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Companies brace for end of cheap made-in-China era
Costlier labor, currency are ending cheap made-in-China era; manufacturers struggle to adapt
July 8, 2010

SHANGHAI (AP) -- Factory workers demanding better wages and working conditions are hastening the eventual end of an era of cheap costs that helped make southern coastal China the world's factory floor.

A series of strikes over the past two months have been a rude wakeup call for the many foreign companies that depend on China's low costs to compete overseas, from makers of Christmas trees to manufacturers of gadgets like the iPad.

Where once low-tech factories and scant wages were welcomed in a China eager to escape isolation and poverty, workers are now demanding a bigger share of the profits. The government, meanwhile, is pushing foreign companies to make investments in areas it believes will create greater wealth for China, like high technology.

Many companies are striving to stay profitable by shifting factories to cheaper areas farther inland or to other developing countries, and a few are even resuming production in the West.

"China is going to go through a very dramatic period. The big companies are starting to exit. We all see the writing on the wall," said Rick Goodwin, a China trade veteran of 22 years, whose company links foreign buyers with Chinese suppliers.

"I have 15 major clients. My job is to give the best advice I can give. I tell it like it is. I tell them, put your helmet on, it's going to get ugly," said Goodwin, who says dissatisfied workers and hard-to-predict exchange rates are his top worries.

Beijing's decision to stop tethering the Chinese currency to the U.S. dollar, allowing it to appreciate and thus boosting costs in yuan, has multiplied the uncertainty for companies already struggling with meager profit margins.

In an about-face mocked on "The Daily Show with Jon Stewart," Wham-O, the company that created the Hula-Hoop and Slip 'n Slide, decided to bring half of its Frisbee production and some production of its other products back to the U.S.

At the other end of the scale, some in research-intensive sectors such as pharmaceutical, biotech and other life sciences companies are also reconsidering China for a range of reasons, including costs and incentives being offered in other countries.

"Life sciences companies have shifted some production back to the U.S. from China. In some cases, the U.S. was becoming cheaper," said Sean Correll, director of consulting services for Burlington, Mass.-based Emptoris.

That may soon become true for publishers, too. Printing a 9-by-9-inch, 334-page hardcover book in China costs about 44 to 45 cents now, with another 3 cents for shipping, says Goodwin. The same book costs 65 to 68 cents to make in the U.S.

"If costs go up by half, it's about the same price as in the U.S. And you don't have 30 days on the water in shipping," he says.

Even with recent increases, wages for Chinese workers are still a fraction of those for Americans. But studies do show China's overall cost advantage is shrinking.

Labor costs have been climbing about 15 percent a year since a 2008 labor contract law that made workers more aware of their rights. Tax preferences for foreign companies ended in 2007. Land, water, energy and shipping costs are on the rise.

In its most recent survey, issued in February, restructuring firm Alix Partners found that overall China was more expensive than Mexico, India, Vietnam, Russia and Romania.

Mexico, in particular, has gained an edge thanks to the North American Free Trade Agreement and fast, inexpensive trucking, says Mike Romeri, an executive with Emptoris, the consulting firm.

Makers of toys and trinkets, Christmas trees and cheap shoes already have folded by the thousands or moved away, some to Vietnam, Indonesia or Cambodia. But those countries lack the huge work force, infrastructure and markets China can offer, and most face the same labor issues as China.

So far, the biggest impact appears to be in and around Shenzhen, a former fishing village in Guangdong province, bordering Hong Kong, that is home to thousands of export manufacturers.

That includes Taiwan-based Foxconn Technology, a supplier of iPhones and iPads to Apple Inc. Foxconn responded to a spate of suicides at its 400,000-worker Shenzhen complex with pay hikes that more than doubled basic monthly worker salaries to $290. Strike-stricken suppliers to Honda Motor Co. and Toyota Motor Corp., among many others, also have hiked wages.

Foxconn refused repeated requests for comment on plans to move much of its manufacturing capacity to central China's impoverished Henan province, where a local government website has advertised for tens of thousands of workers on its behalf.

But among other projects farther inland, Foxconn is teaming up with some of the biggest global computer makers to build what may be the world's largest laptop production hub in Chongqing, a western China city of 32 million where labor costs are estimated to be 20 to 40 percent lower than in coastal cities.

Given the intricate supply chains and logistics systems that have helped make southern China an export manufacturing powerhouse, such changes won't be easy.

But for manufacturers looking to boost sales inside fast-growing China, shifting production to the inland areas where many migrant workers come from, and costs are lower, offers the most realistic alternative.

"The new game is to find a way to do the domestic market," says Goodwin.

Many factories in Foshan, another city in Guangdong that saw strikes at auto parts plants supplying Japan's Honda, have left in the past few months, mostly moving inland to Henan, Hunan and Jiangxi, said Lin Liyuan, dean at the privately run Institute of Territorial Economics in Guangzhou.

