China Business

The End of Cheap China

The end of Cheap China

The Boston Consulting Group came out with an excellent piece last year, Made in America, Again: Why Manufacturing Will Return to the United States. An excellent summary of that article can be found here [link no longer exists], from which I pull the following:

Within the next five years, the United States is expected to experience a manufacturing renaissance as the wage gap with China shrinks and certain U.S. states become some of the cheapest locations for manufacturing in the developed world, according to a new analysis by The Boston Consulting Group (BCG).

With Chinese wages rising at about 17 percent per year and the value of the yuan continuing to increase, the gap between U.S. and Chinese wages is narrowing rapidly. Meanwhile, flexible work rules and a host of government incentives are making many states—including Mississippi, South Carolina, and Alabama—increasingly competitive as low-cost bases for supplying the U.S. market.

“All over China, wages are climbing at 15 to 20 percent a year because of the supply-and-demand imbalance for skilled labor,” said Harold L. Sirkin, a BCG senior partner. “We expect net labor costs for manufacturing in China and the U.S. to converge by around 2015. As a result of the changing economics, you’re going to see a lot more products ‘Made in the USA’ in the next five years.”

After adjustments are made to account for American workers’ relatively higher productivity, wage rates in Chinese cities such as Shanghai and Tianjin are expected to be about only 30 percent cheaper than rates in low-cost U.S. states. And since wage rates account for 20 to 30 percent of a product’s total cost, manufacturing in China will be only 10 to 15 percent cheaper than in the U.S.—even before inventory and shipping costs are considered. After those costs are factored in, the total cost advantage will drop to single digits or be erased entirely, Sirkin said.

All well and good, but what does all of this mean now for YOUR manufacturing and what will it mean five years from now and what should you do about it?

I have always been fascinated by economics and the differences between the macro and micro sides of things. When we read that sales of cars are expected to increase 3% next year, our first presumption is that this likely will mean VW, Honda, GM and Ford will all likely see their sales increase about 3% next year. But of course, nothing could be further from the truth.

I remember during the Asian crisis of 1997 hearing a news report of how exports from the United States to Korea were down about 20% (I admit I am guessing on this number) but that exports of quinces (I think it was quinces) had fallen from $20 million a year to zero. In other words, Korea’s tough economic situation had completely ended the buying of quinces.

I am seeing the same sort of disparate impact when it comes to manufacturing costs. It is all well and good to say China’s wage increases are reducing or eliminating its cost advantage as compared to the United States, but that means almost nothing for each individual business. Our international manufacturing lawyers are always asking our clients about their costs and about their decisions on where to manufacture and here is some of what we have been hearing:

  • Company that makes a high end but fairly simple wood pet product wanted to manufacture in the US, but the cost to do so was four times higher than in China. His explanation was that the manufacturing was very labor intensive and so China had a clear edge. A few years later they were having this product made in Thailand.
  • Company that makes a very complicated, very large, and very expensive piece of equipment told me that its costs to make this equipment are “about the same in the US as in China.” The reason is that so many American engineers need to be in China to oversee things and to check quality. The company wants to retain its dual-country manufacturing capacity but unless it can raise productivity in China it expects to shut down in China within the next five years.
  • Company that makes environmental equipment is moving “some” of its manufacturing to China. It expects production costs to be “a lot” higher there during the first few years but is going there anyway because of the “psychological and political importance of being able to say they manufacture in China.” They believe their manufacturing in China will greatly increase their sales in China.
  • Clothing company that was making 100% of its items in China is in the process of moving about half of its production to Vietnam and to Cambodia. It is doing so because its labor costs will be considerably less in those two countries, even accounting for productivity differences.

I could go on and on, but the point here is that the macro numbers are just the starting point for an individual business.

What are you seeing/hearing/doing out there by way of manufacturing? Is this really the end of cheap China?

14 responses to “The End of Cheap China”

  1. Don’t kid yourself. There will be no manufacturing rebirth America. Not worth the effort to say why, but the reasons are easily found on the internet.

  2. Um, Sure, wage gap will decrease. And yes, salaries in China are rising 10-15%/ year.
    But what is the current gap, anyway?
    Average salary in China (manufacturing): $4,000 USD
    Average salary in US (manufacturing): $38,000 USD
    We’re talking nearly a 10x differential here.
    Now let’s do the math and see how long it will take for this gap to close. Also, how well will Americans respond to this decrease in standard of living?

