Posted by Kit Jennings
Kit Jennings
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on Tuesday, 30 August 2011
in Business in China

Increasing labour costs? Should I stay or should I go

Offshoring and increasing labour costs

Every country with cheap labour eventually gets richer - the labour costs increase and alas, we nomadically relocate to another country. Generally, the key benefit of offshoring is lower labour costs. In light of China’s fast-increasing labour prices, companies are faced with a dilemma - to stick to one’s guns and remain in China, potentially losing that attractive profit margin, or to shift one’s industry to another developing market. This article sums up some key stats and argues for staying in China. The key tenet of this proposition is that a Yuan revaluation is inevitable, leading to an appreciation in buying power. The domestic market in China will experience a surge. This, coupled with China’s increasing investment in inbound SMEs and a superb infrastructure are but a few of the pillars of a competitive multinational in China.

The current labour problem

According to the IMF, China’s labour is now the third most expensive in emerging Asia, after Malaysia and Thailand. New labour laws arguably offer more job security to the detriment of employers and transport prices are rising with the cost of oil. All the while, there is the question of a Yuan revaluation and the resulting impact of an appreciation on the export Industry.

Boston Consulting Group listed a number of multinationals, which have already shifted production, including Caterpillar, Ford, Flextronics and toy manufacturers such as Wham-O. These have moved to other cheaper Asian countries or back to their home markets.

Power shifts

Meanwhile, The Financial Times found that the age-old truism that China’s power is top down is demonstrably changing. A demographic shift is taking place, and competition for workers is increasing. The workforce of those aged between 15 – 25 peaked in 2005 and is set to decrease by 150 million by 2024. All this presents a rather bleak image for companies with operations in China, and for those considering an inbound move. However, such information must be questioned.

China’s domestic demand

First, China has reached a pivotal point in its development. Though some companies are moving out or back to domestic production, in many instances, the profits from China contribute an increasingly important share to their global incomes. Indeed, CEO Lavin of Caterpillar said, “If we don't lead in China, we're not going to be the global industry leader”. Companies, such as Caterpillar, which produces excavator machinery, inevitably face greater competition from other multinationals such as Komatsu (Japanese) and Sany (Chinese). Thus, while some multinational companies are moving out, there is a clear realization that China holds the keys to their future profits.

Furthermore, SMEs deal with a smaller scale of competition and benefit from proportionally high benefits from government incentives. For example, the 12th year plan offers cash and tax incentives to those businesses, which can reduce pollution. Moreover, through industrial parks, local governments offer financial assistance to manufacturers to attract them. For those providing services, there is even greater room for expansion in a market, which has been characterised by an export-led industry.

An Increasing Domestic Demand

The baseline is this: China’s domestic market is growing. In recognition of this, according to EMPEA (Emerging Markets Private Equity Association ), the vast majority of private equity funds targeted at emerging markets goes to faster growth countries like India and China. "Fund-raising activity in the first six months of 2011 reached almost full-year 2010 levels and we estimate that fund-raising for the full year could reach $40 billion or more, which would exceed the 2006 total," EMPEA President and CEO Sarah Alexander said.

Tapping Potential and Managing it

The potential is clear. Operations in China can tap the growing financial stimuli and consumerism. As for labour prices, they are increasing, but according to the Bureau of Labor Statistics, a US research body, devoted to comparing international labour prices, China’s average remains below a dollar an hour. Will this change? Yes. Should such a change evoke a fear of decreasing returns? In reality, it will necessitate a closer hand on management and streamlining existing operations to become more lean and competitive. ‘Remote controlled’ entities, with management from abroad, will inevitably face more difficulties.

Results of investment

Even where labour prices increase, these are offset by labour productivity. The years of heavy investment in technology and education have resulted in an increase in quality of production. Dragonomics, a foreign research consultancy, calculated that “labour productivity in China grew by 13 per cent annually in apparel manufacturing between 2003 and 2010, offsetting most of the increase in wages.” It also found thatsouth Turkey, India, Vietnam and Brazil lag behind in terms of productivity growth. Thus, while labour prices increase in certain areas, the level of production follows on an upward trend and China retains a globally competitive edge.

This leads onto the next issue of distribution. If productivity is growing, how does China move a greater quantity of goods? The answer lies in its rapidly improving infrastructure. The World Bank has found that China’s infrastructure is on a par with South Korea. This remarkable emergence is the result of billions of dollars in linking up China’s ports, airports and cities. This is not limited to China’s internal infrastructure. What is even more extraordinary is, while multinational companies pour money into China, China invests in creating an international infrastructure. The government is going so far as to reinvest in the ancient Silk Route, pushing money into the middle-east, which will serve as a springboard for trade with the Mediterranean and Europe.

Only time will tell if this benefits SMEs based in China, but the general improvement of links across the West of China will provide further opportunities for inbound investment and access to a greater market. It is no longer as easy as it once was to access China’s market. The phenomenal success the country has experienced is leading to pressure on the Yuan to appreciate and a reassessment of the role exports play in China’s economy. But, three things remain clear.

The first point is labour prices, raw materials and a first-world infrastructure continue to attract manufacturers and independent investors alike, more so than Vietnam, India or Brazil. The second aspect is that China wishes to move from a secondary sector economy into a more tertiary, service driven economy, where there is enormous potential. Foreigners must carefully assess the changing direction China is taking and the available opportunities. The third aspect underlines most discussions in China and incorporates the two points mentioned above. China’s place in the world economy is changing, and as CEO Levin said, tapping its domestic market is crucial to any company, which wishes to compete seriously.

Conclusion - Stick with China, but stay ahead of the curve

In short, labour prices in China remain comparatively low, and the disadvantages of increases are most likely offset by China's productivity, incentives and highly efficient infrastructure. For these reasons, China still retains the edge over many other export driven markets. Nonetheless, China's increasing wealth will demand a careful look at the tertiary sector and the emerging opportunities, in what will increasingly become a market driven by domestic demand and services.

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