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Rising Labor Costs Will Redefine China’s Role in Supply Chain

For the past several weeks, on the heels of a December trip to Manila, this space has been focusing on how wages are changing across East Asia. (See: Vietnam Cranks Up Electronics Production Rivalry With China and Differences & Similarities in Asian Supply Chain Wages.)

It’s a complex issue in a complex region. Save on labor, and you might not have reliable electricity. Secure electricity, and you may be paying a bizarrely inconsistent list of taxes. One theme, though, runs through all these concerns: We’re seeing massive leaps in the cost of hiring in China, the region’s largest labor market.

As has been reported widely, Chinese labor costs took a massive leap in late 2010. Last fall, explanations for the steep spike focused on sudden labor reforms put in place by the government, scrambling to respond, in part, to the infamous and horrific suicide scandal at factories owned by {complink 2125|Foxconn Electronics Inc.}

Six months later, as recently as a week ago, a more subtle analysis was emerging from several corners, perhaps most succinctly from Pennsylvania’s Wharton business school. The Wharton economists and others now argue that China’s labor cost leap isn’t just the result of a momentary response to a human rights disaster, but is evidence of broad demographic trends finally showing up in the economy. If true, this would have serious implications for electronics supply sourcing throughout the region.

Here’s their basic argument:

Ten or 20 years ago, China had too many workers. So labor was cheap. So the world went to China for its manufacturing needs. Electronics makers certainly did. New factories opened, mostly on the coasts, near the largest cities and convenient ports. This worked great. It worked so well, in fact, that China’s workers got wealthier and started to demand, and could afford, consumer goods like the ones they were manufacturing.

They also started getting older, and less numerous along the coasts. A surplus of labor had suddenly — in just a few years — turned into a shortage. So wages rose.

That was good news for Chinese workers, but companies started to expand into new areas, looking for new workers in formerly rural areas, for whom a job in an electronics factory would still be a new opportunity, and the old wage scales could still obtain.

Except (and here we reach the bad part) right about then China’s customers in the massive economies of the US and Europe fell into crisis and debt. That caused demand for China’s exports to ebb, and investment — the money to build bigger, higher-wage factories, to do tasks further down the electronics supply chain (not cheap assembly, but high-end manufacturing; not basic circuits for kitchen appliances and digital watches, but high-end boards for computers and medical equipment) — to dry up.

Inevitably, a breaking point had to come, and here we are: 2011. Wealthy American, Japanese, Korean, and EU companies are still building factories in China. But they have also started to look, and build, elsewhere — in Vietnam, the Philippines, and Indonesia. And the Chinese? They’re moving away from being the world’s labor market, and on to selling cars in Brazil.

For electronics manufacturers, this means 2011 is shaping up as the year their supply chains start running in reverse. Instead of seeing cellphones designed in Tokyo, manufactured in Shenzhen, and shipped to California, we’d see them designed in Tokyo, soldered by high-wage technicians in Shenzhen, and then shipped for final assembly on lower-wage Vietnamese lines. Then on to Shanghai, as well as California, Tokyo, and London for sale.

Or the design could take place in California before moving through the supply chain from the West to East. (See: Will Silicon Valley Welcome Chinese Companies?.) That’s a very different map of Asian supply chains than we’ve been living with for 20 years. In this case, China is as much a destination as a source.

Fortunately, in China itself, many seem to already understand what this means for the future. As the video spoof below shows, the Chinese are eager, too, for what the rest of the world has:

26 comments on “Rising Labor Costs Will Redefine China’s Role in Supply Chain

  1. Anand
    January 14, 2011

    @Marc What do you think the role of artifical yuan manipulation in all this development ?

    Its no secret that china manipulated its Yuan just to keep its export attractive. With world pressure building on china to stop this malpractice China definitely started looking unattractive compared to peers.

