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EMS, China and the WTO: EMS providers can benefit from China's accession to the WTO through tariff cuts, elimination of non-tariff barriers and distribution freedom.

China was a founding member of the General Agreement on Tariffs and Trade (GATT), the predecessor of the World Trade Organization (WTO, Geneva, Switzerland), when the organization was established in 1946. That membership eventually became a casualty of the Chinese revolution. In 1986, the country, in a period of substantial reform and liberalization, applied for readmission. Re-entry negotiations took another 13 years, primarily because China was unwilling to make necessary economic reforms concerning sensitive sectors.

Several factors finally drove WTO negotiations to a successful conclusion. In China, the gap between internal economic reforms and the reforms demanded by Western WTO members had narrowed considerably. Joining the WTO not only opened new markets for exports, but also cemented, accelerated and justified an often painful reform process to hostile constituencies.

Western members recognized, through heavily invested companies such as Motorola, that China was too important to ignore. Western leaders could see sustained economic growth, averaging over 9 percent, and the beginnings of a broad-based reform process in the country. By 2000, China had become the seventh leading exporter, and eighth largest importer, of merchandise trade. Foreign firms had invested over $400 billion, and the country had become the second largest destination for foreign capital investment--second only to the U.S. (1) Moreover, Western leaders saw a gigantic population, diverse enough to provide foreign manufacturers with an unending supply of low-wage workers and a massive consumer middle class.

Finally, Western leaders realized that failure to admit China to the WTO was not an option. Failure would not only undermine the organization, but would also damage international investors, destabilize the global supply chain emerging around Chinese manufacturing and close markets that promised rapid, sustained growth. The U.S.-China Bilateral Market Access Agreement concluded in November 1999 and was followed by the completion of bilateral trade negotiations with a series of countries in 2000 and early 2001. In September 2001, WTO negotiations concluded, accession was formally announced in November 2001 and China's official membership began in 2002. (2)

Benefits to EMS Providers

For electronics manufacturing services (EMS) providers, as for most industries, one overarching impact of China's accession exists--the WTO accelerates the economic reform process. Government-driven costs go down, domestic demand goes up and investment accelerates. For many companies, the Chinese business environment, before WTO involvement, was a business nightmare--too important to avoid, but too costly and unpredictable to allow for success. In joining the WTO, the country has committed to sweeping changes that will lead to fewer and more transparent regulations, equal treatment for foreign and domestic businesses and fewer barriers to investment and trade. Over time, these changes will reduce the costs and unpredictability of doing business in China.

Specific aspects of the WTO agreement that will most directly affect the EMS industry can be divided into three categories: 1) elimination of tariffs; 2) equal treatment and elimination of non-tariff barriers; and 3) freedom to distribute and service products throughout China.

Tariffs

For all industrial goods, the average tariff level will go down to 8.9 percent. Some tariffs will be eliminated, and others reduced by 2004 at the earliest, but no later than 2010. Tariffs for electronics and information technology (IT) products, prior to the WTO membership, were relatively low, averaging 6.4 percent. All of these tariffs will be completely eliminated over a three-year period. The first phase of the reduction took place in January 2002, with tariffs on electronic products falling 33 percent and 73 percent on other IT products. All duties were eliminated on scanners, laser and ink jet printers, all types of disk and CD drives, minicomputers and mainframes. Tariffs on many components and semiconductor materials were reduced from 14 to 6.2 percent. Tariffs on laptops fell from 15 to 3.8 percent.

Components and subassemblies enjoyed particularly low (two to three percent) tariffs before accession. These tariffs were eliminated entirely in January 2002. Some wire harnesses and amplifiers, particularly those used in automotive electronics, were taxed at higher rates, ranging from 8 to 20 percent. These tariffs will be phased down significantly over a period of up to five years.

China is likely to see a wave of electronics imports in the near future. Cell phone imports from Korea and Taiwan have surged, and laptop manufacturers, such as IBM, Toshiba, Dell, Acer and Compaq, are selling more aggressively into the Chinese market according to a Digitimes.com (Taiwan, China) report. (3) On balance, the WTO will further increase net exports.

Non-tariff barriers

In addition to tariff reductions, the WTO calls for the elimination of non-tariff barriers, such as local content requirements, restrictive licensing and export requirements. A press release, issued by the WTO on September 17, 2001, confirmed that China agreed to, "... provide non-discriminatory treatment to all WTO members. All foreign individuals and enterprises, including those not invested or registered in China, will be accorded treatment no less favorable than that accorded to enterprises in China with respect to the right to trade."

However, implementation is expected to be slow and inconsistent. (4) Legal reform has progressed over the years, but thousands of laws and regulations--at all levels of government--must be revoked or rewritten, and officials must be retrained accordingly. Conflicts of interest still exist--some government or party officials have close ties to enterprises that could lose protection under the WTO agreement. A recent survey of foreign companies indicated that, while China's environment for investment continued to improve in 2001, corruption actually worsened. (5)

Even if regulations requiring local content are abolished, the EMS industry may not be affected. According to Kent Chen, vice president for Solectron in China, "My customers are emphasizing local content even more. The government has loosened regulations, but businessmen need to buy locally because costs are cheaper. [The] WTO creates more competition, so they need to be cheaper."

