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Yu Zhou: Bring Fair Trade to Electronics

Authorized by the author to crossed-post from the Huffington Post.

Reports about the inhumane or dangerous working conditions in Chinese factories that manufacture the innovative products for Apple, Inc. – most recently by the New York Times – have brought publicity Apple probably does not want. For this student of China’s high-tech industry, however, the revelations are not surprising. In fact, the Chinese media has reported on many of the problems ever since the 2010 spate of suicides at the factories of the Foxconn Technology Group, the Taiwan-headquartered conglomerate that assemble products in China for Apple and many other foreign high-tech companies.

Debates in the United States in response to these disclosures have been how to assign blame or whether consumers can force Apple to be more ethical. This is not enough. The problems are certainly not limited to Apple or Foxconn. The case highlights the evident flaws of the model of corporate social responsibility standards, enforced almost entirely by the global companies bent on maximizing their profits.

Here is the global structure of the electronic industry: Supply chain has shifted largely to Asia, and is dominated by the Original Equipment Manufacturing (OEM) model, in which the lead western companies focus on design and marketing while Asian contractors manufacture high quality and quantity of the products, with extreme flexibility and speedy delivery. The largest OEM is Foxconn, with more than 300,000 workers at its Shenzhen site alone. In this system, pricing power resides primarily at Apple, which could shift or divide orders to other OEM manufacturers in Asia with relative ease. Given that OEM profit margins are razor thin, reduced scales would seriously hurt the OEM companies. In addition, to have such a demanding company as Apple being its clients provides the “seal of approval” for the manufacturers. So they do their best to satisfy Apple. The “breath-taking” flexibility cited by the Times article comes not just from the hard driving OEM manufacturers; it is also achieved by the subcontracting system which can be mobilized quickly when demand grows and contracts just as quickly if particular parts or procedures become obsolete. This makes it extremely difficult for Apple, or anyone, to monitor the entire networks of subcontractors.

While the system clearly has worked for consumers and shareholders, the impact on workers and the environment is much less sanguine. To avoid negative publicity, the current model of corporate social responsibility requires leading companies to demand the practices in their supply chains be improved. Companies such as Apple or Wal-Mart Stores have adopted codes of conduct and audit their suppliers frequently for ethical behavior. Some suppliers have mended their ways; Foxconn, for example, has increased salaries and provided more social support. Yet the relentless pressure to cut costs has not changed, nor have the bargaining positions for the suppliers. With Apple allowing suppliers “only the slimmest of profits” and demanding cost cuts year after year, it is not surprising that suppliers “often try to cut corners, replace expensive chemicals with less costly alternatives, or push their employees to work faster and longer, ” according to the Times.

Improved human and environmental responsibilities involve increased costs. Yet the enforcement of corporate social responsibility standards by lead companies essentially shifts such costs down the supply chain. Suppliers are forced to fulfill existing conditions of the orders as being larger, better, faster and cheaper, while also meeting strict ethical and environmental standards. Hence consumers can have guilt-free use of the products without paying higher prices, and — in the case of Apple — not sacrifice a profit margin which according to an estimate by researchers at Asian Development Bank was a staggering 64 percent for the iPhone in 2009.

While the largest OEMs, such as Foxconn, have some bargaining power with Apple, the same cannot be said for its own downstream suppliers. Among these subcontractors, there are bound to be recurring rules violations concerning workers’ health, working conditions and environmental protection when the pressures on price and timing remain so intense. And when audits do find violations, it is entirely at Apple’s discretion to decide what action, if any, to take. It can punish suppliers if it chooses, but likely will drop them only if the overall supply system isn’t affected and substitutes are available.

So what to do? Fundamentally, the current model of corporate social responsibility system is flawed. Critics could demand that Beijing apply its own labor and environmental standards more rigorously. Yet monitoring millions of factories with expertise and vigilance is a challenging task, even under the best circumstances. China is a vast developing country with huge variations in regional economies and law enforcement. Most Chinese officials at the local level are not interested in giving factories there a hard time. Western ethical standards took decades, if not centuries, to establish; Chinese practices won’t change quickly no matter how hard domestic or foreign critics insist.

But there is another possibility, a version of the fair trade system developed for coffee growers and some other agricultural products. In this system, a third-party investigation sets floor prices based on responsible humane and environmental protection methods. In the electronics industry, the suppliers could use such reference pricing to increase their bargaining positions, and buyers could pay above the fair prices to claim meeting ethical standards. This should not be difficult in the electronics industry, where those in the trade know very well the prevailing prices and costs of particular products. And prices could be revised regularly to reflect technological innovation or wage increases. If some suppliers try to cheat the system by charging the fair price, but with substandard practices, their competitors will soon find out and the negative publicity could lead to contract cancellation. The beauty of the system is to use the subcontracting networks to monitor the contractors as competitors would always be on the lookout for cheating. Fair trade price does not eliminate market competition but curb its worst excesses and reward the responsible players.

