Consider the following: Wages in Guangzhou went up 13% last year while the figure was even higher, at 20%, in Shenzhen, according to Citi Investment Research. Tax holidays are running out, the price of real estate is still rising and the renminbi gained 4.2% against the US dollar in the first quarter.
In January, the Labor Contract Law took effect, making hiring and firing more difficult for employers, and jacking up labor costs.
It should follow that foreign companies with operations in China are seeking greener (and cheaper) pastures in nearby Southeast Asia. Vietnam is usually touted as the first consideration but Cambodia, Thailand, Malaysia, Taiwan and the Philippines are also on the list.
These are countries with increasingly stable economies and more open business environments. What’s more, they have cheaper labor and sometimes more relaxed regulations than China.
It is Timothy Kim’s view, however, that too much attention is being devoted to the headlines and not enough to the bottom line. Kim, who is chairman of Silver Star Silverwares, a Hong Kong manufacturer of metal cookware with factories in Dongguan, dismisses the idea of shifting operations out of China.
“Everybody says we have to go to Vietnam. The newspapers say we have to go to Vietnam,” he said. “[They are] wrong, stupid. You know why? This industry is a materials industry. Material makes up 70% of the cost, labor maybe 20%. In material industries, Vietnam cannot compete.”
But not everyone faces the same financial dynamics as Silver Star Silverwares, and there is little doubt that eyes are turning to new, cheaper, locations.
A survey by the American Chamber of Commerce in Shanghai and consultants Booz Allen Hamilton found that 20% of foreign-owned manufacturers in China are considering new locations.
Dan Entac, CEO of Tradelink Technologies, a supply chain technology company that deals directly with firms producing goods for the export market, has reached similar conclusions. “We are hearing that China is becoming more expensive, and typically apparel goes to the lowest-cost regions in the world,” he said.
Rather than tracking the movements of apparel firms – in many ways the definitive low-end manufacturers – Entac sees footwear companies as a more effective weathervane. While clothes are still subject to import quotas, shoes are not. This means the cost strategies of shoe producers are less polluted by politics.
In recent years, footwear brands have moved production from Korea and Taiwan to mainland China, Entac observed. Now, though, many have moved into Vietnam and Cambodia, and some firms have picked Thailand and India.
“The customers go to the suppliers and say: ‘I need this price-point so I can make my margin selling in the US,” Entac said. “What happens is, the suppliers are the ones who move to lower-cost areas.”
A migration of certain types of enterprises out of China falls in line with Beijing’s efforts to discourage low-end manufacturing. For example, the government doesn’t welcome new additions to the shoe or baby underwear industries.
There are several factors that have helped push forward this agenda. Top of the list is the Labor Contract Law, which makes hiring and firing workers more difficult. This, combined with a steady stream of mandatory wage increases in the past few years, has pushed up the cost of labor. The pressure has been exacerbated by rising real estate prices in industrial hubs, and the renminbi appreciating against the US dollar.
In a note to clients in April, Citi economists Minggao Shen and Ken Peng cited high inflation and increasing commodity prices, as well as the new labor law, as the key contributors to rising production costs.
“But they are likely short-term factors,” Shen and Peng stressed.
Furthermore, even as costs increase, China retains certain advantages, like offering producers potentially huge economies of scale and access to a massive domestic market. These factors will likely help maintain the competitiveness of Chinese goods for a long time, the Citi economists wrote.
Other analysts agree. Sherman Chan and Daniel Mesler of Moody’s Economy.com, a subsidiary of Moody’s Corporation, which includes the ratings agency, believe the rising cost of production in China has actually helped the country retain manufacturers.
“The loss of price competitiveness has driven Chinese manufacturers to improve production efficiency and quality, ensuring they can compete with lower cost locations,” according to Chan and Mesler.
The quality issue is a particularly pertinent one. While China has had its share of product safety controversies in the last year, its factories may produce better goods than facilities in Vietnam.
“Relocation happens to low-end producers because of a trade-off in quality when the manufacturing base is moved from China to Vietnam,” Chan told CHINA ECONOMIC REVIEW. “Vietnam is probably not yet experienced enough to manufacture high-end products.”
However, this works both ways. If Vietnam can’t match China in the production of low-end goods, China, for its part, can’t do as well as some more advanced economies. Some manufacturers shifting from China to Taiwan, for example, have found that the defect rate in their products drops from an average of 20% in China to virtually nothing, said Steven Dickinson, a Shanghai-based partner at law firm Harris & Moure.
Nevertheless, China has something over virtually all the countries in Southeast Asia that attract manufacturers.
Cambodia and Taiwan are small. In Thailand, political stability has become an issue following a bloodless military coup in 2006. Vietnam is probably the preferred destination, but its workforce is not as developed as China’s. Vietnam’s economy is also heavily dependent on foreign investment and thus vulnerable to the expected global economic slowdown.
Flattening, not rising
There are also nuances to the idea that China is getting too expensive. For example, Citi’s Shen and Peng suggest that costs in China are perhaps not increasing so much as leveling out. They believe that cost distortions – in labor costs, commodity and capital prices, and undercounted environmental costs – favoring producers rather than consumers may have accounted for 15.5% of China’s GDP in 2007. This means that in labor, for example, even though wages have risen, workers may still be paid too little.
This state of affairs won’t go on indefinitely. Sooner or later, prices will hit market level, although this process could take another decade or longer. Indeed, that’s what Jonathan Anderson, global emerging markets economist at investment bank UBS, seems to have observed.
“There’s no sign of ‘evacuation’ from coastal provinces to date, and no market share losses in traditional labor-intensive sectors. In short, [there is] no indication at the macro level that exporters might be in trouble,” he wrote in April.
Anderson noted that China is subject to growing pressures from more expensive labor, a stronger renminbi and a potential global economic slowdown, and that an adjustment was inevitable. Chinese exporters have eased some of these pressures by passing on increased costs to consumers by hiking prices. But how long can they keep this up? Quite a while, according to Anderson.
“While mainland exporters can’t raise prices and pass on costs forever … it’s far too early to talk about pending disaster,” he argued.
Manufacturers are taking stock of their options – but in many cases they are happy to stick with the devil they know.
“I have been investigating opportunities in other countries such as Bangladesh, the Philippines and Thailand,” said one textiles manufacturer with factories in Shenzhen, who asked not to be named. “Everything is becoming more expensive, but we are trying to save by automating a lot of our processes.
“In China, everything is stable – the people and the environment. You rarely get strikes. [Elsewhere], if you have a problem you don’t know where to go.”