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China’s Status as a Low-Cost Production Powerhouse Wanes

China's status as the world's center for low-cost production is waning, as manufacturers increasingly seek alternatives elsewhere.

While China's industrial base is expected to continue expanding in the near term, growth is slowing. The more tempered pace is also in stark contrast to the phenomenal growth China saw during the past few decades, which helped to catapult the country past Japan to become the world's second-largest economy.

Firms are increasingly shifting production outside of China for a “number of reasons,” Lian Hoon Lim, managing director of AlixPartners, told EBN. The main impetus is increasing production costs. The need for manufacturers to reduce their dependence on China's production base and companies seeking more localized production play a role as well.

Recent high-profile moves among manufacturers opting to shift production beyond China's borders include:

Outside of the tech sector, China is also seen as a less favorable manufacturer location for garment manufacturing. According to a U.S. Fashion Industry Association study, for example, China is now deemed the least desirable location for U.S brands to source manufacturing among 27 countries. 

The shift away from mainland China is largely due to rapidly rising costs, particularly for labor. According to Hong Kong-based Strategic Decisions Group (SDG), China's manufacturing costs have been rising at least 10% every year.

 “There has been substantial growth in labor cost year on year now in China for over a decade,” Peter Hopper, a partner and managing director for SDG, told EBN.  “[Labor-intensive] industries are very limited in what they can do to remove labor and improve productivity so they need to look for other sources of production. Vietnam, Philippines, and Indonesia are well trodden paths and the recent signing of Trans-Pacific Partnership will likely support this trend.”

Much of the rising cost in labor can be attributed to China's “One Child” policy, which is intended to limit population growth in China. “The one child policy has led to a shortage of labor and a rise in living standards has prompted a desire for better paid occupations,” Hopper said.

However, other factors besides rising labor costs are prompting manufacturers to move production outside of China. Production that is closer to the customer base often outweighs the disadvantages of higher production in China, especially in the technology sector, Lim said.

Production in Mexico, for example, is generally more expensive than it is in China, but the supply chain advantages of a comparatively short lead times of five to six weeks “outweigh the difference,” Lim added.

Some OEMs continue use China production for PCB assembly, but opt for Mexico for U.S. retail outlets for final box assembly, as Mexico is closer to the United States than China is, according to Lim. 

 “Shorter lead times offer more flexibility in final product configuration and less unsold inventory,” Lim told EBN.

The Chinese government's recent push to devalue the yuan has helped to deflect rising production costs in China, but the effects are largely seen in the near term.

“Companies take a long term view of this, say five to 10 years ahead, and they realize the risk of being dependent on one source of production is a too high price to pay,” Hopper said. “Most companies have factored in a devaluation of the yuan in their thinking even when making the decision to move.”

The exodus of production outside of China is also reflective of how China is beginning to shift to more advanced and specialized manufacturing processes, which involve smaller volumes and are less labor intensive. This trend helps to explain why China's long-term status as an economic powerhouse is not under threat, even as its industrial base grows more slowly, Hopper explained.

“China is in transition from an economy based on being the manufacturing center of the world built on an abundant supply of cheap labor to a more value-based economy built on skills. The challenge is to transition to more added-value industries,” Hopper said. “Growth has slowed and some say it is a natural trend but the potential for consumption growth is still huge. Most forecasters still see China growing to be the leading economy worldwide over the next 50 years, but the nature of that growth will be very different to the last 50 years.”

Let us know where you see manufacturing in China headed in the comments section below.

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