China: The Challenges of Growth

A nice article from The New York Times on some of the challenges China will face as they mature from developing to developed economy.  With decades long double-digit growth suddenly a host of issues are appearing: rising labor costs, currency appreciation, social and environmental problems like inequality and smog are all going to cause a transformation of the economy away from low-skilled manufacturing and into more and more value-added activities like engineering and design. But this takes human capital and China is still struggling a bit in this arena.  Anyway here are some excerpts from the article which uses the iPhone 4 as a jumping off point:

[M]anufacturing in China is about to get far more expensive. Soaring labor costs caused by worker shortages and unrest, a strengthening Chinese currency that makes exports more expensive, and inflation and rising housing costs are all threatening to sharply increase the cost of making devices like notebook computers, digital cameras and smartphones.

Desperate factory owners are already shifting production away from this country’s dominant electronics manufacturing center in Shenzhen toward lower-cost regions far west of here, even deep in China’s mountainous interior.

At the end of June, a manager at Foxconn Technology — one of Apple’s major contract manufacturers — said the company planned to reduce costs by moving hundreds of thousands of workers to other parts of China, including the impoverished Henan Province.

While the labor involved in the final assembly of an iPhone accounts for a small part of the overall cost — about 7 percent by some estimates — analysts say most companies in Apple’s supply chain — the chip makers and battery suppliers and those making plastic moldings and printed circuit boards — depend on Chinese factories to hold down prices. And those factories now seem likely to pass along their cost increases.

“Electronics companies are trying to figure out how to deal with the higher costs,” says Jenny Lai, a technology analyst at CLSA, an investment bank based in Hong Kong. “They’re already squeezed, so squeezing more costs out of the system won’t be easy.”

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When a company is operating on the slimmest of profit margins as contract manufacturers are, soaring labor costs pose a serious problem. Wages in China have risen by more than 50 percent since 2005, analysts say, and this year many factories, under pressure from local governments and workers who feel they have been underpaid for too long, have raised wages by an extra 20 to 30 percent.

China’s currency has also appreciated sharply against the United States dollar since 2005, and after a two-year pause by Beijing, economists expect the renminbi to rise about 3 to 5 percent a year for the next several years.

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Contract manufacturers like Foxconn are now searching for ways to reduce costs. Foxconn is considering moving inland, where wages are 20 to 30 percent lower. The company is also spending heavily on manufacturing many of the parts, molds and metals that are used in computers and handsets, even trying to find larger and cheaper sources of raw material.

“We either outsource the components manufacturing to other suppliers, or we can research and manufacture our own components,” says Arthur Huang, a Foxconn spokesman. “We even have contracts with mines which are located near our factories.”

Many analysts are optimistic the big brands will find new innovations to improve profitability. But within the crowd, there is growing skepticism about China’s manufacturing model after years of pressing workers to toil six or seven days a week, 10 to 12 hours a day.

“We’ve concluded Hon Hai’s labor-intensive model is not sustainable,” says Mr. Wang at iSuppli Research. “Though it can keep hiring 800,000 to one million workers, the problem is these workers can’t keep working like screws in an inhuman system.”

This type of low-end assembly work is also no longer favored in China, analysts say, because it does not produce big returns for the companies or the country. “China doesn’t want to be the workshop of the world anymore,” says Pietra Rivoli, a professor of international business at Georgetown University and author of “The Travels of a T-Shirt in the Global Economy.”

“The value goes to where the knowledge is.”

Amen. And this is true globally and regionally. What the US and Oregon both would like is to be knowledge leaders - but this takes sustained investment in education, R&D and infrastructure. Not sexy topics for a politician, but no less important.