been pursuing to respond to the competitive industry dynamics in the East Asian region, particularly China.
East Asia has been the fastest growing region of the world over the last few decades. Despite occasional economic turbulence -- such as the monetary crisis in the late 1990s and the economic downturn brought about by a sharp drop of demand for IT products in the United States in 2001 as well as the SARS epidemic early 2003 ? the East Asian countries have been expanding vigorously.
Reflecting this, trade within the region has also grown significantly. During the 14-year period from 1989 to 2002, the magnitude of growth of intra-regional trade is truly striking. For example, Japan's exports to East Asia increased from 78 billion to 171 billion dollars, and its imports from the region increased from 57 billion to 131 billion dollars. In 1989, Japan exported significantly more to the United States than to the East Asian region; but, in 2002, Japan sold more to East Asia than to the United States. China's trade with the Association of Southeast Asian Nations (ASEAN) also sharply increased. For example, ASEAN's exports to China and Hong Kong together showed a remarkable increase from 4 billion in 1989 to 25 billion dollars in 2002.
Given the strong growth potential of intra-regional trade in Asia, I believe that regional economic integration among Asian countries will become more realistic within the coming decade or so. Let me elaborate this in some detail. Japan's GDP is estimated to be 4.3 trillion dollars in 2003 (at the exchange rate of 110 yen to a dollar). This amount is not much below the aggregate GDP of China, South Korea, Taiwan and the ASEAN countries, which amounts to 4.5 trillion dollars. Thus, the size of the economy of the East Asian region amounts to about 8.8 trillion dollars today. If it continues to grow in coming decades, it will become comparable with the economy of the United States, with the GDP amounting to 10 trillion dollars, and also with that of EU15, with the GDP of 8.6 trillion dollars. East Asia will become one of the three economic powerhouses in the world, which will be led by China and Japan as the major driving forces. Needless to say, if India will participate with its 1 billion potential customers, she will become additional driving force of the region's development. The combined population of China and India (1.3 billion) will be 40 percent of the world population (6.3 billion).
Perhaps the best way to grasp the dynamic changes that are taking place in the industry in East Asia is to focus on China and Japan, each of which is faced with different kinds of challenges. Let me discuss issues by taking the chemical industry as an illustrative example. Let us first look at China. China's petrochemicals growth is forecast as high as 9 percent a year in the period from 2003 through 2007. To meet such rapidly increasing demand, China has been trying to expand its production capacity through debottlenecking and new grass-roots projects, taking advantage of foreign capital, technical know-how and managerial systems. China has also been pursuing major restructuring efforts, beginning with the restructuring of the government agencies responsible for the industry. For example, an agency in charge of petroleum and chemicals has been established by integrating several relevant government bodies. Public corporations in these fields were grouped under two large organizations, China National Petroleum Corporation (CNPC) and China Petroleum & Chemical Corporation (SINOPEC).
Such reorganization represents China's attempt to meet intensifying competition, especially after entry into the WTO. Both CNPC and SINOPEC have been listed on stock markets in New York and Hong Kong through their subsidiaries. This represents China's serious attempt to restructure its oil and petrochemical industries. I believe that China will succeed in carrying out the restructuring of the chemical industry and continue to be a big magnet for foreign direct investment for years to come.
You may wonder about the apparent absence of major commitments to large-scale petrochemical projects by Japanese companies in China. There are three major reasons for this:
First, Japanese chemical companies did not feel comfortable enough to make major commitments because of the lack of industrial infrastructure in China, including railways, trucking, and other means for transporting bulk chemicals. While China has striking advantages in terms of the size of the domestic market and highly competitive labor cost, it does not enjoy such an advantage in terms of feedstock price. The distance from the United States and Europe is much greater than that from East Asian countries. Thus, Japanese petrochemical companies felt that they could comfortably supply China with products from their home plants. They were also concerned about the often-inadequate administrative infrastructure, such as tax and legal systems for the protection of investors' interests and property rights.
