BEIJING China's soaring wages and strengthening currency might blunt the competitive edge of exporters that have seen average pay double since 2007, but it won't stop firms worldwide making a collective $100 billion bet on setting up shop here this year.
Although foreign direct investment inflows in 2012 have seen the longest monthly run of year-on-year declines since 2009, hurt by a weak outlook for corporate investment and sagging global trade, FDI should still top $100 billion for the third year running.
That would bring China's total since 2007 to about $625 billion, based on data from United Nations agency, UNCTAD, during which time a rally in the yuan currency has sliced 25 percent from exporters' margins.
Vietnam, Bangladesh, Indonesia and Thailand combined managed to snag only $141.6 billion in FDI between them from 2007 to 2011, despite being repeatedly touted as the places to which manufacturers fleeing China flock.
What keeps the money coming to China is a steady shift away from cheap assembly lines to high value-added production and from volatile external demand to the spending power of a new mainstream consumer class that analysts at McKinsey reckon will rise 10-fold between 2010 and 2020.
Indeed the decline of low-end manufacturing fits with Beijing's ambition to drive firms up the global value chain to help sustain the wage rises vital to attaining developed economy status and avoiding a "middle income trap" of low wages and stagnating growth.
"It's so far not threatening to the competitiveness position of China because it's the very low-end of manufacturing sectors that are affected," Louis Kuijs, chief China economist at Royal Bank of Scotland in Hong Kong, told Reuters.
"In that sense, it's quite consistent with the government's strategy to move up the value chain and improve the industrial structure," said Kuijs, a former World Bank economist in China.
Under government guidance on foreign investment issued in December 2011, China aims to lure more FDI in advanced manufacturing, as well as services including logistics, research and development, higher education and vocational training.
"The government policy no longer encourages FDI in the low-end manufacturing, only firms that are up in the global value chain can make profits," said Li Yushi, senior economist at the Commerce Ministry's think-tank - the Chinese Academy of International Trade and Economic Cooperation.
WAGE COSTS BITE
That fact is recognized by the likes of Marjorie Yang, chairman of Hong Kong-based Esquel - the world's biggest maker of premium cotton shirts for the likes of Ralph Lauren (RL.N), Tommy Hilfiger, Nike (NKE.N), J.Crew, Brooks Brothers, Hugo Boss (BOSSn.DE), Lacoste, Bestseller and Muji - which has extensive operations in China.
"There is pressure on enterprises in China to transform from being cheap labor-driven to innovation-driven," Yang told a forum in Beijing at the weekend, adding that rising wage costs had forced cost-cutting elsewhere in the business in response.
Some factories in the clothing and footwear industries have closed. German sportswear maker Adidas AG (ADSGn.DE) has shut its only directly-owned factory in China, but it still sources goods from local suppliers.
Supply chains and relatively sound infrastructure make China a stand-out destination for many foreign investors.
"A lot of our suppliers are in the immediate neighborhood, which cuts logistics and other costs," said Park Jong Ho, management director at LG Innotek in Yantai in the eastern Shandong province.
"If it were just a question of labor costs we should go to Southeast Asia. The reason to be here is not labor costs."
Currently, minimum wages in China range from 870 yuan ($139) per month to 1,500 yuan, according to government data. In Vietnam the minimum wage is around 1.05 million dong ($50).
China's foreign direct investment inflows fell 3.45 percent in the first 10 months of 2012 from a year ago, compared with an annual average 9.2 percent rise between 2002 and 2011 that saw investors plough in a cumulative $1.2 trillion.
That cash has now got to work smarter, economists say.
"China's manufacturing sector is suffering from overcapacity and investment opportunities will be limited," said Minggao Shen, China economist at Citigroup in Hong Kong.
"If we assume China's economy can continue to grow around 6-8 percent in the next decade, China's market is still attractive. But we will see a structural change - more on services sector, consumption, more on industrial upgrading."
That shift is already happening, according to official data that shows foreign investment accounted for just over 50 percent of China's total exports in the first nine months of 2012, down from 57 percent in 2007.
Meanwhile, the proportion of FDI inflows into China's services sector were $43.7 billion in the first 10 months of 2012 versus the $40.4 billion that went into manufacturing. FDI into services beat manufacturing FDI for the first time in 2011.
China's services sector makes up far less than the 60-70 percent of GDP typical in major developed economies, but its 43.3 percent share in 2011 is not far behind the manufacturing sector's 46.6 percent share, according to World Bank data.
Beijing aims to boost the services sector's relative share of GDP to 47 percent by 2015.
Under the banner of "industrial transfers" endorsed by Beijing, provincial officials in the interior have rolled out the red carpet for foreign firms trying to escape higher costs in the more developed coastal areas.
Zhang Xiaodong, the communist party chief of Anyang city in central Henan province, said the industrial city was luring more outside investment, including that from big state-owned firms and private firms, due to its lower wages and land costs.
"But the cost for industrial transfers is rising as labor resources, land and capital become key constraints," he told Reuters on the sidelines of the Communist Party congress.
Foxconn Technology Group, the world's largest contract electronics maker, has moved its main operations to such inland provinces as Henan and Shanxi. Its factory in Shanxi alone employs nearly 80,000 people.
In the first 10 months of 2012, FDI into China's six central provinces - Henan, Hunan, Hubei, Auhui, Jiangxi and Shanxi - jumped 19.4 percent from a year ago to $7.8 billion, or 8.5 percent of the total, according to official data.
FDI into eastern provinces, including Guangdong, Jiangsu, Zhejiang and Shandong, fell 6.1 percent to $76.8 billion. But they got the lion's share 84 percent of FDI, suggesting foreign firms still favor established locations.
"Both trends are happening at the same time," said Yao Wei, chief China economist at Societe Generale in Hong Kong.
"It does seem that companies are weighing the pros and cons. But if everyone does look at China as a potential consumer market, it does make sense to first move the inland."
(Additional reporting by Lucy Hornby; Editing by Nick Edwards and Alex Richardson)
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