China's Fading Labor Arbitrage

Commentary By Ron Beasley

I have made it clear that I'm not bullish on China.  The increasing cost of transportation will make it dificult to economically make Walmart fodder in China and ship it back to the US.  We have already seen it the steel industry where both US and Mexican steel makers are doing very well. 

The Economist points out another problem for China - Fading Labor Arbitrage.

�WHEN clients are considering opening another manufacturing plant in China, I�ve started to urge them to consider alternative locations,� says Hal Sirkin of the Boston Consulting Group (BCG). �Have they thought about Vietnam, say? Or maybe [they could] even try Made in USA?� When clients are American firms looking to build factories to serve American customers, Mr Sirkin is increasingly likely to suggest they stay at home, not for patriotic reasons but because the economics of globalisation are changing fast.

One of the leading reasons companies chose to off shore manufacturing to China was labor costs.  Between 2005 and 2010 the wage for factory workers in China increased 69%. 

�Sometime around 2015, manufacturers will be indifferent between locating in America or China for production for consumption in America,� says Mr Sirkin. That calculation assumes that wage growth will continue at around 17% a year in China but remain relatively slow in America, and that productivity growth will continue on current trends in both countries. It also assumes a modest appreciation of the yuan against the dollar.

The year 2015 is not far off. Factories take time to build, and can carry on cranking out widgets for years. So firms planning today for production tomorrow are increasingly looking close to home. BCG lists several examples of companies that have already brought plants and jobs back to America. Caterpillar, a maker of vehicles that dig, pull or plough, is shifting some of its excavator production from abroad to Texas. Sauder, an American furniture-maker, is moving production back home from low-wage countries. NCR has returned production of cash machines to Georgia (the American state, not the country that is occasionally invaded by Russia). Wham-O last year restored half of its Frisbee and Hula Hoop production to America from China and Mexico.

BCG predicts a �manufacturing renaissance� in America. There are reasons to be sceptical. The surge of manufacturing output in the past year or so has largely been about recovering ground lost during the downturn. Moreover, some of the new factories in America have been wooed by subsidies that may soon dry up. But still, the new economics of labour arbitrage will make a difference.

In the beginning companies will simply reconsider plans to relocate plants to China but with increasing transportation expense and increasing labor costs in China it will become increasingly uneconomic to produce consumer goods in China to sell in North America.  You would think that Mexico could be the big winner but it is going down the path to a failed state.  Who would want to build a facility in today's Mexico?