  2. Marc Herman
    January 14, 2011

    France24 had an interesting report on this earlier in the week, after Brazil's finance minister lost his patience over the issue: http://www.france24.com/en/20110110-brazils-finance-minister-warns-trade-war

    Dow Jones, meanwhile, has a former Chinese central banker predicting an appreciation, though gradual.http://online.wsj.com/article/BT-CO-20110110-712674.html

    Only he and perhaps his hairdresser know if that's a real opinion or some sort of dog whistle statement. As for myself, you give me too much credit. If I knew where Chinese currency was going, or why it is where it is, I'd be writing this to you from my private island in the Andaman sea.

    Sadly, I'm not.

     

  3. Marc Herman
    January 14, 2011

    France24 had an interesting report on this earlier in the week, after Brazil's finance minister lost his patience over the issue: http://www.france24.com/en/20110110-brazils-finance-minister-warns-trade-war

    Dow Jones, meanwhile, has a former Chinese central banker predicting an appreciation, though gradual.http://online.wsj.com/article/BT-CO-20110110-712674.html

    Only he and perhaps his hairdresser know if that's a real opinion or some sort of dog whistle statement. As for myself, you give me too much credit. If I knew where Chinese currency was going, or why it is where it is, I'd be writing this to you from my private island in the Andaman sea.

    Sadly, I'm not.

     

  4. Barbara Jorgensen
    January 14, 2011

    Marc–great examples of the possible new look of the supply chain. I completely agree with you on the West-to China-to Vietnam-to-elsewhere scenario, but I wonder when transporation costs/logistics become so prohibitive that so much movement becomes a strategic disadvantage? Between rising oil prices and increased security I see nothing ahead for transportation but more difficulty no matter what the mode of travel. 

  5. Marc Herman
    January 14, 2011

    Well, that's the game, right? Do the savings on labor costs/taxes/whatever outweigh the costs on transportation? One possibility is that we'll see a lot of places start changing their tax laws, and building really big container ports. Or, you know, Asian domestic markets will grow fast enough that the whole thing becomes, in at least some cases, moot.

  6. SP
    January 14, 2011

    Yes the labor costs are rising in China and everywhere in Asian countries.But China being a very strong economy can defintely change the game. With their business strategies they have made the whole west dependent on them for manufacturing almost anything. Whenever I go to Walmart or any other store its difficult or almost impossible to find any product that's not made in china. Well with such strong production capacity no wonder they will rule the game or atleast be a stong decision maker.

  7. Anna Young
    January 15, 2011

    Hi Marc, your article once again has generated interest from this side of the sea.

    I am not surprised at how labour costs are redefining China's role in the supply chain. One question I have always put forward is for how long will China be a source of cheap labour for western firms? China prides itself in the welfare of its workers. When China began opening its doors to western firms, the efficacy behind it was to advance its economy and mostly its technological knowledge.

    China knew what these western firms wanted and gave them the incentives needed to establish them on its land. It has always been known that it would be a matter of time before those incentives begin to disappear. China is the world's second largest economy and may eventually become no 1. The west must be careful not to tread on the dragon's toes by avoiding the rising costs as they appear to seek new pastures in other countries such as Vietnam. 

  8. Jay_Bond
    January 16, 2011

    I feel the rising cost of labor will have some effect on China's ability to retain some manufacturing jobs, but not as drastic as some people foresee. Yes, China's now considered a powerhouse in the world’s economy. And yes their government dictates much of what goes on i.e.; taxes, energy costs, import/export controls. As the world is facing larger costs of transportation mainly due to drastic rises in fuel prices, many companies have the need to compare logistic costs to labor costs.

    If these companies still use China in at least one of their steps, and then send the process along to another country, they have incurred a rising transportation cost. This cost sometimes outweighs the savings from labor reductions. China also has very abundant power sources compared to much smaller Asian countries. Even with the rise in total labor cost, having the energy needed available is a big plus. 

    If China's government steps in as some of these companies reduce their workforce, they have the ability to give many of the large firms tax breaks to offset rising costs.

     

  9. bolaji ojo
    January 16, 2011

    Marc, Is China changing as quickly as you describe or are we just seeing the beginning of change that is most likely decades away? If labor costs are rising in China they aren't accelerating fast enough to erase the reason why many companies moved manufacturing to the region. I am not sure either that Vietnam is the new production center for cheap goods that China has been for years now.

