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?

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