One barrier is the electronics industry’s prevailing secrecy; its executives are reluctant to describe their supplier networks. However, the corporate responsibility movement already has eroded such secrecy, even for tight-lipped companies like Apple. This barrier should not be insurmountable.

Regardless of whether a fair trade system is the best alternative, it is important to recognize that we must move beyond the existing corporate social responsibility system monitored entirely by profit-maximizing corporations. If they are part of the problem, they cannot be counted on to fix it.

 

Yu Zhou is a professor of geography at Vassar College, author of “The Inside Story of China’s high-tech industry: Making Silicon Valley in Beijing.” She is a member of the ChinaAnalysis Opinion Editorial Board.

Can China innovate?

Yu Zhou
Professor of Geography, Vassar College
yuzhou@vassar.edu

Nowadays, it has become fashionable to talk about the technological potential of China. But unlike the case of the United States or other western countries, the question of China’s technological progress almost always revolves around the role of the Chinese state. Romo (2004), for example, credited the strategic emphasis of the Chinese state in innovation as the first of three theorems in his famous “Beijing Consensus.” China observers also routinely scrutinize Chinese governmental documents to foretell the changing directions of state industrial policy. Given China’s recent accomplishments on high speed rail and super computers, feats made through a centralized state-sponsored system, such discussion has a reasonable foundation. Within China, many intellectuals also see the role of the state as a decisive factor, although they disagree on the benefits and costs of state intervention. Some have argued that the Chinese state is at fault since it has not devoted sufficient resources to indigenous innovation so that China remains largely dependent on western technology, to the detriment of China’s long-term security. Others blame the Chinese political regime or governmental interference for creating a research culture that stifles creativity, diversity and dissidence (Shi and Rao 2010).

But is the role of the Chinese state really that decisive? After researching and writing my book Inside Story of China’s High-tech Industry: Making Silicon Valley in Beijing, I am convinced more than ever that the answer is no. To be sure, I do not believe that the state should be banished from the arena of business enterprise. Far from it, I feel that in China, as in other developing states, the question is never whether the state should play a role in technological development, but how. As I traced the emergence of China’s high-tech industry since the mid-1980s, examining the historical evolution of relationships among MNCs, domestic companies, research institutes, and the Chinese central and local states in Zhongguancun—China’s Silicon Valley— I concluded that the role of the state is essential, not as a leader, but as a reflective and flexible collaborator with multinational corporations (MNCs), indigenous companies and research institutes in the process of technological change. My findings can be summarized as follows:

The role of China’s state in technological change has been highly varied and experimental, and sometimes diametrically in opposition. There has not been a single unified model.

Since the founding of the PRC, the Chinese state initially tried defense-led technological development strategies, then changed to focus on the civilian sectors. It tried self-sufficiency and import substitution behind closed doors, only then to pursue the transfer of western technology by opening China’s markets. It established a science and technology system within a centrally planned economy, but then embraced the neo-liberal model by introducing market forces and engaging in technology commercialization. It increased the size and competitiveness of the largest state-owned enterprises, then recognized the need to support small innovative firms and encourage the participation of non-state agents in high-tech industries. It managed to lure considerable western investment while attempting to issue technological standards to assist innovation by domestic firms. None of these efforts can be judged an unequivocal success. China continues to rely greatly on external technology to this day, and Chinese enterprises continue to rely on cheap labor rather than technological prowess. While no one can accuse the Chinese state of not trying, it is clear that it has yet to find a workable model for technological development. So China has not had one single approach to state involvement. Whatever strategies it has today will undoubtedly undergo change in the future.

A State-centered approach for Science & Technology has been tried and failed in most civilian areas.