Secondly, Japanese petrochemical companies have heard stories of failure or difficulties in doing business in China from other Japanese companies which had invested in China earlier and unfortunately failed. They are mostly medium- and small-sized companies that built transfer plants in China to cope with sharp appreciation of the Japanese yen vis-a-vis the U.S. dollar, especially after the Plaza Accord in 1985. Many of these Japanese companies failed to make profits and became extremely cautious when it comes to direct investment in China. To be fair, some of the difficulties that Japanese companies experienced were of their own making. Many of them rushed to China without adequate knowledge of the local language, business practices, administrative systems, and customs and habits of the consumers, and were unsuccessful.
Thirdly, and perhaps the most important reason, is that the Japanese chemical companies have been concentrating on serving their highly demanding customers in the automotive, electronics, and home appliances industries in Japan and the United States. Thus, while Japanese chemical companies are acutely aware of the importance of China as a huge potential market, they have remained rather reluctant to make major commitments. They have accordingly been taking a "wait and see" attitude.
In the mid-1980's the U.S. Trade Representative visited with Deng Xiaoping, then-Chairman of Chinese Communist Party's Central Advisory Commission at Beijing to discuss, among pending trade-related issues, the protection of intellectual property rights. The Chinese leader, who took a bold initiative to turn around China's economic system from a communist to market-oriented one, is said to have told the U.S. chief negotiator that many centuries ago when China made the great technological inventions of gun power, printing and a navigation compass, it did not ask the foreign beneficiaries to pay royalties.
At any rate, I applaud the fact that the legal framework for the protection of intellectual property rights is improving in China. Since its entry into the WTO, China has been working to install systems to protect intellectual property rights and improve the environmental performance of their products and processes. When it comes to enforcement of such protection systems, it is still an issue and a source of our serious concern, particularly in the industries, including agricultural chemicals and pharmaceuticals.
In the electronics and electronic appliance industries, most of the leading companies such as Toshiba, Sony, and Panasonic have built a number of large-scale plants in China for local production on an OEM basis. In order to reduce business risks, a number of Japanese companies have been entering the Chinese market in collaboration with Taiwanese partners who know the local languages and are very familiar with business practices there.
Despite the existing political constraints between China and Taiwan, Taiwanese companies have made significant investments in China, particularly in the electronics industry, and employ reportedly as many as 10 million local people, the same number as the total employment in Taiwan itself. Two thirds of China's exports of electronics products are reportedly being shipped from Taiwanese transfer plants.
Japan's major auto manufacturers, such as Toyota, Nissan and Honda, have decided to enter the Chinese market. For example, Toyota announced a venture with First Automotive Works to produce up to 400,000 cars annually by 2010.
One of China's striking advantages is its extraordinarily abundant and diligent work force and low labor costs. Indeed, China's wage levels are about one twelfth those of Japan. According to the results of a comparative survey on labor costs in various countries in Southeast Asia which was conducted by the Singapore branch of Japan's UFJ Bank, the general worker's relative labor cost index was, assuming the labor cost in Japan as of November 2002 is 100: 8.2 in Shanghai, China; 6.5 in Bangkok, Thailand; 8.3 in Kuala Lumpur, Malaysia; 4.3 in Jakarta, Indonesia; and 3.9 in Hanoi, Vietnam. As you note, only a few countries, such as Vietnam, are able to effectively compete with China in terms of unit labor cost. A number of Japanese and Taiwanese companies have been making or planning direct capital investments in Vietnam by utilizing industrial parks there.
In China, a recruitment system, which may be called "the fixed-term recruitment system," has been developed for the effective transfer of labor resources between the rural areas and urban industrial centers like Shanghai. In this system, with the help of local administrative bodies or recruitment organizations, young people who have just finished elementary school education are dispatched to factories in specific urban areas. They work for 3-4 years in factories that are well-equipped with company housing, cafeterias and other facilities, and thus are able to save enough to buy a modest house with furniture and electric appliances and earn a secondary school diploma before returning to their home villages. When one group leaves the assigned factory, a fresh group of young people comes to work at the same location.