    The China supply chain support system is unlikely to be so quickly replicated anywhere else. It took China 20 to 30 years to evolve this way and I am not sure any other low-cost region of the world is ready to offer a competing structure. Also, are all these manufacturers really ready to pull up and move elsewhere again and ignore China's huge market? It's unlikely China's consumers will soon transform into Western-style consumers who are able to afford goods made elsewhere.

  10. Mydesign
    January 16, 2011

         Marc, you are absolutely right. The post recession era brings up the cost to an extendable level in almost all countries across the globe. During the recession periods many of the companies and countries offered many tax benefits and other soaps to beat the recession. Now almost all countries have survived from the recession period and the hence the government and companies had started withdrawing the earlier offered extra benefits. Over the same period employees are much educated about their benefits’ and rights; more over they are very much cautious also.

        In post era of recession, inflation rate is also increasing which affecting in all sectors includes the living condition too. More over new openings are coming up in other sector also. Obviously employees may look for better remuneration packages and may move to, whoever offers much salary and finally ends up in brain drain. In order to beat such situations the companies also have to do something in favor of employees either by increasing the salary or other perks.  This may internally increase the production cost and burdens to the company. This is a general phenomenon and happening in almost all countries. Since china is famous for its low cost labour, any change in the labour pay may much reflect in international forums. In such scenarios companies have to look for alternate options like training the unemployed for better skilled jobs, exploring other nations where low cost manpower are readily available etc.

  11. Ashu001
    January 17, 2011

    Bolaji,

    You raise a very valid and relevant point,

    It's unlikely China's consumers will soon transform into Western-style consumers who are able to afford goods made elsewhere.”

    The reason for that is very simple.Consumers in China don't have the confidence to spend like Western Consumers do.There are Four main reasons for that

    1)Lack of Health Insurace coverage by the Govt.

    2)Lack of Education Loan coverage by the Govt.

    3)A not very well developed Credit system.

    4)The Entrenched Elite(called the princelings) self-interest in preserving the status quo.

    If this confidence did exist,The Chinese Govt.would have happily raised the Yuan(by letting it appreciate) vs the USD,EUR and JPY;instead of resorting to their current currency market manipulations.Raising the Value of the Yuan(by more than 10%) would surely put a lot of Exporters out of Business but at the same time it would make Chinese consumers incomes much higher to buy Western Products.

    But that is the biggest problem of Central Planning.It tends to misallocate Capital on unimaginable scales.It more than boggles the mind the amount of Resources the Chinese Govt is wasting today….

    Like all the Ghost Cities all over China

    http://www.businessinsider.com/pictures-chinese-ghost-cities-2010-12?slop=1

    Regards

    Ashish.




  12. Ashu001
    January 17, 2011

    Marc,

    I am not sure Vietnam is the solution for all Electronic manufacturers needs.Big problem is that Inflation is rising at Double Digit rates in Vietnam too but in addition Vietnam has a freely floating(within specific bands maintained by the Central Bank)Currency the Dong.If Dong is allowed to appreciate as it should to absorb all the Western Capital that needs to enter Vietnam(to set up all these respective plants);then Vietnamese exports will become uncompetitive again.

    Vietnam does not have the Financial/Political muscle to keep their currency pegged at a fixed rate vs the USD like the Chinese can[Which is precisely why they are buying so much Gold].

    In my opinion the solution will come from a combination of two moves-1)moving a significant amount of manufacturing back to the West(especially Mexico and Southern USA/Europe) where labour costs have fallen precipitously.

    2)More cost cuts by Chinese manufacturers.

    Regards

    Ashish.

  13. elctrnx_lyf
    January 17, 2011

    An interesting commercial though I don't think chinese will be really worried about rise of Vietnam electronic manufacturing industry. Chinese ems companies like Foxconn have invested lot of money and there is process and established work force availble. I

    f vietnam can actually compete with china why not India and Brazil where already many of the EMS companies actually have their manufacturing plants?

