Smaller Chinese factories win big in Africa

Continent an attractive destination for firms wanting to shift their operations abroad

Cao Min, head of the Eastern Africa China desk of Standard Bank of South Africa has advice that in many ways goes against the grain for him. Rather than investing in China, Africa provides a new and promising chance for such medium-sized investments, given China's slowing industrialization, he says.

"In almost every industry in China, competition has become ferocious, and in many cases there is excessive capacity. But for industry in Africa the page is essentially blank and competition is relatively mild. Admittedly, building a factory in Africa is not easy, but moving it to Africa, a continent thirsting for industrialization, presents a great chance for entrepreneurs."

A Lifan Motors car factory in Ethiopia. The vast market and cheap labor in Africa have attracted a large number of Chinese producers to invest here. Feng Yongbin / China Daily

Of course, that idea is not exactly new. Justin Yifu Lin, former chief economist of the World Bank, has been a strong advocate of such transfers for many years, and the Chinese government has started to encourage more Chinese companies to move factories to Africa.

But despite long-term engagement with Africa, China's experienced and new investors, by and large, know little about the continent and its possibilities. The big questions are how important transferring such operations are and where and what to invest in.

Liu Qinghai, an Africa analyst at the Institute of African Studies at Zhejiang Normal University, says transferring industries has happened mainly in manufacturing, and such large-scale shifts have taken place about three times in recent history: from the United States to Japan; from Japan to the four Asian Tigers (Hong Kong, Taiwan, Singapore and South Korea); and then to China.

"So why has manufacturing not shifted to western China or Southeast Asian countries?" she says. "Because labor costs in those areas are higher than in Africa, and the investment climate for Chinese in some of those places is deteriorating, too."

In addition, the exports of African countries to Europe and North America enjoy favorable tariff treatment that can greatly reduce production costs. Many Chinese investors, especially private ones, spotted the opportunity several years ago, and manufacturing started to move.

"In 2013, manufacturing investment in Africa was the third-highest form of investment from China after mining and infrastructure. But it did not even make it into the top five in Southeast Asian countries or Latin America."

When choosing an investment destination, the risks and possible advantages investors need to consider include economic and political stability, whether economic growth is sustainable, whether a certain location offers the chance to expand and whether there is a generally friendly attitude toward Chinese investment.

Eastern Africa, including Ethiopia, Kenya and Tanzania, may be a very good starting point, Liu says.

Mutual benefits for the company and locals are a cornerstone of relocating, and it needs to be bolstered by industrial collaboration, she says. It should also not simply be a lock-stock-and-barrel transfer of manufacturing capacity.

"If investors can process raw materials locally, it will prolong the industry chain and add value to the products."

James Shikwati, chief executive officer of Free Africa's Ultimate Capital, says Eastern Africa may become an attractive investment destination for China's industrial relocation, particularly considering the needs of the East African Community, which comprises Burundi, Kenya, Rwanda, Tanzania and Uganda.

Kenya and Tanzania are gateways to Eastern and Central African markets because of their proximity to the Indian Ocean, while Ethiopia has unique qualities of a huge market, cheap labor and a surging economy driven by its focused leadership.

"Together, the three countries combine a history of market economy and Communist backgrounds that very much resemble a market economy with Chinese characteristics. China's focus on intra-African infrastructure development makes it easier for landlocked Ethiopia to partner with East African countries to access the oceans.

"Kenya is keen to develop infrastructure with an eye to penetrating regional markets. Tanzania finds Ethiopia friendlier because of a shared history of a socialist approach in economics, and together they can push their agenda for an integrated market with their Kenyan counterpart."

However, Ethiopia, Kenya and Tanzania need a unified vision of how they see industrialization taking place, with policies that will manage transfers, supported by a robust legal framework that smoothes the way for transfers, with the involvement of government and private companies, he says.

Another vital element in transferring businesses is transparency, which will ensure that such shifts are underpinned by public confidence.

"Such an industrialization dream has to consider broader regional dreams in East Africa and Central African countries," Shikwati says.

"For instance, for Ethiopia, Kenya and Tanzania, the common denominator is agricultural production. Agribusiness-related industries need to transform rural economies and to create jobs, thus pulling people out of poverty. Mining in Tanzania and Ethiopia is economically important to the region and will lift incomes in these countries."

