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Critical Eye on Jiaxing and Zhenjiang

China's second-tier cities hold great promise—if investors do their homework

by Adam Ross

China's central government initiated a combination of nationwide programs earlier this year to discourage new manufacturing investments in heavily industrialized areas and to slow economic growth. Through a series of administrative actions, government leaders tightened development zone restrictions, project approval procedures, and bank loan controls. These measures have had the greatest effect in developed areas and have, in conjunction with rising costs from upward pressure on wages, energy shortages, and increased environmental restrictions, made doing business more difficult in China's large coastal cities.

In light of these changes that affect manufacturing investments, this Critical Eye focuses on two second-tier cities in the Yangzi River Delta (YRD)—places less developed than the YRD's booming first-tier cities such as Hangzhou and Suzhou, not to mention Shanghai. Compared to China's more popular investment locations, these second-tier cities generally have more land available, more consistent power supplies, lower labor costs, and a more welcoming attitude toward manufacturing operations. At the same time, such places usually lack the overall investment support found in national-level development zones, and fall short in terms of logistical efficiency and managerial talent.

Though the YRD region has many comparable secondary cities, this analysis highlights two that appear to be on the development fast track: Jiaxing, Zhejiang; and Zhenjiang, Jiangsu. Both places (Jiaxing is about 90 km south of Shanghai and Zhenjiang is about 250 km west of Shanghai) are located along major transportation corridors that are currently being upgraded. American companies already invested in these two cities are seeing favorable returns, and because costs in these cities will likely rise more slowly than in larger cities, these profits should continue in the years to come.

Jiaxing, Zhejiang

Jiaxing's factories are located in a sprawling web of five development zones, administered by various municipal and county governments. In some ways, the city is a perfect example of the unrestrained, uncoordinated development zone construction that China's central government wishes to stop.

Yet even though it has run afoul of national planning guidelines, Jiaxing seems destined to grow quickly. After all, the city is one hour from Shanghai and boasts half the labor costs. Jiaxing is also located at the crossroads of several major transport links—the Shanghai-Hangzhou expressway, the Hangzhou-Suzhou expressway, and the new Hangzhou Bay bridge and Shanghai's Yangshan port expressway, both of which are currently under construction.

Because of Jiaxing's excellent transport links, foreign companies will likely continue to follow in the footsteps of the many new manufacturing facilities currently under construction, as well as those already in operation. A dynamic private sector also helps tip the scales toward Jiaxing for some companies that source components or have customers in the immediate vicinity. One American manufacturer of recliner furniture parts said the decision to set up shop in Jiaxing was easy, because several of its customers that make finished furniture are located just across town. Even if this manufacturer were not saving money in labor costs, it would probably still be in Jiaxing to be near its customer base.

A major concern for companies with investments in Jiaxing is power supply. Most companies have purchased one or more power generators; the local government subsidizes generator purchases to relieve demand on the main electricity grid. Power shortages are acute throughout Zhejiang, where supply cannot meet high demand from industry and households. Household demand, in particular, is rising as electric air conditioners and heaters become standard home appliances. Local officials claim that power shortages will ease by 2006, when power plants currently under construction should come online.

Zhenjiang, Jiangsu

Zhenjiang's economy is also poised to benefit from dramatic improvements in the surrounding transportation infrastructure. The expansion of the Shanghai-Nanjing highway from a four-lane road to an eight-lane road is scheduled for completion next year. Though the construction is currently causing freight-transport congestion, traffic should flow freely once the project is finished. And a cross-Yangzi River bridge from Zhenjiang to Yangzhou, Jiangsu, is under construction and scheduled for completion by 2005. The bridge will position Zhenjiang as a gateway to Jiangsu north of the river, a much poorer region that should see steady economic growth in the years to come.

One of Zhenjiang's leading industries is auto parts—and for good reason. The city is located between two major auto manufacturing hubs, Shanghai and Nanjing, where Fiat SpA, the Ford Motor Co., General Motors Corp., and Volkswagon AG all have major production facilities. The Shanghai-Nanjing corridor is well on the way to becoming a full-fledged automotive manufacturing hub, as a steady investment base of vehicle and parts makers is settling into the region. With China's auto industry just beginning to mature, the sector has the potential to boost local economies for years to come.

Zhenjiang's foreign investors in the automotive industry, as well as in other areas, largely target the domestic market. Though this approach has obvious advantages, as China's domestic industrial sectors are growing in leaps and bounds, it also has disadvantages. For instance, China's recent economic cooling measures have affected production cycles in unpredictable ways. For example, auto parts manufacturers in Zhenjiang are not reaching their 2004 sales targets because of cool-down measures that have made it more difficult for Chinese consumers to obtain car loans. Opaque macroeconomic polices and uncertain approval processes affect the domestic economy at all levels, and foreign investors should be prepared for bumps in the road when targeting domestic markets, especially in secondary locations.

At this point, Zhenjiang's continued development appears to have strong support from the Jiangsu provincial government. Major infrastructure projects in the area attest to this support, and foreign companies speak highly of service from local government officials. In September the city hosted a large investment promotion fair, which was attended by high-level provincial officials, showing that local leaders are focused on raising the city's profile within the province. This attitude is generally a good sign for economic growth, but companies should be aware that overzealous local government officials can attract central government scrutiny if growth becomes too fast.

Favorable investment conditions for the cautious

All China investments require extensive due diligence, but investors must be especially careful in second-tier cities. Foreign manufacturers that have successfully established operations in Jiaxing, Zhenjiang, and other such locales benefit from a combination of favorable cost factors and immediate access to domestic markets. To achieve such success, firms must determine a suitable location and perform due diligence on development zones and their sales representatives. But probably most important in second-tier cities, investors must continually engage local officials and businesspeople and seek out and take advantage of favorable market opportunities.

Jiaxing and Zhejiang Foreign Trade and Investment, January-June 2004
	Zhejiang			Jiaxing
	Amount	% Change over 2003		Amount	% Change over 2003	Jiaxing as % of Zhejiang
Total trade	$38.4 billion	+40		$3.5 billion	+47	9
Exports	$25.4 billion	+40		$2.1 billion	+45	8
Imports	$13.0 billion	+40		$1.4 billion	+50	11
Contracted foreign direct investment (FDI)	$7.0 billion	+42		$1.1 billion	+43	16
Utilized FDI	$3.0 billion	+38		$400 million	+31	13
GDP	$61.7 billion	+16		$5.5 billion	+18	9
Sources: Zhejiang Statistics Bureau, Jiaxing Statistics Bureau, Jiaxing Economic Development Zone

Zhenjiang and Jiangsu Foreign Trade and Investment, January-June 2004
	Jiangsu			Zhenjiang
	Amount	% Change over 2003		Amount	% Change over 2003	Zhenjiang as % of Jiangsu
Total trade	$76.1 billion	+61		$1.5 billion	+30	2
Exports	$37.6 billion	+53		$700 million	+24	2
Imports	$38.5 billion	+68		$800 million	+35	2
Contracted FDI	$20.7 billion	+49		$1.0 billion	+28	5
Utilized FDI	$10.9 billion	+47		$600 million	+76	6
GDP	$81.6 billion	+15		$4.6 billion	+14	6
Sources: Jiangsu Statistics Bureau, Zhenjiang Statistics Bureau, Zhenjiang Economic Development Zone

Adam Ross is a research associate at the US-China Business Council in Shanghai.

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