Ms. Ying-Juan Rogers, Executive Vice President - World Trade Center Kentucky
Recent research by IHS Global Insight reveals that as of 2010, China is producing 19.8 percent of the world’s manufacturing output and, consequently, has become the largest manufacturer in the world, a position that the United States had previously held for almost 110 years. A growing fear of United States manufacturers is that there will be an increase in the number of factories shutting down and jobs moving overseas.
However, the China Federation of Logistics Purchasing Managers Index showed in May that new manufacturing orders in China were declining at a faster pace than the overall economic slowdown, a key indicator that manufacturing activity in China may have already peaked in the current economic cycle.
In this article we will examine the effects of rising labor costs, labor shortage, inflation, and increased energy costs in order to gain a more accurate perspective on the current situation and likely future of the Chinese manufacturing industry.
Rising labor cost
Traditionally, China is seen as both a labor-abundant and low-cost producer, which enables manufacturers to comfortably undercut competitors in production costs. However, this may no longer be the case.
Throughout China, wages are climbing at the rate of 15 to 20 percent a year, and Credit Suisse estimates that they will continue to rise 20 to 30 percent every year for the next three to five years.
According to People’s Daily (March 2011), between 2005 and 2010 the average wage for migrant workers in big cities increased 14.1 percent per year, from approximately $130 to $252 per month. At current rates, China’s wages could double in as few as five years.
Wage rates in Chinese cities such as Shanghai, Beijing and Tianjin are currently only 30 percent cheaper than rates in low-cost U.S. states. Overall, manufacturing in China will only be 10 to 15 percent cheaper than in the U.S.–even before inventory and shipping costs are considered.
Shortage of labor force
China is facing an increasingly acute labor shortage. Some manufacturers, already weeks behind schedule because they cannot find enough workers, are closing down production lines and considering raising prices. There is a strong demand for young workers willing to work long hours and live in dormitories, conditions that older workers, those over forty, are considered unsuited for.
This current shortage is compounded by the fact that the average annual growth rate of China’s working-age population is beginning to slow down. The number of 18-year-old new laborers dropped from 27.9 million in 2002 to 22.5 million in 2010, and it is estimated that it will continue to decrease to 16.6 and 14.8 million respectively in 2015 and 2020.
The drop in the working age population is largely driven by demographic trends and strict family planning. The demographic shift resulting from the one-child policy ultimately serves to reduce the supply of young entry-level workers. Additionally, there has been an increase in the number of young people choosing to attend college rather than opting for minimum-wage factory work.
Although there has been an increase in the number of Chinese young people attending college, there is also a serious shortage of skilled workers in the country. Often this results in massive poaching among rival companies and huge wage increases being offered to workers, which ultimately results in higher costs for the companies.
Recent data from the China National Bureau shows a 5.3 percent increase in their consumer price index in April - a slight easing from March but well above Beijing's official 4 percent target for 2011. This rising inflation within China is driving up the cost of production in China and is also driving up the cost of Chinese goods compared to the rest of the world. Consequently, it is eroding some of China’s formidable advantage in export markets.
Over the past 12 months, the U.S. has witnessed a 2.8 percent increase in the price of goods imported from China.
Energy cost increase
In 2010, the energy-hungry Chinese economy burnt a staggering 3.2 billion tons of coal, which accounts for 70 percent of China’s electricity. The Chinese government has already warned that the country may soon hit peak coal production, which would in turn force greater reliance on costly imports. China’s Electricity Association is warning that there will be the nation’s largest power shortage in history this summer. As many as 20 provinces and territories have already been put on power rationing, including the country’s industrial heartland.
This predicted shortage and power rationig has driven up coal prices. Benchmark power-station coal prices at Qinhuangdao port rose 0.6 percent from the previous week to between $128.03 to $130.34 a metric ton on May 30th, 2011, according to the China Coal Transport and Distribution Association. That is the highest price recorded since October 2008.
The government also raised retail power prices for non-residential users in 15 provinces by about 3 percent this month - the first hike since November 2009. The wholesale prices charged by generators to distributors were also raised an average of 5 percent in three provinces after being pushed up in 12 other provinces in April, according to the National Development and Reform Commission, which sets energy prices in China.
The rationing of power and the rise of energy prices will undoubtedly negatively impact many manufacturing operations in China. Plants will face restricted production capabilities and higher overall costs.
Because of rising labor costs, labor shortage, inflation, and increased energy costs in China, manufacturing companies such as Coach, Inc. have already moved production out of the country, and others are reluctant to begin operations there. Some research-intensive sectors such as pharmaceutical, biotech and other life sciences companies are also reconsidering China. In addition to these reasons, which have resulted in an overall cost increase, some U.S. businesses are hesitant to set up operations in China because of the complexity of the business environment there. Obstacles such as cultural differences, political risks and intellectual property issues have also become serious considerations. Some U.S. corporations feel that domestic facilities are easier to manage and that the abundance of skilled workers is an undeniable advantage.
The stability of U.S. manufacturing is illustrated by research done by Boston Consulting Group which projects "that by 2015, strong productivity and relatively low wages would help the U.S. move ahead of China as a base for making goods which will be sold in North America."
U.S. manufacturers have the advantage of producing goods necessary for information technology and media-related industries, and are the leader in the production of chemicals, aircraft engines, industrial machinery, and military defense. These sectors are designed to produce goods that are vital in a technology-based, globalized economy. China, on the other hand, has a manufacturing base that is much more dependent on cheaper goods in sectors such as textiles, apparel, appliances, and certain commodities.
In the long-run it appears that fears of the dramatic decline of the U.S. manufacturing sector are largely unfounded, and that there is a significant possibility that manufacturing activity in China has peaked in this economic cycle and will actually begin to decline.
Ms. Ying-Juan Rogers
Executive Vice President
World Trade Center Kentucky, 333 West Vine, ste 1600, Lexington, KY 40507
Phone: 859-258-3139, Cell: 859-494-6631