Low costs are driving rapid expansion of trade with China, writes Arthur Beesley in Shanghai

Jerry Kennelly came to China nine years ago when he was setting up Stockbyte, the digital imaging company he sold to the Getty family for €110 million last April. He used a print company in the southern city of Guangzhou to produce his first catalogue of stock photos, a 520-page document that set his Tralee-based business on its way.

Stockbyte would not have been viable without that arrangement, he says. "We wouldn't have been able to print it in Europe." There was a huge cost saving with no compromise on quality. "China is where almost all the illustrated books in Europe are printed."

Kennelly is in Shanghai this week on a "CEO retreat" with the 24 nominees for this year's Ernst & Young Entrepreneur of the Year competition.

At a business school and on a busy round of social functions, nominees received a detailed introduction to the Chinese market in all its complexity. Courtesy of Enterprise Ireland, they also met potential business partners.

The winner last year of the "emerging entrepreneur" category of the competition, Kennelly is on the lookout himself for new business opportunities. He has also done business in Hong Kong. It was there that Stockbyte outsourced colour scanning and retouching services from a partner company. "We had difficulty attracting very highly trained colour retouchers to Tralee. It allowed us to substantially scale up and deal with a bottleneck we couldn't solve in Ireland."

For Stockbyte, this venture provided a chance to rapidly achieve scale while maintaining standards and cost control.

With the relentless Chinese boom in full flight, low-cost manufacturing offers obvious advantages. "Manufacturing in Ireland is challenged hugely by what's going on here," he says.

Doing business in China was unusual when Kennelly first went east, but this is no longer the case.

Enterprise Ireland China director Alan Buckley says 60 Irish companies now have a presence here, mostly with representative offices. "Five years ago, you were talking about less than 20."

This rapid expansion is reflected in trade figures, which show Irish imports from China rising by 37 per cent last year to €3.7 billion and exports rising 41 per cent to just above €900 million. That excludes business with Hong Kong, which brings the total value of two-way trade last year to €5.75 billion.

In addition, Invest Northern Ireland says sales to Hong Kong and China from firms north of the Border were in the region of £100.83 million (€145.8 million) in 2004/05.

Irish companies with manufacturing operations here include the Kerry food group, which has a plant in Hangzhou, and Glen Dimplex, which has a plant in Shenyang. Others with operations include software firms Puca Technologies and S3 Group, and online recruiter Keyland. Iona Technologies has a research and development centre in Beijing.

Low costs are the key factor attracting droves of international groups and big-name brands to China. According to Stephen Green, chief economist with Standard Chartered Bank in Shanghai, the average manufacturing wage in China is 50 US cent (€0.39) an hour. That contrasts with an average of $15 an hour in the US.

Green believes China's vast economy will grow by 12-13 per cent this year, considerably higher than the official rate of 10 per cent. In big eastern cities such as Shanghai, the annual growth rate could be as high as 15 per cent.

Internal investment equivalent to $1 trillion is the engine of expansion. This dwarfs the foreign direct investment last year of some $80 billion, itself a huge sum. The foreign investment rate was $47 billion in 2002 and $11 billion in 1992.

The Pudong financial zone in Shanghai, which is undergoing a frenzy of construction, gives expression to the change. There, hundreds of gleaming new skyscrapers reach towards the sky from land that was used exclusively for farming until 1994. Locals refer to the creation of "a whole Manhattan" in eight years.

No matter what the statistics refer to, they all point to a massive economic expansion. In 1986, for example, China had only 1,862 international phone and telex lines and just 3.4 million phone lines in its cities. Fast-forward 19 years and there were 316 million fixed lines, 335 million mobile phones, 79.63 million internet subscribers and 23.2 million broadband users.

For all that, day-to-day business life is fraught with difficulty. Chinese contracts are subject to constant change, to the extent that they can be characterised as no more than a general statement of intent. Government regulations also change, often without warning. Corruption is rife in public bodies and an under-developed legal system means the courts are perceived to be unreliable.

Prof Juan Antonio Fernandez of the China Europe International Business School says small and medium-sized firms face big difficulties attracting English-speaking western-trained Chinese managers into their ranks. "They're looking to work for big international brands like IBM and General Motors."

