LIN Changjie is battling to save a family business making towels, cushions and robes in Ningbo in Zhejiang Province as a dwindling supply of workers forces him to pay higher wages.

"I have to find a new way," says Lin, 29, who is turning his Dejin Textile Co into an online fashion retailer to cut costs and keep the business from closing. "Wages are going up, up, up. If we don't like somebody's work we can't say anything, in case they leave."

China's three-decade-old, one-child policy will accelerate declines in the workforce, forcing companies to upgrade to higher-value products in the way Japan did in the 1960s and 1970s.

China may have as little as five years to make the transition to avoid a slump in economic growth, according to Sun Mingchun, an analyst at Daiwa Capital Markets in Hong Kong and former economist at the State Administration of Foreign Exchange. He said growth may decline in 2016-2020 as low-cost producers fail and investment falls away.

"This is the big issue in China on which everything will turn, China needs to really accelerate this transition." said Barry Eichengreen, an economics professor at the University of California at Berkeley and former senior policy adviser to the International Monetary Fund, who contributed to the 2010 book, "Emerging Giants: China and India in the World Economy."

The pool of 15 to 24-year-olds, a mainstay for factories making cheap clothes, toys and electronic products, will fall by almost 62 million people to a total of 164 million in the 15 years through 2025, United Nations projections show. The demographic shift is a result of the one-child policy implemented in 1979.

Products such as clothes, shoes and furniture that the General Administration of Customs doesn't classify as "high-tech" accounted for about 68 percent of China's exports last year, or US$1.09 trillion, little changed from the 71 percent share in 2005, when they were worth US$544 billion, the agency's figures show. Exports account for more than a fifth of China's gross domestic product. High-tech industries include aerospace and aviation, medical instruments, software, computers and telecommunications.

"The low-end manufacturing industry is tough and will be getting tougher day by day as both labor and land costs are rising," says Xu Hui, 39, the owner of Wenzhou Dazhan Photoelectricity Co in Zhejiang Province. She's switched to making LEDs and solar parts after starting off in the 1990s manufacturing sunglasses that sold for a dollar or two.

"Either you go for high-tech, high value-added industry or you just perish," she said.

China's income growth and stage of economic development is similar to Japan in 1969 and South Korea in 1988, before their rates of expansion fell, according to Morgan Stanley. Japan's growth slid to an average 5.2 percent in 1970-1979 from 10.4 percent in the previous decade, the bank said. South Korea's growth cooled to 6.3 percent in 1989-98, from as much as 12.3 percent during the previous decade, government data show.

Only five economies - Japan, South Korea, Taiwan, Hong Kong and Singapore - have moved from middle-income to developed status while maintaining relatively high growth rates, according to Nobel laureate Michael Spence, a professor of economics and business at New York University's Stern School of Business.

Inflation is serious

China's economic growth may ease to 9.2 percent this quarter from 9.5 percent in the previous three months, the China Securities Journal reported on August 16, citing the State Information Center. The country's inflation may rise to about 6.2 percent in the same period, from 5.7 percent in the previous quarter, the report said.

"Inflation is serious now," said Chen Mei, 23, during her lunch break in the southern manufacturing city of Dongguan. Chen, a migrant, said she's earning about twice the monthly minimum wage of 1,100 yuan (US$172) and expects pay at the garment factory where she works to keep rising as prices increase.

The yuan's gain of about 7 percent against the dollar since June last year has intensified cost pressures faced by China's exporters, which price their products in the US currency.

While the bulk of China's producers have yet to upgrade, high-technology exports are rising, recording a 31 percent jump in 2010 to US$492 billion. That's more than double the US$218 billion in 2005 and almost a third of total shipments, according to the customs bureau.

Economists, including Deutsche Bank AG's Ma Jun, say companies that successfully make the transition will reap huge benefits.

"The single most important investment theme for China's manufacturing sector over the next five years is its upgrading," said Ma, Hong Kong-based chief China economist for the bank and a former researcher for China's State Council.

Investors have yet to price in the "potential outperformance" of the sector, he said.

Companies such as machinery makers Sany Heavy Industry Co and Changsha Zoomlion Heavy Industry Science & Technology Development Co will "emerge to be major winners not only domestically but internationally" said Diane Lin, a fund manager with Sydney-based fund Pengana Capital Ltd, which manages about US$1 billion in global assets.

"Forget textiles and all that, this is the future of China," said Lin. "If you go and look back to Japan in the early 1970s it was a net importer of machinery as well, and within only three to four years it overtook the US and became a net exporter."

Shares in Zoomlion will double to HK$24 (US$3.08) by July next year, according to Zhang Zharlen, an analyst with KGI Securities in Shanghai. Lin said she plans to buy shares of companies including Zoomlion once sentiment improves from the effect of government measures to cool the property market.

Twenty-two years after starting as a welding factory, Sany Heavy has four billionaires on the board, more than 68,000 workers and sells products including concrete pumps and road rollers in 120 countries.

"For ages, people believed that Chinese can only make stuff like toys, clothes and hand torches - all cheap and of bad quality," Sany's Senior Vice President Zhao Xiangzhang said in an interview in Changsha, capital of Hunan Province. "Our dream is to change this bad image."

Equipment makers

Sany opened an industrial park in June in Bedburg in Germany, home of machinery makers Siemens AG and ThyssenKrupp AG. The company also supplied a pump that helped cool the crippled No. 4 reactor at Japan's Fukushima nuclear plant after the March 11 earthquake and tsunami.

Chinese equipment manufacturers will be among the nation's best performers over the next five years, according to Deutsche Bank. They have taken market share from competitors including South Korea's Hyundai Heavy Industries Co and Doosan Infracore Co, Japan's Komatsu Ltd and US-based Caterpillar Inc, Pengana's Lin said.

"We would avoid Komatsu because we think that Chinese companies will increase their competitiveness over the medium term," she said. Komatsu is the world's second-largest maker of construction and mining equipment, trailing Caterpillar.

Other potential "global losers" from Chinese competition include telecommunications companies Ericsson and Nokia Corp, industrial machinery maker Alstom SA and General Electric Co, Deutsche Bank said in a report last year.

The bank recommended buying Chinese equipment makers and avoiding "material- and labor-intensive companies" such as casual footwear maker Yue Yuen Industrial (Holdings) Ltd and VTech Holdings Ltd, a manufacturer of cordless telephones and electronic learning products.

Rising labor and other costs may force manufacturers to move production of some consumer goods to lower-cost regions including western China, Vietnam, Bangladesh and Indonesia to keep prices down.

"I don't believe consumers in the United States or Europe are prepared to pay more," Bruce Rockowitz, CEO of Hong Kong-based Li & Fung, the world's biggest supplier of toys to retailers, said in May.

Cai Fang, a member of the Standing Committee of the National People's Congress, said China's leaders have not yet fully accepted that the so-called demographic dividend is declining. The economic benefit arises after a country's birth-rate falls - creating a few decades when there are a higher proportion of working-age citizens and less need to spend on children and education.

Cai, a director of the Institute of Population and Labor Economics at the Chinese Academy of Social Sciences who helped draft the nation's five-year plan through 2016, said advisers are "comforting" China's policymakers with arguments that the dividend can last another 20 years or more.