A Vietnam consultant friend of mine sent me a Stratfor article (from about a year ago) talking about how rising labor costs in China were slowly causing low-end manufacturing to leave China for other countries, seeking my thoughts on the article. Stratfor’s theory is essentially that clothing manufacturing and mobile phone assembly are precursors to other industries and those two industries are already starting to leave China:
Even though the movement of two indicator industries — garment manufacturer and mobile telephone assembly — signals change, this is a transition that is as yet pre-statistical; few if any reliable trade numbers or volumes now exist to plot the contours of this shift. But it is, Stratfor has concluded, a shift that is already well underway.
Stratfor sees the following sixteen countries taking over (not necessarily completely) low end manufacturing from China, though “[T]he outlines of this group, what we call the Post-China 16, or “PC16,” are only now coming into focus. Indeed, the specific countries may change and the precise roles they play in this transition — their success in following the path China has trod — remain to be fully seen.
Stratfor came up with its list not by “looking for the kind of large-scale movements that would be noticed globally, but for the first movements that appear to be successful. Where a handful of companies are successful, others will follow, so long as there is labor, some order and transportation. Some things are not necessary or expected. The rule of law, understood in Anglo-Saxon terms of the written law, isn’t there at this stage. Things are managed through custom and relationships with the elite. Partnerships are established. Frequently there is political uncertainty, and violence may have recently occurred. These are places that are at the beginning of their development cycle, and they may not develop successfully. Investors here are risk takers — otherwise they wouldn’t be here.”
Stratfor does not see any one of these sixteen countries assuming the “factory to the world” mantle:
There is no single country that can replace China. Its size is staggering. That means that its successors will not be one country but several countries, most at roughly the same stage of development. Taken together, these countries have a total population of just over 1 billion people. We didn’t aim for that; we realized it after we selected the countries.
The point to emphasize is that identifying the PC16 is not a forecast. It is a list of countries in which we see significant movement of stage industries, particularly garment and footwear manufacturing and mobile phone assembly. In our view, the dispersal of industries that we see as markers of early-stage economic growth is already underway. In addition, there are no extreme blocks to further economic growth, although few of these countries would come to mind as having low political risk and high stability — no more than China would have come to mind in 1978-1980. I should also note that we have excluded countries growing because of energy and mineral extraction. These countries follow different paths of development. The PC16 are strictly successors to China as low wage, underdeveloped countries with opportunities to grow their manufacturing sectors dramatically.
Here are the sixteen:
- Dominican Republic
- Sri Lanka
I find Stratfor’s analysis fascinating, but I am not so sure. I especially like how I have the benefit of analyzing the article a year later.
Booz & Company’s Strategy + Business website ran an article entitled, Is China the World’s Next Rust Belt? The article is by John Juliens, a Booz partner out of its highly regarded Shanghai office. Despite the title, Juliens sees China manufacturing continuing to grow because the following five factors “likely more than offset the impact of China’s eroding labor cost advantage”:
1. Domestic demand. China’s rapid economic development will continue to add millions of new consumers to its already huge customer base. The country is, or soon will be, the world’s largest market for a wide range of goods, many of which need to be manufactured close to where they are consumed. In addition, Chinese tastes are sufficiently particular for it to often be necessary to design (and manufacture) products specifically for local customers. Technological developments, such as miniaturization and 3-D printing, will further enable these trends.
2. Urban–rural divide. China remains a highly diverse country with a wide gap between urban and rural incomes. In fact, almost two-thirds of its people still earn less than US$5,000 per year. In contrast to the nation’s more developed coastal regions, China’s less-developed inland regions continue to have low labor costs—suggesting that manufacturing activities could be shifted to retain the country’s labor cost advantage.
3. Operational excellence. To date, few firms have truly optimized their Chinese operations. This leaves substantial room for productivity improvements through, for example, more efficient machines and production setups, minimization of defects, leaner supply chains, and improved labor productivity.
4. Frugal manufacturing. China’s competitive advantage already goes far beyond cheap labor. For example, Chinese firms are often quite innovative in reducing costs by redesigning manufacturing processes, substituting cheaper “good enough” materials, and using simpler off-the-shelf components.
5. Investment versus comparative advantage. Economic theory dictates that when labor costs rise, businesses move elsewhere. However, countries can offer investment incentives to attract or keep businesses, and I believe that such incentives often trump the underlying comparative advantage. China, like Singapore—the country it most seeks to emulate—has the financial means and the will to wield this tool effectively.
In, China Factories Moving In Droves To Cambodia/Vietnam/Myanmar/Malaysia. NOT. we wrote on what we were seeing and nothing has really changed since then:
The article [Wary of China, Companies Head to Cambodia] does an excellent job at setting forth exactly what my law firm is seeing among its clients, which include the following:
- Small clothing and shoe companies that seriously looked at moving operations to Vietnam or Cambodia but then chose not to do so because it would be “too difficult” to set up a supply chain in those places. Just as described by Ms. Olchanetzky above.
- Mid-sized and large clothing and shoe companies that have put their toes into Vietnam or Cambodia by doing a bit of outsourcing from those countries or by setting up small factories there.
- Many companies of all kinds sending people to scope out Vietnam or Cambodia and, more recently and to a lesser extent, Myanmar.
- Many companies looking at adding facilities or offices in Thailand or Malaysia or Indonesia, believing that those three countries are going to thrive in the next decade as ASEAN’s economic importance rises.
Right now, our Vietnam, Cambodia, Thailand, and Myanmar work is all being done out of our existing offices by our traveling to those countries and working with the people we know there. Much of our work in those countries involves the basics like helping our clients contract with existing companies there and helping our clients register and protect their intellectual property there. As more of our clients establish a permanent presence in some of these countries, we will look more seriously at opening a new office to serve that region.
The response to the above was invariably, “that makes complete sense and is pretty much how we are approaching things as well.”
But since we wrote the above posts, our Vietnam work has greatly increased and we view Vietnam as a viable China substitute on both ends of the manufacturing spectrum, but maybe not the middle. What we are seeing with companies manufacturing in Vietnam is that really large companies are going into Vietnam manufacturing with their own factories and SMEs are going into Vietnam to have things like clothing and rubber duckies manufactured there. What we are also still seeing is that China is still the place for most other manufacturing.
More importantly — and this holds true for both Vietnam and China — what we are really seeing is more and more companies looking to places like China and Vietnam as markets, not just as manufacturing centers.
So what is going to happen three, five, ten or twenty years from now? Will China be a rust belt? Will clothing still be manufactured there? Which if any of the Stratfor 16 can we expect to be ascendent and when? Answers please.