Massive investments in roads, railways and other infrastructure are reducing the isolation of the inland cities, part of a decade-old "Develop the West" strategy aimed at shrinking the huge, politically volatile gap in wealth between city dwellers and the country's 600 million farmers.

Gambling that the unrest will not spill over from foreign-owned factories, China's leaders are using the chance to push investment in regions that have lagged the country's industrial boom.

They have little choice. Many of today's factory workers have higher ambitions than their parents, who generally saved their earnings from assembling toys and television sets for retirement in their rural hometowns. They are also choosier about wages and working conditions. "The conflicts are challenging the current set-up of low-wage, low-tech manufacturing, and may catalyze the transformation of China's industrial sector," said Yu Hai, a sociology professor at Shanghai's Fudan University.

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China is putting the brakes on export-driven growth
July 9, 2010

Growth in China is going to slow. After the country posted 11.9% growth in the GDP for the first quarter of this year compared to last, there's really no other option. For one, the sovereign debt scare in Europe, which has eroded the purchasing power of China's largest export market, will be a big knock on the economy. The Chinese government has even set their full year growth estimate at 9.1%, explicitly implying a slow down is coming. And, with the Shanghai Composite down 26.5% year to date, Chinese equity prices confirm this.

Savvy investors are realizing that China's growth remains attractive because Beijing is battening the hatches by turning to a new group of consumers: their own citizens. Over the past several weeks, China has taken a number of steps to increase its citizenry's purchasing power -- none arriving with more fanfare than the de-pegging of the yuan.

Despite the prospects of a stronger currency, the People's Bank of China still mandates that the yuan only fluctuates 0.5% from the daily official rate. As a result, the yuan's appreciation might not be the silver bullet China is looking for to stimulate domestic consumption. Domestic consumption has actually fallen over time until a small recent rebound, as the chart above shows. As a share of GDP, personal income has had an even more dramatic decline: 53% in 1999 down to just 39.7% in 2009.

That said, there have been a number of positive developments regarding wage growth and government stimulus that will help move China forward towards a more consumption-oriented economy, rather than one that has been fueled by manufacturing and exports in recent years. Here's an incomplete list:

Wages: In April, Shanghai raised minimum wages 17% to 1,120 yuan per month. Guangdong (China's largest export base) raised minimum wages in five locales within the province by an average of 21%.

Cash for clunky ovens: On June 3rd, China extended its home appliance trade-in program until 2011. Sales of such appliances have reached 54 billion yuan and 5 billion yuan of subsidies were handed out since the start of the program.

Job growth: On June 8th, a survey indicated that Chinese employers' hiring plans reached a six-year high.

More jobs: On June 11th, the IMF reported that the surplus of rural workers for labor-intensive work has fallen to about 25 million from roughly 120 million in 2007, which is bullish for wages in that sector (less supply). Conversely, research from China International Capital Corp. that suggests that 31 million Chinese will return to the labor market in 2011 after the completion of projects resulting from the government's 4 trillion yuan stimulus package. Net-net: supply of labor-intensive workers is still shrinking but perhaps at a slower rate, which is net bullish for wages.

More wages: On July 1st, Bejing increased monthly minimum wages by 20% to 960 yuan. In a similar fashion, Henan (China's most populous province) raised its minimum wage by 33% to 600 yuan per month.

Rising wages to empower the Chinese consumer

All told, more than 20 provinces and municipalities plan to increase minimum wages this year, according to the Ministry of Human Resources and Social Security. As a result, we should begin to see evidence of accelerating domestic consumption in the coming months. Furthermore, companies that are positioned to service the Chinese local economy (i.e. domestic retailers and savings deposit institutions) will see an added kick from this wave of wage inflation.

In short, while China built its impressive industries on the back the global economic boom of the past twenty years, it's now figuring out how to sustain them by turning its citizens into better consumers.

Will higher salaries just mean inflated prices?

Yes and no. The bulk of the wage inflation is coming from the labor-intensive manufacturing sector, where thin margins in certain subsectors of that industry (i.e. textile manufactures) warrant passing through higher costs. In those sub-sectors that can perhaps afford to absorb the hit to margins (auto manufacturers, CPU manufacturers, construction), inflation won't immediately take hold, if those sectors refrain from passing through price increases to consumers.

The latest CPI reading in China is +3.1% over last year. A likely scenario is that this round of wage inflation is passed through to importers of Chinese goods, with the E.U. and the U.S. being the largest recipients (20% and 17%, respectively YTD through May).In other words, there will be some lag time before Chinese consumers have to worry about inflation hitting their newly fattened wallets.

And keep in mind, China is a save-first economy, so 20-25% wage inflation doesn't instantly equal 20-25% more consumer spending. Some portion of that will be socked away for a rainy day. Even that may turn out to be a net positive for the Chinese economy: The last 12-18 months have seen a huge growth in loans as the middle class has struggled to keep up with soaring real estate prices. With more money in their pockets to service that debt and recapitalize lenders, China may avoid walking into the credit bubble trap that nearly felled the U.S. economy two years ago.