  3. Well, it may not be the end but (obviously) it is becoming much more challenging. Wage rates in south China are increasing at an almost logarithmic rate. Clearly the gap is closing with other manufacturing options. Conversely, the gap is widening between China and other developing countries like Vietnam. The bright star in all of this is western China, specifically Chengdu and Chongqing primarily because of their favored business climate (tax incentives and oftentimes other concessions and investment) and comparatively (for China) low wage rates.

  4. I think, also, that the days of the US South getting manufacturing jobs on the basis of favorable legal, tax, and labor grounds will also be over. Most, if not all of them, will need to be certain of maintaining access to credit, and that means–functional economy with more higher wage jobs leading to good tax collection from wages and land(pretty much the same drivers of institutional preference for higher wage jobs in China) and those that try to be extra mean, like Wisconsin under Walker, will be too dysfunctional to attract capital. In the near future, corporations will place plants where there is a surplus of good workers. Otherwise, why leave China for the US when you can do Vietnam?

  5. Isn’t “The End Of Cheap China” the name of Shaun Rein’s book – that has just been published? Coincidence?

  6. I suspect that cost isn’t everything in manufacturing. China seems to have enormous capacity and a critical mass, not to mention momentum in the production of a wide range of products. Which may be an important factor in producing low to medium level complexity products. The Australian surf board industry is being wiped out (no pun intended) by cheap Chinese competition. I’ve heard the same is happening for Afghan carpet makers. On the other hand, I notice a lot of clothes and shoes now seem to have Made in Romania/Morocco/Vietnam labels on them.
    Might be a different story also when it comes to the higher end of the market, where R&D, design and stringent quality control become critical factors for success.

  7. I guess it’s fun to use words like “logarithmic” as you try not to say “exponential”, and since they mean the same thing of course they are equally and “galactically ” wrong.
    The gap may be closing, but on balance somewhat more like the distance between the moon and the sun. Not the greatest near-term concern.

  8. I’ve been hearing more EU, and particularly German and French, companies moving home — US companies seem to be more likely to stay. When it came up at the expat bar, one American cited health insurance — and I think he may be right. US companies just make more money from not having to pay/administer health insurance that it makes more sense for them to stay in China. EU companies already have their employees’ benefits covered in their taxes, so it’s not a consideration. I definitely have noticed more mid-sized companies deciding to stay, so that would explain it.
    I’ve also heard that QA/QC issues as well as transportation costs are becoming issues.

  9. >> Average salary in China (manufacturing): $4,000 USD
    >> Average salary in US (manufacturing): $38,000 USD
    comparing per-capita wages between two countries or the average wage per hour of a worker in two countries doesn’t (begin) to describe the actual difference between manufacturing costs in the two countries; productivity is vastly different between different countries (and between different industries) and is a huge factor. it’s also a moving target, as manufacturing processes are changing all the time.
    If you write down the average salary numbers for Germany instead of the US (as above), then you’d immediately conclude that Germany must be manufacturing nothing. Instead it is a huge manufacturing center and net exporter. The reason is mostly productivity, but also monetary and trade policy. The equation is not nearly so simple as it would seem to be.
    The U.S. could easily tip the balance back in its favor with the right balance of trade and industrial policy. Whether it will, or whether it will instead continue to shoot its own feet is anyone’s guess, but it’s by no means impossible.

  10. It seems this month alone has seen more “end of cheap China” articles than the last six months combined. Why do you suppose that is the case, when from my viewpoint here, China is hurting economically and as a result of that, it is falling back on the manufacturing that it knows. Why so many and all this month? Does anyone know because I sure don’t. The New York Times did one too.

  11. This is old hat for anyone who took a course in Economic Development in College. Developed Nations make more per hour because of capital/technology and human capital. There’s no way for the US to go backwards. China is cheap, until you look at, yes, Vietnam and Cambodia, which are even less developed. So there you go. China is a still a developing country ( I live in Shanghai ) and will be for a long time.

  12. This whole “end of cheap China” thing has been going on for years now and it hasn’t really changed a thing. Some day it will happen, but I’m thinking we are a good twenty years away.

Leave a Reply

Your email address will not be published. Required fields are marked *