June 16, 2007
Why outsourcing to China may backfire in the long run
“During the period from 1995 to 2003, China's automotive components industry made great progress. The average annual growth rate (AAGR) was 23.7%. Given anticipated growth of the Chinese market, the country's low labor costs, and expected improvements in quality, there have been numerous press announcements regarding plans for greatly increased Chinese automotive components purchasing by vehicle manufacturers and suppliers. These claims, along with China's growing competitiveness, are generating rising concerns by worldwide suppliers and manufacturers.” ---BCC Research, 2005
“China's auto parts exports have increased more than sixfold in past five years, at almost $1 billion in April, emerging as one of fastest growing categories in Chinese industrial products sold overseas; manufacturers like Wonder Auto Technology and Wanxiang Group find success by modeling businesses after United States auto parts companies like Delphi Automotive Systems and Visteon and taking advantage of cheaper labor in country to increase bottom line” ---The New York Times, June 7, 2007
Anyone working in the automotive industry will attest that more components manufacturing is moving to China each year. Ford Motor Company has even transferred most of its electronics components purchasing to China in order to take advantage of the Middle Kingdom’s low labor costs.
China might seem to be a dream come true for American manufacturers. However, the longer term prospects for manufacturing in China are not necessarily rosy. There are indeed several flies in the egg drop soup:
Not cheap forever
China won’t be the land of cheap labor forever. Sources in the automotive industry tell me that labor costs in China are rising about 10~13% each year. Moreover, China has one of the most rapidly aging populations in the world, thanks to draconian family planning policies that Beijing has enforced since the late 1970s. China suffers from a top-heavy population; and demographic projections indicate that China (unlike the U.S., Western Europe, and Japan) is destined to grow old before it grows rich.
There is also a relative shortage of women among the younger generations. (Confucian ethics place a premium on male heirs, leading some Chinese to have sex-selective abortions.)
This means that China may lose its cheap labor advantage in the near future. And the shortage of females will not only put a squeeze on labor costs----it may also create social turmoil.
Logistics
Logistics costs are a major consideration in any manufacturing operation. Some U.S. manufacturers have even tried to strategically concentrate all their suppliers around specific roadway systems----like the I-75 corridor that runs through the Rust Belt and the Southeast.
It is already cost-prohibitive to manufacture large, bulky components (like automotive batteries, for example) in China. If labor costs continue to rise, China’s already high logistics costs may quickly offset the country’s labor cost advantages.
Political uncertainty
China seems to be on a long-term trajectory toward becoming a “normal” member of the global community; but the Chinese Communist Party still has a stranglehold on the government. And there has been significant turmoil in China in recent years. Only 18 years ago, China was gripped by major domestic unrest that culminated in the Tiananmen Square massacre. In April 2001, Sino-American relations hit rough waters when Chinese pilots grounded a U.S. spy plane off China’s southern coast.
Another spate of domestic unrest---or another downturn in Sino-American relations---could potentially cut off access to suppliers in China. This very real possibility should be taken into account whenever a U.S. company decides to become dependent on a source in China.
American manufacturers also have to keep the American political situation in mind. The Bush Administration has taken a laissez-faire approach to offshoring. The next president may be more hands-on. Hillary Clinton has already begun talking about “free trade vs. smart trade.” China’s status as a low-cost source of manufacturing is largely dependent the country’s recognition under the most favored nation (MFN) framework. China’s MFN status has to be renewed by the president each year. What will happen to manufacturing costs in China is the next president decides to remove China from the MFN list? (If China’s MFN were revoked, tariffs on Chinese-made goods would rise 6 to 44 percent.)
You can’t bring it back so easily
Manufacturing jobs require special expertise, which is one reason why these jobs have traditionally paid more than jobs in the service sector. For example, a skilled machinist spends years learning the nuances of crafting different kinds of metal with a lathe or a milling machine.
If U.S. companies continue to move manufacturing jobs to China, they may be treated to a rude awakening when an emergency forces them to bring these jobs back one day. Americans follow the money. And they will not continue to learn the skills of manufacturing if all the manufacturing jobs are overseas.
Overly optimistic?
China is destined to be one of the economic giants of the next century; and America should have a business presence there. Nevertheless, the current “move everything to China” attitude may turn out to be bad business in the long run.
