Fleeing China

It’s been eighteen months since we predicted that companies chasing low labor costs to China would eventually have to strap on the sneakers and globetrot to another part of the world.  Perhaps we should have been oracles instead of bloggers.

Ahh… to be a world tourist.  Globetrotting from country to country
in search of lower direct labor costs to help offset unrecognized
internal process waste cost.  The first stop was Mexico, then on to
Honduras or the Dominican Republic.  After a while there were too many
gringos there as well, so how about a nice cruise over to Asia. China’s pretty nice… lots of cheap labor… that should do just fine for a while.

No longer, as the latest issue of Business Week confirms our prediction.

Since then the [Guangdong] region has grown into the largest manufacturing base
in the world for a host of industries, including electronics, shoes,
toys, furniture, and lighting. The combination of low wages, minimal
regulation, and a cheap currency was unbeatable. Now many of China’s manufacturers—including Shan Hsing—are
undergoing the kind of restructuring that tore through America’s
heartland a generation ago.

What’s causing this?

A new Chinese labor law that took effect on Jan. 1 has significantly
raised costs in an already tight labor market. Soaring commodity and
energy prices, as well as Beijing’s cancellation of preferential
policies for exporters, have hammered manufacturers. The appreciation
of the Chinese currency has shrunk already razor-thin margins, pushed
thousands of manufacturers to the edge of bankruptcy, and threatened
China’s role as the preeminent exporter of low-priced goods.

And the impact?

Comprehensive statistics on shutdowns are hard to come by. But the
Federation of Hong Kong Industries predicts that 10% of an estimated
60,000 to 70,000 Hong Kong-run factories in the Pearl River Delta will
close this year. In the past 12 months, 150 factories making shoes or
supplying shoemakers have closed in Dongguan, says the Asia Footwear
Assn. More plants will disappear as demand slows: UBS analyst Jonathan Anderson expects overall export growth of just 5% or less for China this year.

5% export growth for China in 2008; that’s less than what is predicted for the United States.  That should give the "China is stealing all our jobs" crowd something to chew on.  Actually probably not, as facts are usually irrelevant in that discussion.

Is the Chinese government going to do something about the crisis?  Nope, in fact they almost encourage it as a way to increase their industrial capability, similar to what Japan did in the 70s and 80s.

Chinese policymakers so far profess little concern. The closures are
mainly hitting lower-value, labor-intensive exporters that pollute
heavily and use energy inefficiently. Beijing now wants cleaner
industries that produce higher-quality items for the local market, from
cars and planes to biotech products and software. That emphasis not
only helps boost domestic consumption—a key national goal—but also
reduces frictions internationally from the ever-swelling trade surplus.

Which in itself should give the rest of the world something to be concerned about in the upcoming decade or two.  Is the next Toyota, the next competitive benchmark powerhouse, going to come from China?  Some multinationals are waking up to the new reality, but instead of focusing internally they are still chasing simple direct labor cost.

The bigger multinationals may be having second thoughts, too. A report
by the American Chamber of Commerce in Shanghai found that more than
half of foreign manufacturers in China believe the mainland is losing
its competitive advantage over countries like Vietnam and India. Almost
a fifth of the companies surveyed are considering relocating out of
China. "The big story here is that globalization is for real—and China
is no longer what it was," says Ronald Haddock, a vice-president at
consultant Booz Allen Hamilton, which wrote the report.

No, the real story is the failure of many manufacturers to realize that internal process waste generally costs more than actual direct labor.  Especially when you account for the creative value of the experienced brains providing that labor. 

Therefore instead of chasing cheap labor around the world, continually investing in new factories and new supply chains while re-hiring inexperienced workers, wouldn’t it make a lot more sense to look inward?  Figure out how to reduce internal waste and also leverage the knowledge, creativity, and experience of your employees.