As rising wages and global trade frictions drive up the cost of manufacturing in China, some investors are revaluating their operations in China’s coastal provinces. With competitive wages and a rapidly improving business environment, China’s inland provinces have emerged as an increasingly viable option. To encourage increased investment in Central and Western China, numerous incentives have also been instated by the central and local governments.

This does not always mean that moving inland is the correct choice for every investor. When considering a location in China, it is critical that an investor analyze their own needs in the context of a location’s labor conditions, infrastructure, business environment, available incentives, and regulatory environment.

Labor:

When evaluating the labor pool of any given location, cost, and supply are crucial metrics.

In China’s coastal provinces, wages are much higher than China’s inland provinces. Compare Shanghai’s minimum wage of 2,480 RMB 350 USD with 1,580 RMB 223 USD in Hunan capital Changsha. In addition, the labor supply is still abundant relative to China’s more developed coastal regions.

However, it can be much easier to find qualified labor in China’s coastal regions. Although enrollment in high school and literacy in China’s inland regions tend to be high, universities and training programs tend to be more developed in China’s first and second-tier cities. Applicants for management positions are more likely to have the appropriate knowledge and experience to implement complex industrial processes. This benefits of experience and education can also have a positive effect on the general quality of a labor force, with an overall environment of knowledge about certain industrial processes that are commonplace in China’s more developed industrial clusters.

Industries must determine exactly what their labor needs are when evaluating a potential location within China. If relying on simple, but labor-intensive, manufacturing processes, then moving inland could be a cost-effective move. Alternatively, when relying on processes that require complex technical knowledge or technology, then remaining in China’s coastal regions is more likely to be preferable.

Business Environment:

When evaluating a potential location, a foreign investor should pay close attention to the advantages of locating close to China’s numerous industrial clusters. Investors can often benefit immensely from the industry-specific networks and business cooperation in these clusters, which can lead to rapid growth and competitiveness. China’s industrial clusters can get much more specific than simply locating a high-end manufacturing facility in Shenzhen. In some cases, we see specific vertical differentiation between industrial clusters in China, with different cities known for producing very similar products at different levels of quality. In China’s vast network of industrial clusters an investor can usually find one that specifically addresses their business needs.

Often, these industrial clusters tend to develop in China’s Special Economic Zones (SEZs). SEZs are geographically designated areas in which laws and regulations related to labor, environmental protection, taxation, etc. are relaxed to create a more conducive business environment for investors. SEZs are subdivided into numerous classifications including Free Trade Zones (FTZs) which often attract investors by treating goods within the designated zone as outside of typical Chinese customs jurisdiction. The use of FTZs in China has expanded drastically in the seven years since its introduction, with the inland provinces of Guangxi, Sichuan, Hubei, Yunnan, Henan, Hebei, Chongqing, and Shaanxi as well as numerous coastal provinces all receiving FTZs over this period.

The government has expressed clear development goals for these zones such as the promotion of connectivity through the One Belt One Road initiative, high-end manufacturing, and tourism. This kind of state planning and guidance further promote the development of industrial clusters within China.

Ultimately, it is in the interest of an investor to choose the best environment available for their business. This can drive investors towards prioritizing industrial clusters, deepening regional concentration. For example, Shanghai is home to 730 regional headquarters of multinational corporations while the relatively unknown city of Ouhai produces around 90% of global brand eyewear.

Finding an environment conducive to conducting business in China requires both a deep understanding of your need as a business and a specialized knowledge of each industrial clusters’ individual characteristics. For many investors, the benefits of locating yourself in a pre-existing industrial cluster will continue to outweigh the rising costs of production. As a result, up to 80% of these clusters remain located in China’s coastal regions. However, local and central government incentives are actively trying to mitigate the extra logistical costs associated with operating in China’s inland regions.

Incentives:

Since a State Council circular on promoting foreign investment was released in 2017, local governments have been given greater autonomy to provide incentives to encourage foreign investment. These incentives have largely taken the form of tax breaks, real estate deals, foreign currency exchange and credit, easier access to financing, and visa assistance in order to mitigate costs related to logistics.

For example, the Central Chinese city of Wuhan offers import tariff exemptions for necessary foreign equipment, value-added exemption for domestically bought equipment, and simplified registration procedures for foreign-invested enterprises, among other pro-business measures. As a result, foreign companies like Honda, Nissan, and Peugot-Citron have made sizable investments in Wuhan.

This is a clear example of China’s local government effectively utilizing incentives to facilitate the emergence of a new automotive industrial cluster in Wuhan. Investors should pay close attention to local government incentives towards specific industries, these can create valuable investment opportunities in China’s less saturated central and western markets.

Increased autonomy often creates competition between localities to attract attractive investments in which local governments will offer increasingly concessionary terms to foreign investors; this can be extremely profitable for investors in desirable industries. However, this has led to concerns about local governments being engaged in a “race to the bottom” which has led to attempts by the Central government to standardize local incentives with the 2020 Foreign Investment Law. Despite the apparent benefits that a foreign investor might receive from a bidding war, they should be aware of increasing Central government oversight and the financial penalties that might result from receiving an illegal incentive. Because of this, proper due diligence on any local incentives is crucial.

Incentives encouraging increased inland investment are also available on a national level. For example, in May 2020 the Central Government announced that they were extending preferential tax policies in China’s Western provinces until 2030. This will continue the reduced corporate income tax of 15%, 10% less than the standard rate of 25%, for industries that make at least 60% of their revenue in a range of encouraged industries from infrastructure development to fertilizer production. This corporate tax reduction is estimated to make China’s south-western provinces like Guangxi and Sichaun cost-competitive with South East Asian manufacturing hubs like Vietnam.

China’s various local and national incentives are numerous, complex, and, for the most part, not easily retrieved on Google. Furthermore, the exact form incentives take are often the result of negotiation with local authorities and personal connections. Understanding how to maximize the benefits of incentives while remaining legally compliant can make the difference between succeeding and failing in the Chinese market.

Regulation:

As regulations, especially environmental, have become increasingly stringent in China’s coastal regions, investors can often find a more conducive environment in China’s inland provinces. Heavy industries have been increasingly pushed into China’s inland regions due to a changing regulatory environment. Foreign investors should consider the relevant regulations when evaluating their business needs and carefully choose a location with regard to what regulations might be instituted in the future. This can often allow a foreign investor to pre-empt government regulation and minimize disruption to their operations, as Japanese chemical producer Ashai Kasei did by moving production from the Chinese city of Suzhou, to the less-developed city of Changshu, citing overly restrictive environmental regulations.

Foreign investors should not blindly pursue investments in areas of China with less-developed regulatory systems, however. Developed coastal regions in China with a more restrictive regulatory environment can also mean better enforcement of existing laws in court, something very much in the interest of foreign investors. Staying in China’s developed coastal regions can provide protection from unfair business dealings and intellectual property theft. Recent legally significant wins for brands like Jaguar Range Rover and Nike in Beijing and Shanghai indicate that intellectual property protection is a priority for these areas.

Ultimately, choosing a location in China not only requires an in-depth understanding of China’s rapidly changing economic and legal regional differences, it also requires a profound understanding of an investor’s own business needs. While a Chinese city like Shanghai may be suitable for a large multinational pharmaceutical company’s regional headquarters, a chemical manufacturer may find a more cost-effective and regulatorily relaxed environment in an inland city like Yichang, Hubei province. However, as infrastructure continues to improve, and the lower cost of doing business in China’s inland regions looks increasingly attractive, expect an ever-increasing number of investors to take a more serious look at the cost-benefit analysis of locating flagship investments in this emerging region.