China Comment

Energy, Environment, and Economy

Out of China

Canon, Nissan, and Germany’s Steiff Toys are either forgoing China expansions or leaving China to produce in other countries. Other companies are leaving China to find cheaper, less regulated places to manufacture. RMB appreciation, costs of training, the new labor contract law, end of some preferential tax breaks for foreigners, inflation, visa regulations, and energy rationing have made China a little less attractive for foreign businesses and manufacturing. But where will these companies go, and why? Even some of the so-called drawbacks to doing business might be good for the long term. Below, the issue is examined.

Why Leave China?

Booz-Allen and AMCHAM released a March 2008 study that argued “More than half, or 54 percent, of companies surveyed [out of 66] believe that China is losing its competitiveness to other low-cost countries.” And “wages in China now [as of June are] rising close to 25 percent a year in dollar terms in many industries” (IHT). Specific “problems” include:

1.) China’s new labor contract law, which went into effect this year, might increase costs by 8% on average per firm, and will make it more difficult to lay off workers. One provision states; “from January 1, workers who have been with a company for 10 years – or signed two fixed-term contracts – will be entitled to one month’s severance pay for every year worked.” One could argue that this law is well-needed to align Chinese workers’ interests and pay with international norms. But still, it does put upward pressures on costs of doing business.

2.) RMB appreciation. The currency has risen by 7.1% this year against the dollar, which is amazing since the RMB only appreciated 3% from July 2005 through March 2006. (But there are opposing views, namely that the evaluation is overstated due to a weak dollar- since the RMB has actually declined 16% from 2006-2008 versus the Euro.)

3.) Preferential Tax Rates Ended for Foreign Firms; Export Tax Rebates Ended. Now, foreign firms pay a higher rate, generally 25% of taxes. (Information on the new law is from Deloitte, and HERE.) Also, export tax rebates were phased out. A trade manager quoted in AFP claimed, “The yuan appreciation has a huge impact on our business. It costs us much more in the production and delivery costs. What’s worse, the export tax rebates of 13 percent were cancelled so our total costs are up 20 percent,”

4.) Inflation.  “Seven out of 10 respondents cited the rising renminbi as a major reason for China’s decline, while wage inflation was cited by 52 percent of those polled.  Wages for white-collar managers and blue-collar workers have jumped 9.1 percent and 7.6 percent, respectively [on the year],” according to the AMCHAM study.

5.) Visa Regulations. The Wall Street Journal described how, due to the newly onerous visa regulations, one businessman had to leave China for Thailand, even though his company “researches commercially viable ways to sustain water and land resources in China.” In China’s defense, this businessman’s situation was made troublesome because his company had not been legally registered to operate. (Previously, many companies have not been registered). Visa regulations and enforcement of already on-the-book rules may do a little to slow inward-bound China growth. Ultimately, however, enforcement of logical laws will benefit China, so the stifling effect of strict Visa regulations may pass post-Olympics. (Michael at The Opposite End of China explains his visa problems HERE.) 

6.) Costs of Training/Turnover. The experience of Steiff Toys provides an interesting anecdote about the challenges of training and turnover in an emerging market. After being trained, employees might seek to market their talents at a better paying company. In Steiff’s experience, “[t]he company had frequently visited its Chinese partner to try to build up a good relationship. However, once, during a six-month gap between visits, almost the entire work force at one factory had changed.”

“It was no surprise the quality varied so much. New people came, the quality dropped, then they improved their skills and left,” he said, adding that the Chinese-made trampoline parts did not reach high enough endurance standards.”

7.) Energy Rationing. In January, and then again this summer, factories had to shut down power to ensure the grid was not overloaded.

Where to Go? 

Vietnam is the country most mentioned as a relocation place, but it faces surging inflation. In May 2008, food prices were 42% higher than they had been one year ago. China, in comparison, saw food prices increase by only 21% since 2007. Still, inflation worries in both countries only cuts their economic outlook from growth at 1-2% less than initially projected. This allows both countries to grow at 7% (Vietnam), or +9% (China) on the year.

What Vietnam lacks, that China increasingly has, are sufficient infrastructure developments. AmCham Vietnam discusses the problem of infrastructure. Vietnam’s plans for development are available at the World Bank.

