China No Longer a Low-Cost Paradise

Nayan Chanda - Straits Times Indonesia
March 15, 2012

Workers assembling computer mice at the Logitech International factory in Suzhou, Jiangsu province early this month. Last year, wages in a majority of China's provinces went up by as much as 22 per cent. (Bloomberg Photo).

As the dust settles on the post-financial crisis world, new contours are emerging that throw doubt on earlier certainties: United States manufacturing is not in a terminal state, nor is China destined to remain the world's factory. Energy and transportation costs, environmental concerns, demographic factors, and the march of technology are reshaping the world economy.

China's growth rates, which seemed to sizzle throughout the financial crisis, are beginning to slow. Premier Wen Jiabao's announcement this week that China is looking at a 7.5 per cent growth - the lowest in two decades - has raised the prospect of painful domestic adjustments.

Chinese leaders long considered 8 per cent growth a minimum to maintain internal stability. Double-digit growth for the past two decades has brought China record prosperity but also yawning inequality and environmental challenges.

Ironically, growing signs of social discontent and a looming environmental crisis have forced China to abandon its 8 per cent target.

Worker discontent has now forced the government to raise the minimum wage and promise annual pay rises. Last year, wages in a majority of China's provinces went up by as much as 22 per cent.

Costs of production have increased manifold because of government-mandated measures to reduce environmental damage, foreign employers' obligation to provide pension benefits to workers, skyrocketing price of land and growing price of electricity. The resultant across-the-board rise in costs has begun to drive investors to other low-cost Asian countries.

In fact, some labour-intensive manufacturing has already shifted from China to Thailand, Vietnam, Indonesia, and Cambodia. Compared with China's average wage rate of US$ 4.11 per day, manufacturing wage is US$ 2.75 in Vietnam, US$ 2.81 in Indonesia, and US$ 1.84 in Cambodia.

The most high-profile example of wage hikes last year was Foxconn, whose sprawling factories in China employ over a million workers to produce Apple's iPad and other items. Facing international criticism for its treatment of workers, some of whom were driven to suicide, the company doubled its wages but also hedged by opening a new factory in Vietnam.

Given the growing social media-based activism on behalf of workers, it is becoming more difficult for large Western businesses to continuing employing cheap labour.

China's attraction as a low-cost paradise is dimming as rising fuel prices, transportation costs, quality control, and other factors are breathing new life into the American manufacturing sector. Persistent unemployment has driven down US wages and state governments have tried to entice investment back with tax breaks and subsidies. The result: After steadily declining for years since the beginning of 2010, US manufacturing created 3 per cent more jobs last year - more than the rest of the G7 countries put together.

In a study on the trend of US manufacturing companies leaving China to head home, titled 'Made In America, Again', Boston Consulting Group concludes that by 2015 for many goods destined for North America, 'manufacturing in some parts of the US will be just as economical as manufacturing in China'.

Adjusted for productivity, which is much lower in China than the US, the total cost differential with China is expected to drop to 10 per cent to 15 per cent by 2015. The study predicts that if the current trends in productivity and wage growth in both countries continue, manufacturing in the US may become cheaper than in China. The Boston Consulting study notes that already a number of US companies have shifted their production back to the US for logistical advantages and efficiency.

The experience of the past decade has also taught manufacturers the value of being near their main markets for R&D. Having production facilities in Mexico is convenient for serving markets in the US. For tax reasons, too, clothing and electronics assembly in Mexico and central American countries might turn out to be a better bet than China. Membership of the trading bloc Cafta allows, for example, duty-free import of apparel from central America if it contains US yarn and fabric.

This is not to suggest that China will lose its status as the principal location for the manufacture of consumer goods.

Its large and efficient labour force, high-class infrastructure and government-supported large-scale production facilities will continue to draw investors. But with the US multinationals finding new value in being closer to their primary markets and relying on new technologies and automation, China's dominance in manufacturing may have peaked.

Reprinted courtesy of Straits Times Indonesia. To subscribe to Straits Times Indonesia and/or the Jakarta Globe call 021 2553 5055.