Since 2003, the Chinese government has paid growing attention to Science & Technological (S&T) sectors. China’s Eleventh Five-Year Plan and its Plan for Medium and Long-Term Science and Technology Development (2006–2020) call for building an innovative society with heavier investment in domestic R&D. The increased investment is necessary, but given that China’s central state has a powerful tradition and bureaucratic interest in favor of a centralized approach, it is worrisome that some officials advocate the revival of a state-directed R&D program. In 2005 the head of the Ministry of Science and Technology cited China’s success in producing nuclear bombs and a satellite in the 1960s, products of state-directed research programs, as examples of strategic technological breakthroughs that could be emulated in other technological areas. Unfortunately, this argument shows little understanding of the difference between military and civilian technology, or of the reality of the global marketplace in which Chinese companies must operate. Although defense technology is utilized in the civilian sectors in the United States and China, a nuclear bomb does not have to stand the rigorous test of open global competition. Thus, China’s success with bombs proves nothing about the effectiveness of state-directed research programs in commercialized technology. In fact, China’s state-directed S&T research prior to the mid-1980s had a very poor record in responding to market needs. So what about high speed rail and super computers? As many have noted, both are built based on existing foreign technology and collaborations with other companies. Given the intensity of globalization today, a state-centered approach to R&D would be counterproductive, if not simply unfeasible. There will be sectors, defense and railroad, among others in which the existence of a natural monopoly may give the centralized approach a better chance of success. But it would be a major mistake to imagine that, in the absence of business competition and wide spread knowledge diffusion, state investment would result in sustained competiveness.

The most important role of the state is to be an honest and responsible collaborating partner with other technological agents.

So what should be the roles of the state? The Zhongguancun experience shows us that these roles are necessarily multi-faceted. Zhongguancun is better characterized as a result of institutional evolution under globalization, in part tolerated and assisted but largely unanticipated by the state. The state’s crucial roles are not just providing specific policies or R&D capital but collaborating effectively with other technological agents and learning to reform regional institutions under changed circumstances. Institutional transformation is necessary for the growth of China’s high-tech industry, but such transformation is a learned process, as entrepreneurs, businesspeople, professionals, bureaucrats, scientists, and consumers learn to work with each other while the new rules of the game are being negotiated, established, and observed.

Simply put, the accomplishments of China’s Silicon Valley thus far cannot be attributed primarily to the Chinese government. Domestic companies and MNCs alike have spent considerable energy pushing the state to change its resource allocation, ease its restrictions, and alter its regulations. Over the years, the Chinese state has largely been responsive to and tolerant of the various experiments in the regions, setbacks notwithstanding. But the state has not gone far enough. In the long run, genuine innovation can only come from freedom of thought, experimentation, collective effort, and frequent exchanges with advanced technological parties and marketplaces. All that will require the Chinese government to continue to collaborate with—rather than supervise or direct—other parties. Only then can a fairer and more open institutional structure for fostering innovation can be built.

 

Can China innovate?

Yu Zhou
Professor of Geography, Vassar College
yuzhou@vassar.edu

We know that China can manufacture at low costs, but can Chinese companies innovate? With many of China’s exporting markets face prolonged recession, the question is becoming more urgent. For China to become a worthy global economic engine, it has to move beyond specializing in cheap-labor exports. Evidence is mounting on both sides. On the one hand, China claims the world’s largest number of engineering graduates and the second highest amount of R&D spending. Its registered patents exceeded those of Germany in 2007. On the other hand, China’s rigid political and educational systems are seen as crippling creativity. Chinese enterprises sit low in the global production chain so they have low profit margins with little room for long-term R&D investment. China’s weak intellectual property rights protection is another popular explanation for lack of innovation. Debates also rage on who will lead Chinese technological changes. Some believe that multinational corporations (MNCs) are the leaders. Others believe that China has become too dependent on Western technology. The Chinese government stresses “indigenous innovation” as a national priority.

I argue in my book, “Inside Story of China’s High-tech Industry: Making Silicon Valley in Beijing“, that Chinese domestic companies can become technology leaders, but only when they successfully collaborate with foreign MNCs. My research traces the emergence and development of China’s high-tech industry since the mid-1980s in Beijing’s Zhongguancun–the so-called China Silicon Valley. By detailing the stories of the region, collected over six years through interviews, I argue the following:

1. MNCs have limitations in bringing technological transformation to China. Chinese firms have a competitive edge in the home market, which may serve as a launching pad for their international ambitions in the long run.

Foreigners often assume that if a large multinational company, say HP or Google, is successful in the United States and elsewhere, it should also be successful in China. If it is not, the Chinese government is blamed for unfair treatment. But the reality is that China is a vast, regionally fragmented, rapidly evolving and largely low-income market. It is challenging for MNCs to reach beyond China’s affluent core. In contrast, Chinese domestic firms understand their home court better, and have greater commitment and flexibility. Successful Chinese companies have served the Chinese market with their access to competitive, reliable, and high-quality component suppliers—the same suppliers that MNCs use for exports. The Chinese companies then target the Chinese market with special designs, pricing and marketing that enable them to beat foreign-brand competition. This is the story of Lenovo, Huawei and many other successful Chinese high-tech companies. Though they are not at the cutting-edge of technology at the beginning, they have always been extraordinarily effective in bringing new technology to the Chinese market at an affordable price.