In my view, China's basic strategy toward industrialization has two distinct features:
First, for developing new industries, China has been introducing the foreign technologies, capital and management systems needed to achieve growth, while allowing public enterprises to take time to reform. Public corporations have been organized as administrative units that have their own hospitals, schools, supermarkets and the like, and employ a very large number of people. It is a big challenge for China to reform such public corporations in order to enhance their competitiveness vis-a-vis overseas firms. They seem to be taking a sensible approach to reforming public corporations, since hasty privatization would be extremely counterproductive and bound to fail.
Another striking feature of the industrialization process is the "simultaneous, multiple-sector approach," whereby China simultaneously pursues both labor-intensive and highly sophisticated capital-intensive industries. Thus, in addition to traditional labor-intensive industries such as textiles, dyestuffs and household electric appliances, China has been effectively pursuing vigorous development of capital-intensive industries, including machinery, telecommunications, automobiles, and semiconductors.
China's industrialization process is apparently different from the so-called "flying geese formation" process, which was applicable to the Asian tigers and Southeast Asian economies. In that instance, Japan spearheaded the process of industrialization, followed by Singapore, Taiwan and Korea, and then other Southeast Asian countries such as Thailand, Malaysia and Vietnam.
The Japanese manufacturing industries are confronted with the problem of the "hollowing-out" of their major customer industries in Japan. Indeed, many companies in Japan's home appliance and electronics industries as well as other manufacturing industries have already shifted their production bases to Southeast Asian countries and China.
Competition among the producers in the region is extremely keen. In notebook PCs, Taiwan's share continues at a high level, and Singapore's position is predominant in manufacture of HDD. In consumer electronics products such as DVD players, VCRs, and mobile phones, China's production share has been increasing rapidly over the past few years. The important lesson each company or each country should learn is that, to achieve the best possible results, it has to select core businesses and technologies in a very timely manner and concentrate its managerial resources on those areas where it has a distinct comparative advantage. I would predict that a series of dynamic restructuring moves through M&As and strategic alliances will take place among Japanese companies more frequently in the coming years. In the process of pursing such strategy, Japanese private sector companies can no longer expect the Ministry of Economy, Trade & Industry, the pertinent government agency, to take the kind of initiative that it did after the second oil crisis in 1979. Individual chemical companies have to tackle surplus capacity problems on their own, instead of resorting to industry-wide consensus, where the initiative often originates with government agencies.
Because of intensifying global competition, private sector companies are giving greater emphasis to applied research that will enable them to introduce new products to the market in the shortest period of time possible. Hence, industries like ours look increasingly toward universities and other basic research institutes for discovering innovative technologies. At the same time, rapid and phenomenal development of IT has been bringing about a new industrial revolution, and has become the driving force behind drastic changes in modi operandi of business as well as research and development activities.
With the extensive use of IT, the physical boundaries between private sector companies and universities have practically disappeared, enabling researchers in both academia and industry to communicate and collaborate with research institutes at home and abroad on a much broader basis. I believe in this regard that building close cooperative relationships among the United States, Europe and Japan in the fields of advanced technology should be an agenda of high priority for both industry and academia. All the parties concerned stand to gain a great deal through such collaboration.
On the part of Japanese companies, it is a challenge to work out a "new management system" that makes effective use of Japan's close human network. While Japan is equipped with human resources that are well-trained in manufacturing and the knowledge to develop new skills, it is not sufficient to succeed in the era of globalization and the IT Revolution. One of the important challenge for Japanese companies is to develop an "entrepreneur ecosystem" which can fully utilize advanced technologies such as biotechnology and nanotechnology both inside and outside Japan. And if Japanese people do not justify pessimism, Japan's economic future in the coming decades will be very bright.