SURVEY: MANUFACTURING

The ever-spreading tentacles of Hong Kong
Jun 18th 1998
From The Economist print edition

What the world’s third-richest place has to teach

YOU would have thought that being one of the richest places in
the world, a hub of international trade that sits at the gateway to
China, would produce a certain satisfaction among the 6.5m
inhabitants of Hong Kong. But even in this apparent economic
paradise people worry, and argue, about where paradise goes
next.

In one corner of the argument, fighting for the service-economy
idea, are the team of authors who last year wrote “The Hong Kong
Advantage” (Oxford University Press, £20). They say that this
city-state’s prosperity will continue if it concentrates on being a
centre of financial and business services and a provider of culture
and entertainment for the Asia-Pacific region. The Harvard
professor who led the team, Michael Enright, has voted with his
feet and moved to Hong Kong University. In the other corner, the
authors of “Made by Hong Kong” (also Oxford University Press,
£20), who come from the Massachusetts Institute of Technology,
retort that Hong Kong will stay successful only if it holds on to its
manufacturing prowess and takes manufacturing up-market into
high-tech products.

It was manufacturing that made Hong Kong’s fortune. When more
than 1m refugees from the Communists’ victory in China’s civil war
flooded over the border in 1949, the British colonial authorities had
to do something to keep them alive and Hong Kong afloat. Cheap
land for building factories, and public housing, were the answer.
Helped by the talents of entrepreneurs who had fled from the
mainland, the rescue operation worked. By the early 1950s Hong
Kong was supplying the world with T-shirts, plastic flowers and
flip-flop sandals. The big industry was textiles, but handbags,
toys, watches and shoes also poured out of tiny sweat-shops for
export to America and Europe. By 1961, nearly half the workforce
was employed in manufacturing, making a quarter of Hong Kong’s
GDP.

But China’s Communists halted the flow of refugees, and Hong
Kong started to run short of labour. It was then that the Chinese
government took a historic decision which changed the way
manufacturing operates in this part of the world.

In 1978, China opened up some of its coastal regions, including the
area on Hong Kong’s border, to foreign investors. Suddenly, Hong
Kong’s businessmen had a new supply of cheap labour and new
land for factory-building. Most of the light manufacturing that used
to take place in Hong Kong crossed the border into China. By 1997
manufacturing’s share of Hong Kong’s jobs was down from nearly
half to a mere 15%; its share of output fell to a mere 8.8% (see
chart 6). But over the border, around the Pearl River delta, 5m
Chinese are now employed in factories owned by Hong Kong
businesses. Today Hong Kong has $72 billion invested in China,
nearly all of it in manufacturing.

Two examples show what has
been achieved by this leap
across the border. Allen Wong
runs VTech, a Hong Kong
company that has 60% of the
world market for kiddies’
computers and other electronic
learning devices, and also
makes cordless telephones. Its
sales have grown from an
annual $150m ten years ago to
over $800m today. In 1987,
when he found he could not
get enough workers or cheap
land in Hong Kong, Mr Wong
moved production over the
border into Guangdong
province.

He now employs 22,000 Chinese women in two factories, most of
them brought in by bus from Sichuan province deep inside China
(because the wages the locals want are already too high). The
women get 500 yuan ($60) a month, plus board and lodging,
compared with the HK$6,000 a month ($770) people get for similar
work in Hong Kong. Now Mr Wong is scouting for even cheaper
labour in Thailand. Hong Kong is the conduit through which his
exports pour. Distance from the eventual market does not matter
much to him. Because his products are mostly bought by parents
for their children, demand is pretty stable; he can predict sales, he
says, for about two years ahead.

But not all Hong Kong-based businesses can afford to be so
relaxed about distance from the market. Another company that
crossed to the mainland is Johnson Electric, which makes the tiny
motors that go into electric toothbrushes, CD players and many
other things. The average Mercedes car has 80 such micromotors
to open its sun-roof, adjust its mirrors and move its seats.