The main obstacles to success are a lack of infrastructure, of skilled labor and of power supplies, he says.

He sees the commitment of African governments to long-term, sustainable development as critical in ensuring business activity is buoyant.

Kenneth Chelule, deputy director of the Research, Technology and Innovation department of Kenya Industrial Research and Development Institute, says Kenya has been making an all-out effort to improve infrastructure and power supply to put industrialization on a more sure footing.

Part of that effort is a project called 5,000 Plus Megawatts, in which the government of Kenya intends to increase Kenya's electricity supply by 5,000 plus Mw in a period of 36 months. This program started in 2013. As a result, the cost of energy, and thus business costs, are forecast to fall.

The eventual goal of transferring industries is to establish full industry chains in Africa, upstream and downstream, Chelule says.

When such industry chains are up and running, consumer demand will increase, which in turn will attract more investors, says Tilahun Temesgen, chief regional economist for the East Africa Regional Resource Center of the African Development Bank.

"There is also scope for a market on a huge scale. For example, if you look at Ethiopia, it has a population of 90 million. It's the second-largest country in the continent, so it's a huge market. As for Kenya and Tanzania, they have better access to the other three members of the East Africa Community."

One of the biggest challenges in East Africa is to improve productivity and competitiveness in manufacturing by upgrading infrastructure and finding more financial support, he says.

Cheap labor is an asset that is valued by many potential investors from outside, but this issue should be viewed in a more comprehensive way, he says. Cost is an element, but sustainability is more important.

"Even though the skills required aren't there, labor here is trainable. You know the basic understanding of technology. When you bring in enterprises to use this labor, you probably need to upgrade skills. But that is much better than training from scratch."

Training institutions in Africa are troubled by a dearth of teaching facilities, and companies need to become involved in training employees and potential employees, Temesgen says.

"So if companies come in from China or other parts of the world, they really need to take responsibility for vocational training."

While cheap labor in labor-intensive industries obviously benefits a company, there also has to be improved productivity, he says.

"If you look at the average worker in Ethiopia and the average worker in China, taking into account their education and so on, what you find out is striking. The cost of labor in Ethiopia is one-third of what it is in China, so you may think labor-intensive industries in Ethiopia will be more profitable than those in China. In fact, productivity in Ethiopia is one fifth of what it is in China, which means in China people are paid triple what their Ethiopian counterparts would be paid, but they produce five times as much."

China's participation in Africa's industrialization presents the chance of transferring skills and technology to make local labor more productive, at the same time as taking advantage of lower labor costs, Temesgen says.

Host governments also need to ensure that policies are adopted that are conducive to a healthy business climate, he says.

Chinese companies need to formulate long-term plans to transfer technology and skills and make an effort, with a long-term view, to train locals.

Cao of Standard Bank says that over the past few decades many Chinese investors have gained their biggest fortunes in Africa.

However, SMEs that will be the leading investors in this wave of industrial transfers will find it difficult to obtain adequate financial backing because they lack collateral. They will also lack the financial expertise that can accurately gauge the implications of such a move, Cao says.

"So these companies usually use their own funds to start their businesses in Africa, neglecting rich local resources."

Having an accurate picture of Africa is vital, he says, and financial sources in Africa may offer a great chance to expand business.

Entrepreneurs coming to Africa should fully respect local legal systems and culture to integrate into a host country's business environment, rather than being wedded to cliches about Africa and how they should do business here.

If a company, private or state owned, has an attractive and viable business plan, a local bank will be keen to help, Cao says. However, management needs to be transparent and honest, financial statements need to be authentic and audits need to be credible.

It is critical that a management board be localized, he says, because local staff will be familiar with the rules on the ground, and this can avoid employment conflicts and problems with financing and marketing.

However, operational costs in Africa can be onerous, so he suggests that Chinese companies join together to invest in Africa.

"This means capital will be well organized and optimized, and a solid investment can be made in localizing management, controlling local risks and developing local funding sources."

Contact the writers at lilianxing@chinadaily.com.cn, houliqiang@chinadaily.com.cn

(China Daily Africa Weekly 05/22/2015 page1)