High-end manufacturing holds the key

Ricky Tung, co-leader of the manufacturing industry group of Deloitte China, says the ratings suggest that China is now more of a developed economy competitor rather than an emerging economy player.

"In addition to supportive policies, China still has relatively lower labor costs and is above average in the attractiveness of its corporate tax rates. With its focused efforts to localize supply chains and create innovation hubs, China is also seen by CEOs as the only emerging economy offering the same supplier network advantages as developed economies," Tung says.

A closer look at how China has scored in each category of manufacturing competitiveness in this survey also indicates China's strengths and weaknesses. Among 38 countries, China ranked high in "cost and availability of labor and raw materials", "attractiveness of local market" and "government's investment in manufacturing and innovation". But China ranked low in "legal system" and "healthcare system".

With labor costs, which is a grave concern domestically, the study shows China's average cost ($2.8 per hour) is lower than most manufacturing powers. By comparison, Brazil's labor cost is $12 per hour while in the US it is $35.4 per hour.

Andrew Heath, director of the international marketing division of Shenyang Machine Tool Co Ltd, China's largest machine tool producer, says China's manufacturing strength lies more in its established supplier network.

"Those who are talking about relocating units do not know the basics of business. It is not so easy to relocate these plants," he says. "We need to have natural resources. We have to purchase and have a supply chain. Since we have the huge market here, why would I even consider moving?"

Tim Hanley, global leader of the Global Manufacturing Industry group of Deloitte Touche Tohmatsu Limited, says that China is driving efforts to bolster advanced manufacturing knowledge and capabilities.

"If China wants to climb up the pyramid of the manufacturing world, it has much to consider besides labor costs," he says.

The best example is labor productivity, as Chinese workers generate just $14,200 worth of value per year, far below the global average of $33,000. By comparison, German workers generate $43,300 worth of value per year. In terms of innovation capacity, China has 1,071 researchers for every million population. The global average is 2,980, while Japan's is 7,038, the highest.

China's poor performance in these areas has also led to a low score in "talent-driven innovation", which Deloitte says is a leading indicator of a country's competitiveness. China scored 5.89 in this category while Japan scored 8.14 and the US scored 8.94.

Global CEOs also feel that China's trade, financial and tax environment is less competitive than that of US, Germany and Japan. Though China's corporate tax is slightly lower than the global average, many CEOs think the government's non-tax revenues are not included. Some experts say if all hidden costs were considered, China's tax burden would exceed 40 percent.

In January, the French tire maker Michelin Group decided to invest $1.5 billion, its largest single investment in China, to open a factory in Shenyang, capital of Northeast Liaoning province.

Asked if rising labor costs were a concern for the factory, Michelin's executives said China's huge market demand is "tempting" enough to offset the impact of a cost rise.

"As one of Michelin Group's most important markets, we will meet the diversified demands of local consumers through our innovative technologies and products, especially in the high-performance sector," says Jean-Dominique Senard, president of Michelin Group.

Michelin Group's Shenyang investment demonstrates how foreign manufacturers are still scrambling to enter the Chinese market despite rising labor costs.

China overtook the US as the world's biggest car market in 2010. In 2012, China's automobile sales rose by 4.3 percent, the lowest growth in several years, amid slowing economic growth and restrictions on auto purchases.

But not all manufacturers have the confidence that growing domestic demand will offset rising labor costs. A report by international accounting firm Grant Thornton in February revealed that 61 percent of the businesses in China cite shortage of general workers as their primary problem, while 55 percent cite a shortage of technical skills as a major concern.

Li Huaying, owner of the Shanghai Litan job agency, says it is becoming increasingly difficult to fill the lower-paying positions, as workers' demands are higher than expectations.

"It is becoming difficult for a company to hire an ordinary worker without any specific skills for a monthly salary of 2,000 yuan, as the salary is deemed to be unacceptable for migrant workers in Shanghai," Li says.

Lu Ming, an economics professor with Shanghai Jiao Tong University, says that what worries him most is that the latest round of wage increases is the result of insufficient labor supply, rather than the result of productivity increases.

"A healthy scenario is that people want to increase their salaries or find a job with stronger fulfillment so that they can go to colleges and get more training. This helps enhance skills and improve productivity," Lu says. "Currently this does not seem to be the case in China."

Zhou, however, says that higher labor costs are a good thing as they create pressure on Chinese manufacturers to improve their efficiency, upgrade their products and move up the value chain. "The truth is that you have to create more value, or else you will die."