Thursday, February 21, 2008

Rising Factory Costs Erode China's Edge

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We've been talking about this issue since the blog began [Aug 19: Interesting China Article] I wrote

Interesting to see this inflation scenario literally exploding across the country. I always find the story of China interesting because it is poised to be a world superpower on demographics alone. However, I read even 2 years ago that China is starting to become 'expensive' for manufacturers, and now companies are looking for the next cheapest place, i.e. Vietnam. Which is quite amazing. I remember all the NAFTA talk in the 90s and how companies were moving to Mexico en masse for low cost labor - $2.50 or so in US wages. Within a decade much of those factory towns are now ghost towns, as that capital moved to Asia.

Can we imagine a time in 15 years when China is too expensive? It could happen. Especially with the need to add more layers of safety, what with toothpaste, dog food, lead in toys, etc etc etc.

The NYTimes finally figures this out earlier this month [China's Inflation Hits American Price Tags]. I have to say I thought the constant flow of new labor (rural) would cause this to play out over a longer time frame, but we are already seeing incremental issues within China... I am constantly amazed by the flow of capital to find the cheapest spot on Earth for labor (with preferably little to no safety regulation or environmental regulation of course). I don't think China will become Mexico in 10 years, (even within China the coastal areas are far more well off and factories can be moved inland to take advantage of...err I mean utilize cheaper factory workers)...with abandoned factory towns littering the landscape, but it is quite astounding to see how quickly things *can* change. This is why I try to not extrapolate anything out 15-20 years; so many moving variables out there. But I do believe as China turns into a more developed country it will begin outsourcing its "non skill" labor to the next cheapest place (as will many other companies). I still await that darn Vietnam ETF...
  • The teddy bears selling for $1.40 in Shanghai's IKEA store may be just about the cheapest in town, but they're not made in China -- they're stitched and stuffed in Indonesia.
  • The fluffy brown toys reflect a new challenge for China: Its huge economy, which has long offered some of the world's lowest manufacturing costs, is losing its claim on cheapness as factories get squeezed by rising prices for energy, materials and labor.
  • Those expenses, plus higher taxes and stricter enforcement of labor and environmental standards, are causing some manufacturers to leave for lower-cost markets such as Vietnam, Indonesia and India.
  • Costs have climbed so much that three-quarters of businesses surveyed by the American Chamber of Commerce in Shanghai believe China is losing its competitive edge.
  • The higher costs mean Western consumers are bound to face steeper prices for iPods, TVs, tank tops and many other imported products made by small Chinese subcontractors.
  • "Americans continue to want to buy at lower prices," said Kevin Burke, president and CEO of the American Apparel and Footwear Association. "They are used to going to the store during Christmas and getting something cheaper than a year ago."
  • For instance, American toy makers, who rely heavily on Chinese factories, expect prices to increase 5 to 10 percent for the 2008 holiday season, largely because of rising manufacturing costs.
  • Costs in China are climbing nationwide, but the greatest pain is being felt in the south, where about 14,000 Hong Kong-run factories could close in the next few months, said Polly Ko of the Economic and Trade Office in Guangdong, which neighbors Hong Kong.
  • To adapt, many multinational manufacturers -- including Intel Corp., iPod-maker Hon Hai Technology Group and Japanese companies like Canon Inc. and Sony Corp. are expanding operations in Vietnam. Auto parts makers are decamping for the Middle East and Eastern Europe, textile-makers to Bangladesh and India.
  • Despite its huge pool of unskilled rural laborers, China's supply of experienced, skilled talent falls far short of demand. The gap has been pushing wages up by 10 percent to 15 percent a year.
  • A new labor law requiring stronger employment contracts is expected to raise costs even more.
  • Prices for plastics and other materials have climbed 30 percent or more, and electricity rates are surging, too. The government has also slashed export tax rebates -- originally given to promote exports -- on more than 2,800 products accounting for nearly 40 percent of all Chinese exports.
  • In inland China, wages still lag far behind the richer eastern and southern coastal areas.

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