Another concern is currency management, as the WTO does not lift restrictions on currency exchanges. According to Thomas Xie, director of finance, Flextronics Shenzhen, the original equipment manufacturers (OEMs) focused on the Chinese market find themselves with large surpluses of Chinese Renminbi. These OEMs prefer EMS partners in China who can be paid in Chinese currency. Multinational EMS companies prefer suppliers in China for the same reason.

Freedom to distribute and service goods

Before the accession, foreign-funded enterprises in China were not allowed to distribute goods--unless those goods were produced in China. Such enterprises were not allowed to own or operate distribution, wholesale or warehousing networks--activities handled by inefficient, government-designated (or owned) agents. The terms of accession state that, "Within one year after China's accession to the WTO, foreign service suppliers may establish joint ventures to engage in the commission agents' business and wholesale business of all imported and domestically produced products ... Within two years after China's accession to the WTO, foreign majority ownership will be permitted and no geographic or quantitative restrictions will apply." (6)

The opportunity to take on distribution and service functions is attracting global EMS providers. For China in particular, WTO terms differ in two ways. First, prior to accession, both foreign OEMs and EMS providers were locked out of distribution and service. OEMs were forced to rely on local partners. So, in marketing these services, EMS providers are not competing against pre-existing OEM investments. Instead, EMS providers need to build services to outperform local third parties--to offer a superior alternative to "in-sourcing."

Secondly, companies attempting to introduce service and distribution services in China will not find established multinational third-party logistics companies (3PLs) to assist them. Many 3PLs are just emerging in China. FedEx, for example, is currently expanding into Southern China and is eager to pioneer logistics business.

New Customers

Rapid growth in China's electronics market has not only expanded, but also shifted, the types of opportunities available to EMS providers. Early EMS investments in China were focused on providing low-cost manufacturing for multinational OEM customers who wanted to export products. As OEMs began to target the domestic Chinese market, they brought EMS partners along. Currently, first-tier EMS providers are beginning to target Chinese OEMs as customers.

Selling to domestic OEMs is a challenge, says Xie, because of their focus on low price and difficulties in honoring 30- or even 60-day net payment terms. Flextronics considers Chinese customers if the government, or a bank, will guarantee payments.

Also, because many local OEMs tend to focus on price rather than quality or brand value, the investment that first-tier EMS providers' have made in quality may price them too high for local OEMs.

However, Chen was more optimistic about the market. He says Solectron is actively learning how to target domestic OEMs. "Price is not the only priority for the Chinese OEMs," he said. "We offer time to market, quick ramping and a [faster] incorporation of new technology." Chen also said that Solectron's global footprint made it an attractive partner for Chinese OEMs selling internationally. "We can help them by doing final box build overseas, near their customers, or by manufacturing subassemblies in China, then shipping to their facilities overseas."

New Competition

The concept of EMS is relatively new in China. Many electronics professionals see EMS as a first step for companies that hoped to develop into original design manufacturers (ODMs) and ultimately OEMs, rather than a stand-alone business model. Xie anticipates that local EMS providers do not pose a significant, competitive threat to first-tier multinationals in the near future. He feels local EMS providers are not sufficiently mature in sourcing, materials management or technology, and may take up to five years to become competitive.

In contrast, Chen says Solectron sees competition coming from every corner of the globe, citing not only local companies, but also foreign EMS providers and Taiwanese ODMs relocating manufacturing to the mainland. Concerning the EMS industry, he feels that the WTO does not equal a significant change, but an acceleration of both opportunity and competition. Chen's prescription for success in China is twofold: 1) engage the government to take advantage of liberalization--establish an EDI-based customs tracking system to cut down on costs and accelerate the cash cycle; and 2) establish superiority on at least one competitive front, such as procurement, materials management or technology, while remaining competitive on other fronts.

References

(1.) http://english.peopledaily.com.cn/200203/14/eng20020314_92082.shtml.

(2.) For the terms under which China acceded to the WTO, visit www.docsonline.wto.org.

(3.) To view the report, visit http://www.digitimes.com/NewsShow/Article.asp?IR =N&ClassID=502&datePublish=2002/03/07&pages=09&seq=52.

(4.) Morrison, W. RS20139: China and the World Trade Organization. National Council for Science and the Environment. http:#cnie.org/NLE/CRSreports/ Economics/econ-42.cfm.

(5.) Floyd, S. China's investment environment continues to improve. China Online.http:#www.chinaonline.com/commentary_analysis/thiswk_comm/020109/(2 01122031.asp.

(6.) WTO. Report of the Working Party on the Accession of China. http:#www.gsei.gansu.gov.cn/lay/wto/03.htm.

Matthew Chanoff is a consultant with Technology Forecasters, Inc., Alameda, CA; (510) 747-1900.
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Title Annotation:ectromechanical systems; EMS
Author:Chanoff, Matthew
Publication:Circuits Assembly
Geographic Code:9CHIN
Date:Jun 1, 2002
Words:1832
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