China can become the lowest cost producer for the auto industry like that for light manufacturing industries, and with a road undergoing three phases, said Andy Xie, a China economist with Morgan Stanley in Hong Kong.

In his new research report released Friday, Andy Xie said that the key weakness of China's sedan market is its high prices that are higher than in Japan, a country with per capita income 30 times as China's. 

"But the market was growing very rapidly despite the high price in 2002 and 2003 despite the high prices.  The industry players and financial investors believed that, with penetration so low, the high price-and-high growth situation could last for many years."

Xie believes that when a new market takes off, there will be high growth and high price in the first phase, because it is penetrating high-income population first. The high-income population is quite small.

In the second phase, the businesses with too much capacity try to cut costs and prices to increase sales to keep capacity utilization high. As prices fall, the market begins to penetrate medium-income population. If technologies permit, the penetration could even reach low-income population as home appliance and mobile phone industries have been able to do.

In the third phase, the major industry players realize that they could make more profits by exporting. 

When localization reaches sufficient level, the production cost of a product begins to fully reflect China's labor cost that is substantially lower than in other major industrial economies. 

"In this phase, the major players in other market markets also realize that they can make more money by outsourcing production to China," said Xie.

Xie noted in his report that the key to China's auto success is in creating a big parts industry. 

"The domestic market for sedan is about 2 million, twice as big as South Korea's. It is already big enough for a big parts industry to emerge, in my view."

Xie said the coming price war in the car market will force major producers to search for cheap local parts, which will be the catalyst for the industry to take off. 

"The process could be quite similar to what happened in the household appliance industry. The scaling-up of the parts industry allows producers to cut prices, which increase domestic demand."

The rising demand allows the parts industry to scale up more to cut prices further, said Xie.

(Xinhua News Agency November 19, 2004)