Under Patrick Wang, whose father founded the business 39 years
ago, Johnson has tripled in size in the past ten years. It now has
sales of HK$2.6 billion ($33om) in 20 countries. It employs 13,000
people, most of them in Johnson Electric City, two huge factories
50 miles from Hong Kong in the Pearl River delta with their own
dormitories, canteens and sports centres. The peasant girls who
work in Electric City earn around 500-600 yuan a month, plus food
and board: again, only a fraction of what a similar worker would
get in Hong Kong. Yet they save much of what they earn. After a
few years in the factory, they can go home to their villages with a
dowry to help them look for a husband.

In Hong Kong itself Johnson employs only 200 workers, mostly
engineers designing new products. They work in teams that have
to keep in close touch with the customers. A car manufacturer, for
instance, will want Johnson to come up with a little motor ideal for
the particular job it has to do in a given car. Mr Wang says that
ten years ago customers asking for design changes were happy
with a two-week response by telex. Today, they want an e-mail
within two hours.

This has made Mr Wang change his organisation. The problem of
distance looms larger every day. “Two weeks in a container on the
sea was bad enough in the days of telex response times,” he says.
“It is no use now.” So he is investing in a new factory—in Mexico,
a maquiladora on the doorstep of his biggest market, the United
States. There he will be paying wages of around $2 an hour, about
three times what he pays in China. But that is the price of being
close enough to his market to meet sudden changes in what the
customer wants.

Wider still and wider

In short, much of what began in Hong Kong and then moved over
the border into mainland China is now having to think of migrating
even farther afield. This applies in particular to the textile and toy
industries. David Dodwell, one of the authors of “The Hong Kong
Advantage”, estimates that two-thirds of Hong Kong’s 30,000
producers of clothes and soft toys operate in two locations
(usually China as well as Hong Kong) but that as many as a fifth
now have plants in two places outside Hong Kong. The continuing
search for cheap labour is not the only reason for this diaspora.

There are two disadvantages in selling things made in China
through Hong Kong. For textile firms, trade continues to be
regulated by the hoary old Multifibre Arrangement, which still
contrives to protect the textile industry in rich countries where
labour costs far more than in China. So China gets no quota for
exports to Europe and America. And anybody exporting anything
from China has to live with the risk that one day Congress in
Washington will take away China’s most-favoured-nation trade
status, which allows it easy access to the American market. So
some manufacturers have started to move on from China, to put
at least some of their production into countries where they can
hope to disguise its Chinese origins.

Victor Fung is chairman both of the Hong Kong Trade Development
Council and of the family firm of Li & Fung, a fine example of this
new diaspora. Li & Fung is a spider’s web of manufacturing in 23
countries, with operations not only in various parts of South-East
Asia but also in Latin America, Eastern Europe, the Caribbean and
Mauritius.

Mr Fung explains how the system works. A foreign company will
come to him with a modest product—a ballpoint pen, for example,
or a simple dress—and ask him to find out where it can be made
more cheaply than anywhere the inquiring company yet knows
about. Mr Fung’s people set out to find not only a source of
ever-cheaper labour but also somewhere safe from trade
restrictions on Chinese production. Take that simple dress. The
yarn may be spun in Korea, the fabric woven in Taiwan, the zips
bought from Japan, and the garment part-finished in China before
it passes through a final stitching-factory in Indonesia. “What we
are doing is finding the best place for every operation,” Mr Fung
says. “At the same time, we are lining up factors of production so
that we can cut lead times from three months to five weeks.”

Li & Fung has a network of 7,500 regular suppliers, employing an
average of 200 workers apiece. In other words, about 1 1/2m
workers to some extent depend on this firm. Mr Fung uses only
about a third of his network at any one time; but the system gives
him—and his customers—a splendid degree of flexibility. The hub of
the system is his team in Hong Kong, what he calls his “smokeless
factory”. The clothes business has always been keen on fast
responses to changing tastes. Mr Fung reckons the habit is now
spreading to other industries, even those making things like
personal computers. This needs an international network which
can make sure that all the parts needed for the final product are
flowing smoothly, while keeping its inventories economically small.
Mr Fung’s company has been doing this sort of thing for
years—“but now we see them calling it supply-chain
management.”

