"China's Manufacturing Competitiveness Is at Risk": Sort Of

Knowledge@Wharton recently published an analysis of the Booz Allen & AmCham China Manufacturing Competitiveness 2007-2008 report entitled New Challenges for Foreign Producers: 'China's Manufacturing Competitiveness Is at Risk. K@W summarizes the report and conducts its own research to discover that China's manufacturing sector is still strong and that we should only expect a decline in the competitiveness of the "high labor, low value-added area" (read: basic cheap stuff).

The Booz Allen report identifies the three biggest challenges to China's manufacturing competitiveness in order as: 1) the appreciation of the RMB, which makes manufacturing costs and the costs of exported goods more expensive in real value amounts; 2) inflation, which increases commodity prices and rents; and 3) wage increases, which are necessary as inflation continues, workers become better organized and the supply of unskilled laborers becomes smaller in relation to the increasing demand for unskilled laborers. But, the AmCham study found that these concerns are only driving 17% of the 66 companies surveyed to form concrete plans to expand "manufacturing capacity to other neighboring countries." K@W notes that it is only the low-value added companies that are moving out of China because the profit margins that these companies operate under are slim enough that they will see a significant gain by moving to India, Vietnam, Thailand, Malaysia or Brazil. And, these firms that are leaving are largely Taiwanese and Hong Kong companies that first opened factories in China back "in the late 1980s and early 1990s." They set the trend with moving into China, and they are setting the trend in moving out of China.

K@W notes that high-value-added manufacturers, such as heavy harbor equipment manufacturers, have plenty of room for profit growth in China because there are many compelling reasons to keep factories in China:

• "Moving a production base is expensive and time consuming, and new markets, especially those outside China, have their own unique and unknown risks.
• "[T]he size and scope of the domestic market."
• "[T]he high quality of Chinese labor."
• Workers in nearby countries may get paid 25-50% of the wage of a Chinese worker but Chinese workers are good and tested at their jobs. Plus, the industrial equipment is high quality. And, countries such as Bangladesh and India suffer from "poverty, widespread religious zeal and a huge disparity in wealth."
  
• "[W]ages in China are still quite low by global standards."

K@W finds that the manufacturers best able to continue to thrive in China are those that insulate themselves from two of the largest concerns: RMB appreciation and wage increases. The way to do this is sell your products to the local market as well as manufacture for export. The domestic market is growing fast, partially due to wage increases, and if wealthier workers are purchasing your goods in RMB, then there are no transaction costs in currency value fluctuations. There are still transaction costs in wage increases but these are decreased by expanding into the domestic market. K@W warns that "underperformers [in manufacturing] . . . simply prefer to source and manufacture products for export." Manufacturers may continue to succeed in simply sourcing high-value added goods from China, but K@W thinks that the days of profitable low-value added sourcing from China are numbered.

For Further Reading:

Booz Allen/AmCham Shanghai Study Finds Key To China Success at All Roads Lead to China
China Competitiveness Survey at China Hearsay
As costs increase in China, Thailand and other “Tigers” see renewed investor interest at China Briefing News