Also, Vietnam’s population of 86 million pales in comparison to China’s 1.3 billion. International Lawyer Dan Harris, in informal interviews with several of his clients, believes that Vietnam’s manufacturing processes and human capital still need a great deal more of investment before they can compete with China- which may never happen.

Cambodia. Hailed as the next Vietnam, some garment manufacturers are relocating here. And “South Korea and Malaysia have been pouring in investment. In 2006, foreign direct investment totaled $2.6 billion, up from just $340 million in 2004, according to the International Monetary Fund” (IHT).

Cambodia “is where Vietnam was some 8 to 10 years ago.” [Yeo] likes a lot about Cambodia: its location in a fast-growing region, a young and inexpensive work force, rising productivity, a pro-business government, stable politics and strong GDP growth, which peaked at 13.5 percent in 2005 but was expected to mellow to 7 percent or 8 percent in coming years” (IHT). Still, Cambodia is tiny, with a population of 14 Million. And the vast majority of Cambodians are laregly uneducated and unskilled. Hyping Cambodia as a future economic powerhouse is probably overstated.

Malaysia’s International Trade ministry hopes to position itself to poach manufacturing plants that leave China. Malaysia claims it is interested in investments in “high technology,” less labour-intensive industries. Malaysia’s economy and workforce, however, is much smaller than China’s (at $357 billion PPP [Purchasing Power Parity] in 2007 and a 6.3% yearly growth compared to $6.9 trillion and 11.4% growth in China). More importantly, Malaysia has less to grow than China.  Only 13% of its workforce is in agriculture, compared to 43% of the workforce in China.) While it may attract certain manufacturing industries, a large-scale relocation is unlikely since costs in Malaysia will rise as the pool of workers decrease and compete for better-paying jobs.

India. People like to laud India over China due to its democratization, but India suffers environmental degradation just like China. And India suffers internal dissent, from Naxalites, from Jammu-Kashmir, from Islamist extremists, and from its rival Pakistan. Attempts to deal with water purification, smog, and other challenges will slow India’s growth in the short run, just like such attempts can short-term stall Western countries’ industrial expansions.

India’s Democratic society is also less likely to sanction the painful changes than China’s semi-autocratic government permitted to increase development. China ended or reduced many state pensions, reduced health benefits, and evicted thousands from their homes. As Robert Shapiro, a former undersecretary of Commerce, describes in his book Futurecast:2020, it does not appear India has the political will to carry through needed reforms.

India still faces a large variety of difficulties it must overcome before it can rightly challenge China as a competitive place for companies to relocate their industries. The day of relocations may come, but it is not yet here.

Why China is Still Attractive

China Law Blog believes the Labor Contract law did little to directly dissuade big foreign companies from investing in China. And that makes sense. China is a huge market, well worth the time and effort of investment, both for substantitve purposes (returns on capital), and for prestige (WE have a China office; do you?).

However, CLB also noted that “China has seen a number of factory closings of late, but most of these are very domestic factories that produced low end goods. I also have no doubt that many Taiwanese and Hong Kong and Korean factories producing the same sorts of goods have closed as well [because]… Beijing has instituted a number of policies explicitly aimed at marginalizing such factories so as to push China up the value chain. ”

Asia Sentinel backs up Dan Harris’ comments, calling attention to the closing of marginal manufacturing industries, but also stating that the higher value, better-run factories are staying open.

The Chinese Miracle, of its economic growth, still has a long way to expand. As the Motley Fool’s argues, the China Story is not going to end because wages are rising in coastal provinces. Instead, a new chapter will open as manufacturing and development “Go West” and drive to the interior. China has hundreds of million-person-populated second tier cities like Xi’an, Lanzhou, and Wuhan that can benefit from and contribute to internal development, services, and manufacturing.

China is experiencing teething pains, but it still has vast human resources. Its largest problems appear to be sustaining energy supply, its need to move more toward rule of law, and a need to contain inflation. And China, for the most part, is moving toward those goals (although containment of inflation is an open question). So will businesses depart from China? Some manufacturing might. Other manufacturing will just move farther inland, to take advantage of cheaper provincial labor as the coastal regions move up the value chain.

Extra

* September 8, 2008, the Washington Post presented a story about manufacturing moving from China to the US.

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22 July, 2008 Posted by | China Economy | , , , , , , , , , , , | Leave a comment