Andrew Batson, one of the Wall Street Journal’s best and most experienced China journalists (and that is truly saying a lot) has written an important article, entitled, Rising Wages Rattle China’s Small Manufacturers.
This article is chock full of great information, starting with a map of China’s industrial clusters. This clustering of factories in a particular industry allows for massive specialization while reducing transportation and logistical costs.
Whenever a client tells me they are going to be setting up shop in a particular Chinese city or even buying from a particular city, I virtually always ask why that particular city. Sometimes the reasons are idiosyncratic, like, “my wife’s cousin owns the factory.” Oftentimes, however, the response will be more along the lines of “that city is the center of China’s rubber-ducky industry.” Amazingly enough, until today, I had never seen a good map breaking out “China’s major industrial clusters.”
Batson’s article is not so much about China’s industrial clusters as it is about the impact of China’s rising wages on China’s small privately owned businesses, which so often are located in these clusters. The article mostly focuses on some of the small businesses in Zhili, “where it seems nearly every business specializes in some part of the production of children’s clothing.”
It takes this micro examination and uses it to reveal the following important truths about China:
- Wages in China have been rising for years, but pressure is now particularly strong as the economy’s rebound is running up against the shrinking supply of younger workers caused by the one-child policy.
- The impact of rising wages is likely to be most strongly felt by China’s more than 10 million small businesses, which account for 60% of the economy and 80% of jobs.
- Many small, light manufacturing businesses crowd together in highly specialized “clusters,”particularly in Zhejiang province on the eastern coast.
- The businesses in these clusters rely “on the low-cost labor that is in increasingly short supply.”
- The cluster-based model is labor-intensive. The real question is whether it can survive in the new environment of labor scarcity and higher labor costs. “Right now is a critical transitional period. Some clusters will survive, some will collapse.”
- Since China relaxed its currency’s peg to the dollar in mid-June, there is added uncertainty for manufacturers that depend on export markets.”If the currency appreciates 5% or 10% then we wouldn’t be able to do this business anymore,” as it would wipe out China’s cost advantage, says Cindy Wu, sales manager of Da Wei Zipper Co. Such fears from businesses are a big reason China’s government, despite outside pressure, is generally expected to limit the pace of its currency appreciation.
Zhili sounds like a typical China cluster town. It has focused on children’s clothes since the late 1980s. It is “a sprawl of low-slung buildings, a mix of family businesses in narrow alleys and larger factory complexes,” many of which relocated here from other parts of China so as to reduce their costs and to increase their sales.
Rising wages have made things difficult for the factories of Zhili, and yet, it is “hard to abandon Zhili’s network and relocate to a cheaper province” due in large part to the increased investment such a move would require. I note that the overwhelming majority of these factories likely operate on razor thin margins and lack the kind of capital necessary to close down and start anew elsewhere.
Batson notes how one company “figured out that a company’s competitive advantage is in its technology.” This company invested “more than 20 million yuan in equipment for producing high-quality cotton cloth, when most local garment factories invest less than half a million. As a result, the factory needs only 70 workers.” This is important because so many Westerners seem not to realize that a number of Chinese companies, even in historically low tech industries, are thriving not just because of cheap labor, but because they are technologically advanced.
Batson concludes his article by noting the importance of financing for these private companies and how difficult it can be for them to obtain it:
For more entrepreneurs to follow in his footsteps they will need better access to financing than they have gotten from China’s banking system, which favors big state-owned corporations. The government has promised to improve things, and says loans to small businesses are now growing faster than those to big ones.
This post has Thailand in its headline because a client of my law firm just called me for assistance in setting up operations in Thailand as it has plans to move about a quarter of its outsourcing there. I, of course, asked why the move and was told it was because they saw costs increasing in China and “even though Thailand has its issues, they thought it important to diversify now, “rather than waiting.”
I mention this client because they are of so many of our clients who do business with or in China. This company has been operating internationally for thirty years and moving some of its sourcing from China to Thailand is not that big a deal for it, as it has done a number of such moves in the past and it has the human infrastructure in place to make it work.
I do not believe Chinese companies are going to be able to make the foreign move as smoothly. Yes, there are a number of Chinese companies already in places like Thailand, but near as I can tell, few of those companies are the small private ones described in the Wall Street Journal article. If I am right on my assumptions, China’s rising wages are going to end up being toughest on China’s small private companies.
Will this be true? What are you seeing out there?