  14. Ashu001
    January 17, 2011

    As If America and the US Dollar does'nt have enough problems already…

    Now The Chinese Govt.is openly calling for an end to the US Dollar hegemony…

    Time to say Goodbye to all the Deficits and Over-inflated Pensions/Salaries for Govt Employees in the US???

    http://www.bbc.co.uk/news/world-asia-pacific-12203391

    Or is this just a pipe-dream as far as the Chinese are concerned?

    Only time will tell.

    Ashish.

  15. Hardcore
    January 17, 2011

    The Americans really need to make up their mind as to what they want.

    Either they want the RMB delisted and tradable, in which case it is a major threat to the US Idea of a the Dollar beeing the only major Currency for trade.

    Or they don't want it trabable but do want it devalued.

    But they cannot have it both ways at the same time, just because the political winds change.

    As regards manufacturing,  China is a vey big place and currently it is only the outer costal areas that have been developed, This has now been stabilized and the government is currently spending really massive amounts of  cash on Infrastructure. (even by my home two brand new rail links and a road have gone in)

    I would say the plan is to further enhance the costal regions, with high tech industries then leverage the  new infrastructure to connect the inland areas, who can in turn start at the bottom of the  production ladder. Then leap-frog the systems, with the costal areas leading development with goods for  internal markets, that have developed as a result of the infrastructure and moving low level production in land, at which point the world market will no longer be the staple for Chinese manufacturers.

     

     

     

  16. Ms. Daisy
    January 17, 2011

    The West is in a pickle. The rising cost of labor in China as well as some parts of Asia, the global resession, and we are all stock in China whether we like it or not. Do not underestimate China!

    The discussion of companies still using China in at least one of their steps, and sending the processed goods to another country; and the assoiated rising transportation cost makes beating a retreat by the west and Europe almost impossible, We lack the surplus funds that we had in the past 2 decades to shift manufacturing to smaller Asian countries. This also blocks the West and Europe from leaving China.

    To seal the coffin, China has abundant money, highly developed factories and power sources that is hard to turn away from. So the notion that rising labor cost will redifine China's role in Supply chain is not likely in the near future. I will submit that China will in fact re-define the Supply Chain.

  17. Ariella
    January 17, 2011

    Ashish, I recognized your writer's voice even before I came to your signature.  Can we really bid good-bye to all deficits? 

  18. Ashu001
    January 17, 2011

    Ariella,

    Nice hearing from you again.

    Frankly speaking if you ask me,we are point the past of no-return as far the US Dollar and Deficits are concerned.There is no way America is going to be able to pay back all its Debts in Sound Money.

    This trend will continue until the market finally decides,enough is enough and we won't lend the US Govt cash at Interest rates below 10% (for 30 Year Treasuries).At which point the US Govt will first make a belated attempt to tighten the purse strings(by doing Austerity ala Europe) ,while simultaneously getting the US Federal Reserve to Print more and more Money to Finance the Deficit.After a while even that won't be possible ,which will lead the US Govt to one fine day wake up and say-

    HELLO PEOPLE,WE ARE “RESTRUCTURING”  ALL OUR DEBTS.ALL OUR EXISTING DEBTHOLDERS WILL BE PAID BACK WITH NEW TREASURY BONDS AT A 50% DISCOUNT(or maybe even more) TO EXISTING DEBT.

    When this happens the US Dollar will no longer be considered the Reserve Currency of the World.Most probably Gold will take back its rightful place.

    The same thing has happened again and again all over the World.In fact even America has done it twice before(one when FDR devalued the US Dollar and later on when Nixon closed the Gold Window).

    Regards

    Ashish.

     

     

     

  19. Ashu001
    January 17, 2011

    Hardcore,

    For the sake of the stability of the World Economy and financial system I hope you are right.

    I had written in details about why the Chinese elite are interested in preserving the current system for as long as possible here

    http://www.ebnonline.com/messages.asp?piddl_msgthreadid=236427&piddl_msgid=335904#msg_335904

    Frankly speaking they have the most to lose if the current system breaks down again decisively like it did in 2008-9.

