Tuesday, February 26, 2013

The Future of Cheap Labor in China

The reading this week brought out the interesting topic of offshoring in China. In Supply Chain for iPhone Highlights Costs in China, it mentioned that Foxconn Technology is planning on moving its plants and workers to Henan, a relatively poor Province in China. I got this impression that manufacturers like Foxconn is just trying to hop from one city to the next, searching for the cheapest cost. If this city's labor cost is going up, they will easily abandon it and go for the next. But will that really solve the problem? why did the labor cost keep going up? In my opinion, besides inflation rate and other general economical parameters, there is a certain pattern which results in this increasing labor cost in China. Let's take Shenzhen as an example:

The Cheap Labor Cycle

Shenzhen is one of the biggest import/export hub in China. But it was just a normal city in China before it was chosen as the Special Economic Zone in 1979. In the beginning, supported by the Government, Shenzhen has attracted a lot of foreign investment. As many new plants and factories were opened in the city, the local labor pool was no longer sufficient to meet the demand. This great opportunity has attracted thousands of millions of workers from other provinces crowded into Shenzhen. Only count from 1980 to 1990, the year-end permanent population has increased by 1.34 million people. [1]

Although western companies considered the labor cost per person in China was really low, it was actually a pretty good deal in the view of workers. In 1990, the average salary per year per person in Shenzhen is CNY 4,304[2], which is USD 690.42 (calculated based on current exchange rate). Whereas the average salary per year per person countrywide was only CNY 2,150, which equals to USD 344.89 (calculated based on current exchange rate).[3] Since the workers in Shenzhen had higher power of consumption, more and more new shops, restaurants, and other entertaining facilities were built up in Shenzhen. As a result, the commodity price level in Shenzhen was increasing rapidly. Meanwhile, as more people moving in, the housing price is going up too. Therefore, the overall living cost in Shenzhen had increased drastically. 

The high living cost had forced up the workers' salary. Now that we can see a pattern of city development and labor cost: cheap labor cost --> more import/export orders placed --> higher needs of working capacity --> more workers moving into the city --> higher living expenses --> higher labor cost.

Thus, we can foresee that even if Foxconn moved its plants to Henan province, history will repeat itself. When the labor cost in Henan province goes up, where will be Foxconn's next target? After exploiting all the cities in China, what should Foxconn do? 

China: Manufacturer or Customer?

As discussed above, the cheap labor cycle will stop when the labor cost reach a certain level. That is to say, the city should no longer be considered as cheap labor target market. When most of the cites in China are no longer cheap cost targets any more, how will China redefine its role in the global economy?

Notice that alongside increasing labor cost, the purchasing power of workers is also strengthening. Actually not only for workers, as the economy grows, the average purchasing power of the whole population will get stronger. Thus, I think China will gradually transform from a supplier into a customer. In fact, I just read a news recently talked about that Apple is working on iPhone mini in order to expand into Chinese market.[4]

Now looking back at the role of manufacturer, China will no longer be a low-cost offshore choice any more. Instead, China should be consider as a near-shore supplier. Therefore, the higher labor cost can be compensated by lower logistics cost. In the future, China could still be one of the world's biggest manufacturer in the upstream of the supply chain. It is just that the downstream consumer it will serve has changed from other countries to China itself.

My question is: to what labor cost level do you think a country should no longer to be consider as a low-cost target? If China become both manufacturer and costumer, what kind of supply chain adjustment should be made to adapt to this new mode?

[1] http://www.sztj.com/main/xxgk/tjsj/tjnj/8140.shtml

[2] http://sz.bendibao.com/szsi/2008227/si62700.htm
[3] http://www.stats.gov.cn/tjgb/ndtjgb/qgndtjgb/t20020331_15384.htm
[4] http://www.zdnet.com/how-could-apple-make-a-cheap-iphone-mini-7000011719

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