In addition, the protection of intellectual property and copyright in China is notoriously challenging. Tales are legion of the Chinese half of international joint ventures fleecing their partner's technology. "Westerners say you're copying from us. The Chinese say we're learning from you," says Prof Fernandez.

While the central government in Beijing says it is committed to stamping out piracy, Prof Fernandez says enforcement can be lax at local level because the closure of a local factory tends to increase unemployment and reduce regional taxes revenues. What is more, there is nothing to stop groups forced to close down factories from opening an alternative plant 2,000 miles away.

Still, none of that is likely to deter businesspeople in pursuit of an advantageous deal.

Dundalk computer company IQon Technologies, a nominee in this year's competition, sources 90 per cent of its products directly from Taiwanese companies with factories in China. Managing director CiaráO'Donoghue spent time this week at a first-tier manufacturer of laptop computers in the industrial town of Suzhou, about an hour from Shanghai.

IQon's turnover this year will reach €90 million. But while the company expects to ship 180,000-190,000 computers in 2006, its demand for laptops is not big enough to secure a supply contract from tier-one manufacturers. To compensate, O'Donoghue says IQon recently entered a joint purchasing agreement with a Polish and a German concern. "We've been knocking on the door of that company for the last three years. Will we be buying from them before the end of the year? Absolutely no question," he says.

O'Donoghue has been to Taiwan twice a year in each of the past five years, but this was his first visit to China. "We should have been in China before this trip. For me, it's about what we don't know rather than what we do. We're missing track of new products that we've no visibility of as yet," he says.

O'Donoghue returns home from China with improved business terms from an existing supplier and new ideas about the expansion of IQon. It's a safe bet that similar thoughts are on the minds of other nominees.

With a Chinese government job creation target of 15-20 million a year, all the talk is about growth.

Prof Qi-yu Tu, assistant president of the Shanghai Academy of Social Sciences, outlined the official plan for the development of the city.

He says Shanghai will be the "brain of world trade" by 2020 and the "biggest international transportation centre in the world". It plans to be an advanced manufacturing centre in 2010, a high-tech industrial centre by 2015 and, five years later, an innovation centre.

But for every grand plan, there are looming dangers. Stephen Green of Standard Chartered warns of pain for Chinese exporters and higher unemployment if the US economy moves into recession. He notes, however, that this could be negated by Japan's resurgence.

There is more. While analysts differ over whether the Chinese renminbiis undervalued against the dollar by 5 per cent or 20-30 per cent, the consensus is that revaluation is required. Yet if mishandled, revaluation could destabilise an already fragile banking sector that has a big exposure to bad debts.

According to Green, "if growth remains above 8 per cent, everything's okay", but the issue is politically sensitive. Ernst & Young, whose Dublin office hosted this week's event, retracted as "factually erroneous" a report last month that suggested the level of non-performing loans in the big-four state-owned banks was almost three times as high as the official figure of $133 billion.

This issue is unlikely to scare off Irish entrepreneurs in their explorations of the Chinese market.

Still, analysts stress that business people should be aware the Chinese market itself is not homogenous. "It's easy to produce in China, but it's difficult to distribute," says Prof Fernandez.

While the conversion of the Communist Party of China to capitalism has brought consumerism and the possibility of a western lifestyle to more than 300 million urban people, another 900 million rural dwellers are not in the loop. Income inequality is rising, carrying with it the threat of social unrest.

While that acts as an incentive to bring economic progress westward from the fast-growing east, separate questions surround China's growing environmental problems and its questionable attitude to human rights.

Prof Fernandez says China had 32 per cent of world gross domestic product in 1820. This ancient civilisation saw its share of world wealth wither away to 5 per cent by 1950. By 1980 it was scarcely higher. For many in China, this was a temporary gap within the sweep of history that must be redressed. Thanks to the embrace of capitalism, it is on its way.

For business people elsewhere, this can be an opportunity or a threat.

• Tomorrow in 'Weekend Review' Fintan O'Toole reports from Shanghai on the changeover to more lucrative but less secure jobs