    The rebalancing(away from Export demand to Domestic Demand in China) will take time(atleast another 7-10 years).Till then China is very-very dependent on the West for Growth.

    The Central Planning system in place in China is throwing up amazing asset bubbles across various sectors of the Economy.

    http://www.businessinsider.com/pictures-chinese-ghost-cities-2010-12?slop=1

    Why do we see these bubbles in Real Estate??? Because the Princelings/ruling elite benefit the most from these bubbles.

    What would be a better/more sustainable way for China to grow?

    Provide Full Medical Insurance coverage to every Chinese citizen and build up the Hospitals/Other related infrastructure to match up with that.

    By not having to save any more for Medical expenses,the Chinese consumers(even the poorest ones) will feel more and more confident to spend on items beyond day to day neccessities,thereby triggering a massive Demand for all  manufactured products (within China itself).

    Will this happen? Well it all boils down to Self-Interest of the Political Elite in China.So Frankly speaking it won't happen atleast for next 10 years or so.

    Regards

    Ashish.

     

  20. Ashu001
    January 18, 2011

    Daisy,

    I don't think anyone is underestimating China(neither the media nor among the economic pundits everywhere).

    But you can't argue with Demographic trends(which indicate a severe shortage of labour coming in China primarily on account of its One-Child policy).

    My post here speaks about some of the most relevant issues China faces today as well as what can be done to sort things out

    http://www.ebnonline.com/messages.asp?piddl_msgthreadid=236427&piddl_msgid=336099#msg_336099

    Your comment here is highly inaccurate.

    We lack the surplus funds that we had in the past 2 decades to shift manufacturing to smaller Asian countries. This also blocks the West and Europe from leaving China.”

    We as in the Govt,lacks funds to make Capital Investments but Corporations (most of whom are loaded with surplus cash);Don't lack cash.As for blocking the West/Europe from leaving China,all it takes is a bout of serious protectionism or a crash in the value of Euro(vs USD/Yuan) and some more incentives for moving production back to Southern Europe(Spain/Greece/Portugal) which is facing double-digit unemployment and could easily do with a few hundred thousand manufacturing jobs.Even in America ,Southern States are making big strides to lure manufacturing jobs back from China.What remains to be seen is whether the Federal Govt supports their policies.Policy-makers can improve the situation in the West.The question is do they have the Will???

    As for your comments-China will redefine the Supply Chain.I remember similar Grandiose things being said about Japan in the 1980s,Then the Bubble collapsed and politicians chose the wrong policy look where Japan is today…

    Regards

    Ashish.


     

  21. Ms. Daisy
    January 18, 2011

    Ashish.

    The first question you have to answer is – How willing are these loaded Corporations to off-load their surplus in another far away off shore place or to even move back their production?

    Financial Crisis are cyclical and vey good strategists pay attention to the long haul!

    It might seem “Grandiose” at this time to hear and heed my statement of China redefining the Supply Chain. Yes, Japan failed in the 80's but the economic realities of Japan is different from China's circumstance now. Have you paid attention to China being in almost all the developing countires of Africa. They are at the fore front in mining of Rare Earth Metals and other minreal resources in these places which helps them to diversify their financial base from just manufacturing- something diffent to the japan of the 80s.

     

  22. Marc Herman
    January 18, 2011

    Well. It seems we have a few opinions about this. Personally, I agree with Bolaji more than I do with the Wharton scholars cited in the article: we're talking about decades of industrial policy putting China where it is. A shift in currency or a trend of a few years one way or another isn't going to deconstruct all that in a few months. At the same time, it's hard not to notice the investment flowing elsewhere, in ways it never has before. For that reason, it seems to me worth thinking about China not just in terms of its growth or its capacity to produce more electronics, but to also think about how its production practices are evolving, and what that means for the supply chain. It's not that China will lose business to, say, Vietnam. It's that it will knowlingly abandon certain parts of the supply chain that it previously occupied, and move on to other parts. We know China is doing much more of its own R&D than in the past, for example. That has implications for what kind of factories it builds, and by extension, the destination of the products coming out of those factories. It certainly seems that Made in China is on a path to be Designed in China, Fabbed in China, Assembled in HCM City. Which is a change.

