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The End Of Cheap China: Low Costs Eroding

By Dan Harris on Posted in Uncategorized

Just read a really excellent Foreign Policy article, entitled, “The end of the Asian Miracle.“  The article is written by Antoine Van Agtmael, “the investment guru who coined the term ‘emerging markets.’”  To grossly summarize, the thesis is that the following five pending “game changers” could bode ill for China and bode well for the United States:

  1. The shale gas explosion
  2. The erosion of low-cost advantage
  3. The burden of aging populations
  4. The smartphone revolution
  5. The fighting spirit of smarter competition

I found number two the most interesting because it is the most immediate in the sense that it is already directly relevant to Western manufacturers.  According to Van Agtmael, “China is no longer the place for manufacturing,” for the following reasons:

  • A large wage gap remains but even narrowing it will have a big impact. In a dinner speech at the Brookings Institution, Jeff Immelt of GE claimed that an American factory worker can be competitive at $15 per hour with a $3 worker in China.
  • Unit labor costs in the United States, according to OECD data, have declined from 100 to 88 since 1995, better than anywhere in the developed world except Sweden (80). For comparison, Spain (135) and Italy (120) are much higher. That’s good news for U.S. global competitiveness.
  • According to several manufacturers I met with who have plants in China, China now suffers from a lack of technologically trained manpower. Bangladesh and Vietnam are now lower-cost manufacturing centers than China — even Thailand, the Philippines, and Mexico are becoming wage competitive.
  • Productivity per manufacturing worker is also better in the United States than widely assumed. Hyundai, for example, has car plants in South Korea, the United States, China, and India and “unit per hour” production is actually highest in Alabama.
  • World-class Indian car axle maker Bharat Forge found that Chinese workers in its plants had only 40 percent of the productivity of other workers. The Pune hub (near Mumbai) has become much more competitive because of trained labor and better transportation (a container trip to the port used to take at least two days but now only four hours and the port is more efficient).
  • Of course, China’s enormous competitive advantage is not just in wages but also in its scale for assembly-type production, infrastructure, internal competition, and growing domestic market. These advantages are not going to disappear overnight but are now being questioned.

Many of the above are just various ways of saying the same thing: productivity in China is generally not very good at all, particularly when compared to countries like the United States.  I now have a term for the problems that are so often inherent in manufacturing in China: the phantom 20%.  I tell clients who are just starting to manufacture in China that in my experience (which really is the experience of my clients), it usually is not worth doing unless the cost savings are projected to be at least 20%.  Of course this 20% figure can vary considerably, depending on the risks involved in manufacturing a particular product in China. But the point of all this is that there are a lot of inefficiencies and uncertainties in China of which Western companies new to China often underestimate and those costs can be the difference between cost savings and cost increases.

Definitely not saying you should not manufacture in China, but I am saying that you do need to look at your cost numbers with a jaundiced eye. People have been talking about the end of cheap China for years now (click here for a television interview I gave in China last summer on this topic), but I am definitely feeling as though this is the year that American companies are really starting to account for this and looking elsewhere in Asia for their manufacturing needs.

What are you seeing out there?  What China costs were caught you unprepared?

  • Lucas

    Ah. The China is Japan argument.

    1. China has larger shale gas reserves than the United States. It is only a matter of time until the development of these resources begins to have an effect.

    2. It is still cheaper to manufacture in China not just because of wages, but more importantly because of logistics. China is uniquely geographically positioned. It’s supply chain for manufactured goods is far more developed than the United States. Furthermore, it’s labor advantage is enormous. Any project that requires engineers is generally much cheaper to complete in China do to the abundance of skilled labor. The 8,000 engineers in three weeks, compared to six months stateside.

    3. Aging populations are a worldwide problem. The percentage of older people in the United States is roughly the same as in China. And unlike the United States old people actually retire and then perform a function, educating and providing childcare. Medical costs are also extravagantly less in China, and due to the strength of the family bonds, elderly usually do not provide an extremely difficult burden. As well, personal savings in China is considerable an thus the financial burden of care is less significant.

    4. Smartphone revolution? China has completely skipped computers and jumped right into the mobile computing market. China has the largest number of internet users and cellphone owners in the world. And, have you ever used a phone company in China? Try 1,000 times more convenient, with better service, and cheaper costs.

    5. Fighting spirit of smarter competition? Another way of saying Western superiority right?

    China just launched it’s first women into space and docked with its own, solo operated space station. The United States is paying Russia to ferry around its astronauts. Never, ever, ever underestimate the Chinese, it is the day you begin to go out of business.

    As for your points. I would encourage anyone who sees China’s GDP per capita growth as a sign of a domestic slowdown in manufacturing to travel outside of the developed 1st tier cities. Industrialization in China has just begun. It will be another 50 years before a permanent dent in Chinese manufacturing takes place, and that dent will arrive when industrialization finishes and China’s economy is twice the size of the U.S. economy.

    The United States is a very productive country, but not because of the ability of our labor force. The only factor that causes an increase in output is that the U.S. citizens work more hours than anyone else in the rest of the world. We have no daily lunch breaks, vacations are nonexistent, almost no one really retires. Furthermore, our labor force participation rate is paltry, at a mere 62%, nearly 38% of working able Americans don’t work. Taking this into account our productivity looks much more dim.

    As well, you must also consider the mechanization of U.S. manufacturing, something that is only now just arriving in China. U.S. factories are comparatively unmanned, with factory wages and skills being rather undeveloped.

    What is currently occurring is the United States economy and the Eurozone is dragging down the rest of the world. The West is like dead weight. For years everyone has been relying on Westner consumers, and now that wages, standard of living, and the rate of education is all falling in the West, labor costs are becoming much more affordable.

    We rarely talk about the crisis in India (economic meltdown essentially). You never hear about Brazil grinding to a halt. We hear about China because it is our largest competitor. But when you honestly examine the data the results are clear. Either the West will recover and the trend will continue, our the West is going to die and the new world that emerges from it’s ashes will be a much more level playing field.

    No matter what the world economy will change. Once the baby boomer generation dies, young people both in America and abroad are going to be able to construct a much more just and equitable worldwide society.

    And furthermore, if China does turn downward, there is absolutely no reason to think that wages here won’t follow the same pattern they have in the United States. We are already seeing the yuan depreciating.