New policy directions that will shape China's manufacturing sector were unveiled in the 2020 Government Work Report (Report) at the recently-concluded Two Sessions, the key annual event in China's political calendar. This report analyzes key outcomes from the Report, industry trends, and highlights key takeaways for multinational corporations (MNCs).

1. From Manufactured IN China to Manufactured FOR China

The shift from "manufactured IN China" to "manufactured FOR China" is being accelerated by a government agenda aimed at boosting domestic consumption and industrial transformation. Employment and livelihoods were at the core of the 2020 national development strategy outlined at the Two Sessions, signaling greater momentum for domestic-oriented manufacturing.

In a growing number of sectors, China's salient role will be as a market rather than a supplier. Previously, goods were designed and produced mainly for global markets and overseas customer needs to meet Western-dominated standards. With the rise of "manufacturing for China," companies need to orient their mindsets and operations towards the Chinese consumer. The State Council on June 23 released a guideline to support export firms selling products in the domestic market by easing market access, expanding sales channels, and strengthening financial assistance.

Policy Triggers

Two external factors are driving the shift to “manufacturing for China.” The first is the sharp decrease in overseas demand in the wake of COVID-19. The second is the worsening of geopolitical tensions. Both the pandemic and China-US trade war are exacerbating deglobalization. More states and companies are inclined to rely on local production to mitigate risk.

Global trade remains important, but China's economic growth drivers will lean more towards domestic demand, as shown by the growing weight of consumption in GDP.

Chart 1: The Contribution of Consumption to Annual GDP, 2010-2017

Consumption, Annual GDP, Percentage of Consumption in GDP

*Sources: National Bureau of Statistics

Policy Directions for Manufacturing

Confronting greater external uncertainty, the Chinese government plans to upgrade and integrate manufacturing with the digital economy to gain competitive advantage. The Report highlights the Industrial Internet and Intelligent Manufacturing as ways to raise the quality of Chinese manufacturing. Both will be key policy threads in the new story of Chinese manufacturing. The government will seek to phase out traditional manufacturing – intensive in labor, pollution and energy consumption – and develop advanced manufacturing.

Key Driving Forces

Three infrastructure-oriented drives will support the shift to high-end manufacturing: "new infrastructure," "new urbanization," and "major projects" on basic infrastructure, known collectively as the "Two New and One Major."

In 2020, this will be funded Special Local Government Bonds of CNY 3.75 trillion and central government fiscal support of CNY 600 billion, along with a massive increase in medium- and long- term loans to manufacturing.

The push to develop "5G plus" urban infrastructure and transfer rural residents to medium- and small-sized cities will fuel demand for high-tech and construction-related products, respectively. For instance, renovating 39,000 old residential areas will spur demand for facilities such as water pipes and elevators. As previously, government-led investment is being used to stimulate the economy, but this is now more closely linked to people's everyday needs.

Main Catalysts

The Report outlines several catalysts for manufacturing transformation. On the positive side for advanced manufacturing, the government will support innovation, international cooperation, and IPR protection, and liberalize inputs including land, capital, and data. This also applies to SOEs. According to an action plan unveiled before the Two Sessions, SOE mixed-ownership reform will be expanded and restructuring will be accelerated in a number of sectors, including equipment manufacturing, chemicals, and gas and oil assets. On the negative side for traditional manufacturing, stricter regulation of environmental protection and production safety will drive low-end firms from the market.

For all manufacturing enterprises, the cost of compliance will climb. This will be especially painful for firms and sectors that lack the technology to offset negative impacts. Sustainability will be an increasingly important source of competitive advantage. For example, Huntsman has completed its Polyurethanes Tianjin System Plant to produce high-performance products, aligning with circular economy practices to meet China's growing emphasis on sustainability.

2. Key Manufacturing Trends in China

Analyzing the 2020 Report highlights three key trends for the future of Chinese manufacturing:

Acceleration of Innovation and Digitization

China has made huge strides in innovation in recent years, becoming a global force in digital economy and Artificial Intelligence technologies. From 5G to New Energy Vehicles, policymakers and companies are looking to upgrade China's manufacturing capabilities by embracing Industry 4.0, which encompasses automation and data exchange such as cyber-physical systems, Internet of Things, and cloud computing.

Many such technologies are homegrown rather than adopted from the West, creating a Chinese model of digitization that will profoundly impact global competition in the long run. Manufacturers will use real-time data to link product designers, smart factories, and distribution centers across the value chain. The spread of e-commerce and digital payments and COVID-19 disruption of physical operations has sped up this process. For example, besides its T-mall and Taobao B2C platforms, Alibaba has launched 1688.com for B2B customers.

Does the shift to domestic-oriented manufacturing mean MNCs are done in China? No. Foreign capital, technology, and talent are still highly valued by the Chinese government and seen as enablers for Reform and Opening-up. At the Two Sessions, it was announced the negative list for foreign investment will be shortened and hidden barriers to market entry dismantled. 

So, how should MNCs adapt to thrive in the new era of "manufacturing for China"?

• It's time for executives to reassess the role that China operations play in global strategy and value chains. This means clearly defining aims for the China market, such as deciding if China is to be a key growth engine or if sales will be targeted to niche areas.

  
  

• Given the government's continued role in shaping markets, MNCs can bolster their position by elevating contributions to national development beyond just employment and tax. This could entail optimizing investment in China as part of a long-term strategy, investing more and doubling down on core value creation activities – for example, playing enhanced roles as an R&D collaborator, JV partner and advisor to the government. MNCs with an edge in technology and compliance have a favorable window to engage and unlock opportunities.

  
  

• Effective localization of R&D, management, and marketing should be embedded in digitization strategies. For example, MNCs can proactively engage and build alliances with Chinese tech giants such as Tencent and Alibaba, who have a deep understanding of local realities. Companies such as Siemens and Royal DSM are opening flagship stores on 1688.com to serve booming demand for online B2B purchases.

  
  

• MNCs need new ways to tap dispersed high-growth markets beyond their first-tier metropolis comfort zones. The “New Urbanization” strategy focuses on smaller tier three to tier five cities and will drive demand in these scattered, less accessible areas. These more complex geographies present supply chain challenges that call for agile business organization, flexible and efficient systems for sales and distribution, and specialized local knowledge of customer preferences.

  
  

• More importantly, success in lower-tier markets is strongly affected by local government, requiring MNCs to strengthen relationships with local stakeholders. To tap growth in tier three hospitals and beyond, Boston Scientific has prioritized "wide coverage" and "strengthening local cooperation," joining with partners to innovate "Internet Plus" healthcare models.

  
  

• MNCs should consider building alliances with Chinese companies ranging from SMEs to SOEs. Such partnerships are more than just a combination of MNC technology and local market sensitivity; they are also tools to cultivate and manage key stakeholders such as local government and potential investors. MNCs can forge a range of partnerships that meet specific demands – from JVs with SOEs that increase sway with key policymakers, to local partnerships that boost digitalization or production capabilities, to agreements with local channel partners to overcome distribution challenges to small cities. For instance, LyondellBasell has formed a JV with Liaoning leading private company, Bora, combining its leading technology with Bora's operational excellence to provide quality polyolefin products to the China market.
  

China remains an important arena for growth and innovation. MNCs must nurture long-view mindsets and operational advantages to capture the new wave of opportunities amidst post-COVID-19 uncertainty. Strategic agility is needed to articulate and deliver value propositions tailored for the China market, aligning business objectives with national goals, and adjusting China footprints accordingly. To succeed in this rapidly changing operating environment, MNCs should track and be responsive to local developments while investing in public affairs and risk management. For those that do, the potential rewards are huge.