  23. Ms. Daisy
    January 18, 2011

    I defintely agree with the changes you have statedis happening in China and your forecast is also very likely. All these combined puts China in a position to dictate the tune of the music!

  24. Ashu001
    January 19, 2011

    Daisy,

    Sorry to interrupt you again on this issue;but the problem is that you are not understanding the situation. The problem is not one of Supply,Its of Demand .

    Whether the products are manufactured in China/Vietnam/Europe or America is completely immaterial.The much more important question is who is going to Buy those products???

    There is no doubt that the Chinese are doing much more than the Japanese or anyone else before them to ensure their continued Dominance of the Manufacturing Supply Chain(by locking in Resource inputs in long-term contracts as you so rightly suggest).

    But who is going to Buy all those products churned out by these factories???

    As two of the latest articles on the EBN rightly suggest,there is a massive wave of scepticism regarding the latest newly fangled Gadgets in the Tech-space.

    Spare me the 3D is rapidly becoming one of the most popular blog-posts ever on EBN..

    http://www.ebnonline.com/author.asp?section_id=1071&doc_id=203169&

    http://www.ebnonline.com/author.asp?section_id=1102&doc_id=203271&

    In particular read the comments here from Anna Young,Prabhakar and Saryantil.

     

    Whether we like it or not America has worked very hard to develop a Financial System (based on Credit)that has supported the Consumer based economy for a long-time.

    What happens if this demand vanishes(as is now being observed as more and more Americans start saving and also we see State Govts cutback on Salaries and Pensions-A trend which is soon going to be observed at the Federal level as well).Europe is already on this path of austerity.So Demand has fallen of a cliff(its undisputed) and Inventory is just piling up everywhere.

    The Consumers from the BRIIC and N-11 countries(Goldman coined terminilogy),Do not have the Purchasing power yet to purchase all these newly fangled gadgets(atleast in the numbers required to offset the fall in American/European Demand).

    Which is the bigger worry right now.

    The Chinese is particular face a Catch-22.If they do open their economy further(by making it more consumer oriented),their citizens will start demanding openess everywhere(incl.on the Political front) .If they do loosen control,then that will eventually end up leading to a complete overthrow of their Communist Party and their princelings..And as they say Power is very-very addictive.

    Once you grab hold you don't wanna let go.

    Interesting times for sure.

    Lets watch how things turn out….

    On the Resource front heres some more interesting stuff that happened recently.

    http://goldstocktrades.com/blog/2011/01/14/the-rendezvous-date-for-junior-uranium-miners-in-wyoming/

    Regards

    Ashish.

     

  25. Marc Herman
    January 19, 2011

    Fair points. The original argument the Wharton item made was that China was becoming less dependent on US and EU markets. It's arguable how big China's domestic market will be in 15 years, but it's probably reasonable to assume it will be larger than it is today. Similar predictions seems fair for other Asian countries with rising middle classes and large populations: Indonesia and India, most obviously. It's fair to say, I think, that all this will have implications for how electronics are produced and moved. If you're arguing that China won't have customers in 10 years, I think that's a tough argument to prove. If you're arguing that there won't be enough customers to create new supply patterns, that's a bet I'd take. Winner gets a 2030 model-year iPad manufactured in Ulaan Batar and shipped via Lusaka.

  26. Ashu001
    January 20, 2011

    Marc,

    I side totally with you(& your opinion here).

    There will most definitely be Demand 10 years from today(from China or whoever is manufacturing those products then).

    The more important question is can the Chinese afford to hold on(in case Demand falls off as suddenly as in 2008 again???).My bet is they won't ;leading to a great deal of social instability in China.So maybe that factor(alongwith China's unbelieveable trackrecord of stealing IP) could prod manufacturers to think twice about moving more production there(rather moving more to regions which actually are happy& hungry for those jobs)-Like Mexico or Southern Europe.

    Regards

    Ashish.

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