2. The key constraint for Chinese companies to produce cutting-edge innovation is the Chinese market, but this will change.

Many believe that the lack of innovation by Chinese companies has to do with their low R&D capacity. This is only partly true. It is worthwhile to remember that almost all Chinese technology companies were established after the mid 1980s, and also that most have emerged only in the 1990s. This short history sets them apart from business power houses in Japan, South Korea and even India.

But beyond their inexperience, capital capacity, and technological lag, the key constraint for the Chinese companies to innovate is the Chinese market. Michael Porter in his book The Competitiveness Advantage of Nations argues that it is the quality of the domestic market that is critical for national competitiveness. A technologically sophisticated market pushes innovation by forcing the companies to constantly upgrade their products. Yet Chinese consumers value low-price and lack experience with many products. Most have yet to attach the same importance to the quality, design, and newness of products that consumers in advanced economies do. This provides little incentive and reward for cutting-edge innovation by domestic companies. It is not surprising, indeed it should be expected, that most Chinese companies would concentrate on following the MNCs’ lead in making products cheaper and better suited to Chinese customers rather than blazing their own paths. But as the market evolves with sustained higher income and more sophisticated consumer tastes, one can bet that Chinese companies will evolve with it by offering more innovative products.

3. The competition between Chinese indigenous firms and MNCs is not a zero-sum game.

The growth of Chinese companies does not crowd out foreign companies. It is tempting to view the competition between MNCs and domestic firms as one side trying to eat the other’s lunch. But the prevailing pattern is actually a relationship of collaboration. Virtually none of the Chinese products are made without MNCs’ components. This is true for both hardware and software. China’s most popular enterprise management software by UFIDA, a domestic company, uses an Oracle database. As domestic companies cultivate and expand the market, MNCs have an enlarged consumer base for their products.

Some critics from China lament the lack of innovation in China, and imagine that if only Chinese scientists put their minds to innovation with ample state funding, innovation would take place. The truth is that domestic companies cannot generate globally significant technology unless they work with MNCs. Chinese companies are actively learning from MNCs how technologies, markets, and human resources are managed in the modern world.

In turn, MNCs have learned from local firms’ marketing expertise to enhance their market performance. For example, when Nokia and Motorola suffered setbacks in marketing cell phones in China in 2002-2004, they managed to regain the market by adjusting marketing strategies in part modeled after local competitors’ regional distribution channels. Overall, the increased involvement of MNCs in China in the past 20 years has been accompanied by, and indeed dependent upon, the growing competence of local Chinese companies. By partnering with Chinese companies, MNCs can penetrate far larger markets than would be possible relying on their own work force. The interdependence of Chinese and foreign firms can be seen regionally. The regions with more advanced development of indigenous companies are the same regions where one can find a greater presence of MNCs in more diverse fields, not the other way around. It is uncommon to find foreign technology firms work alone very successfully in the Chinese market without major Chinese business partners.

Innovation is a long term process, and can only be approached step by step, not just by a few strong companies in China but by succeeding generations of them, collaborating with foreign companies. My research in Beijing’s Zhongguancun has found that there have been rapid generational successions in the region, from a first generation of competitive Chinese personal computer makers in the 1980s, to an entrepreneurial Internet generation in the 1990s to current overseas returnee-founded high-tech companies in the 2000s. In the last two decades, Chinese indigenous companies have moved a long way in capital capacity, management expertise and technological sophistication. In the end, it is the development of these indigenous companies, not MNCs or the Chinese government, that will ultimately determine the extent to which China controls its technological destiny, and how much China can contribute to the world economy.

About ChinaAnalysis Opinion

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The ChinaAnalysis Opinion page seeks to provide insights into, and generate discussion on, important issues relating to innovation and economic development in China. The intent is to facilitate and encourage knowledge sharing among academics and practitioners with expertise on Chinese innovation, competition, and economic performance.  If you are interested in making your opinions, based on your research and experience, visible to a broad global audience, please contact Yin Li, our Opinion editor at yin_li@chinaanalysis.com.  Submissions to the Opinion page, which should not be more than 1,000 words, will be considered for publication by our Editorial Board.

ChinaAnalysis Opinion Editorial Board:

William Lazonick, the University of Massachusetts and the AIRnet
Yin Li, Georgia Institute of Technology
Yifei Sun, California State University, Northridge
Hao Xie, ChinaAnalysis.com
Yu Zhou, Vassar College