All these companies keep in Hong Kong the central functions of
product development and engineering—the front end, as it were,
of the manufacturing supply chain. The back end, marketing and
distribution, also stays in Hong Kong. Although these are officially
classified as “service activities”, they are really part of
manufacturing in the modern, lean-all-through sense of the word.

Hana Technologies, part of the Thai Hana Group, which bought it
from the Swire conglomerate a few years ago, still uses Hong Kong
for some manufacturing in the old sense of the word. Its factory
puts microchips into plastic packaging and fits them with terminals
to link up with other parts of the end-product, a computer or
whatever. It sounds simple, but this is high-precision work that
needs sophisticated machinery, and often involves novel
operations. Once any given operation is running smoothly, the
company moves production to Thailand or China. Here is another
example of the way Hong Kong is moving up-market. It does the
difficult jobs of design and early production, and then hands the
routine stuff over to others.

Taiwan can do it too What has happened in Hong Kong was not
going to escape other people’s notice. The Taiwanese have
caught on well. Back in the 1950s, Taiwan was part of the region’s
plastic-flowers and flip-flop-sandals economy. Things moved on
when state planning created a series of industrial parks along the
island’s coast, each specialising in its own thing—petrochemicals
and plastics (from imported raw materials), cement, steel and so
on. But the economy really started coming alive when the
government gradually stopped poking so many fingers into it. The
bureaucrats no longer try to pick winners, though they still provide
cheap science parks and some handy tax breaks.

Hence the blossoming of companies like Acer, a computer company
which has its main factory in the Hsinchu science park, two hours
down the road from the capital, Taipei. Acer is now the world’s
third-biggest maker of personal computers. Its boss is Stan Shih,
who started his business life selling ducks’ eggs off a street stall.
Until 1993, all Acer’s computer mother boards, the basic circuitry,
used to be assembled in Taiwan. But then, with local wages
approaching $600 a month, and local labour so short that Acer had
to ship in hundreds of Filipinos, it opened factories in Zhongshan in
China’s Guangdong province and in Subic Bay in the Philippines.
Now it has added another, in Mexico, and has assembly plants in
Malaysia, Singapore, Indonesia, Dubai and Europe.

Productivity in the Philippine plant is only half of that in the
Hsinchu science park, in the Chinese plant only a third. But then
the wages the company has to pay in the Philippines are less than
a third of those in Taiwan, and in China only a tenth. At the other
end of the scale, Acer now has assembly plants in Britain, France
and Italy. These are expensive to run but they are physically close
to the market, so that the final product can be adjusted to meet
local requirements. Mr Shih has got the message about distributed
manufacturing networks.

The Hsinchu factory in Taiwan will not be extended; the
company’s expansion will all happen abroad. Already, two-thirds of
its output of mother boards and nine-tenths of its computers are
made outside Taiwan. The Hsinchu plant, like those Hong Kong
factories, is changing its role to concentrate on research and
product development, plus the pilot production of new items.
Maybe some of its more expensive products will continue to be
made in Taiwan but most others, once production is proceeding
smoothly, will go abroad.

It took Acer nearly 20 years after its foundation in 1976 to move
to offshore production. Other companies are doing it more swiftly.
About ten years ago Kuo Feng Corporation and Shamrock
Technology, among others, started making personal-computer
monitors in Taiwan. Soon Taiwan had getting on for 60% of the
booming world market for these things, worth $15 billion a year.
Now, as demand for them levels off and profit margins fade, their
manufacture is seen in Taiwan as a sunset industry. But the sun is
not vanishing into the sea; it is just moving over the water into
China, where costs are so much lower. Both Kuo Feng and
Shamrock plan to shift the bulk of their production to the mainland
in the next 12 months.

Within a single decade, Taiwan has become the world leader in this
field, and then almost abandoned it. Scotland’s Clydeside
dominated world shipbuilding for three generations and then took a
quarter of a century to hand the baton over to South Korea and
Japan. The globe spins faster these days.