The Friends We Used to Have


While I was over at The China Trade , I came across this piece (thanks Fons for the link) whose sentiments I thoroughly endorse. As he says, China's currency future passes through institutional reform:

In the lobby of the Beijing Hotel, there was always a wonderful portrait of Chairman Mao surrounded by a diverse set of smiling people. Entitled: "We have friends all over the world," it is a legacy of the days when China was the political inspiration for the developing world. Today, there are few places around the world where China is not considered a direct economic threat.

The Managing Director of a well-known European firm says he will spend "the remainder of [his] career closing factories in Europe, and opening new ones in China." The North American customers of a well-respected European engineering firm now require them to manufacture 30% of their output in China, and to benchmark the remainder against Chinese prices. Mexico is reported losing jobs to China, and in the U.S. entire industries are at risk of vanishing, leaving only the unemployable behind. The stark reality of China's becoming "the factory of the world" is that factories elsewhere are closing.

This is a big issue! Unemployment is a tragedy wherever it occurs. In the past few weeks, nearly every manager I have met with has had China on their minds - and it's not good. There are no easy answers here, but as this debate grows, it is key to remember several key points:

Revaluation will not be the solution: Despite political pressure for yuan revaluation, this will not happen, or matter, in the short-run. China will not put its own growth at risk; it is as afraid of unemployment as we are. Furthermore, the magnitude of China's manufacturing cost advantages in many industries are well-beyond what any realistic revaluation could correct.

Floating the yuan is even more unlikely as long as China fears significant capital flight once currency constraints are relaxed. Correcting this is about institutional infrastructure.

Chinese factories are now key players in the global supply chains of "our" multinationals: Their success becomes "our" success. "Our" corporations are the beneficiaries of China's cost-advantages, and so are Western consumers! It is not so much that China is taking our jobs away, as it is that "we" are making different sourcing choices in the value-chains that serve us.

Moving-up the value-chain is no longer assured protection: China is becoming a major source of intellectual property - in science, R&D, design, & entertainment. The reality of 1.3 billion people is that China can and will compete on the basis of low-wage labor and high-impact brains, at the same time.

Much of what we have long-wished for in China has occurred: a market economy is growing and Chinese people are better-off than they have ever been. China is presently the best bet for an Asian growth-engine, and a force for political stability. As China integrates into the global economy, some job relocation is to be expected.

Gradually, the Chinese will certainly import more as growth continues. In the meanwhile, look for a lot of political bluster on all sides, but little effective immediate resolution of the dilemma.
Source: Bill Fischer, ChinaBiz Sunday Column
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China's Real Munfacturing Revolution


Here's a nice piece for a change from the WSJ, and as they say, it's 'fair and balanced'. The message seems to be that there are scale and 'learning by doing' components to working in China, which is what theory would lead you to expect. Supply chain reliability and local management expertise are things which will only develop with time. This is really the strongest, and the only really uncontroversial globalisation argument. The third world isn't going to 'bootstrap up' if it doesn't have the opportunity to learn. Of course, once they start, then they become potential competitors, and we get to hear another set of arguments.

The argument about plant design is interesting, since having a high labour component is only a temporary option for China: with time wages and living standards will rise. Of course if they also manufacture capital goods there, then this will keep capital cheaper, and if a large part of capital costs are in IT hardware and software, and these come from China and India, then where we are going is anybody's guess. (BTW, thanks to Walter for drawing this article to my attention).

The Real Contest Between America and China
By THOMAS HOUT and JEAN LEBRETON


Shopping at Wal-Mart will give you the wrong idea about where China's threat to U.S. manufacturing lies. Most made-in-China consumer goods on those shelves represent industries which left the U.S. for Mexico and Southeast Asia years ago. Instead the real contest between American and Chinese factories is taking shape over industrial goods, a $2 trillion market of everything from small motors to oscilloscopes to locomotives, where fast-moving U.S. productivity and technology have kept production at home.

The problem is that China's rapidly-growing capability and huge scale are turning these U.S. defenses on their head, creating astonishing cost advantages in moving to China. These can amount to savings of 20-35% with no loss of quality -- opening the doors to moving even high-performance, highly-automated product lines there.

Unlike Japan a generation ago, which reinvented manufacturing through quality and continuous improvement, China is deinventing it by removing capital and reintroducing manual skill and handling on the plant floor. China's far lower cost of not only production workers but plant technicians, accountants and managers allows U.S. companies to rethink everything from how the product and its parts are designed to how they are made and tested.

The result is more craft, less complexity in plant processes, and often a shorter time from design to production -- all at a far lower total cost. Together with the improving quality of materials and reliability of supply chains inside China, this means some American companies are moving whole core product lines there.

But many are not. China is still small fry in the U.S. industrial-goods market. Domestic production accounts for 70% of industrial goods sold, and imports from Japan and Western Europe account for another 20%. Only 10% comes from low-wage economies, and China has less than one-third of this -- or 3% total penetration of the U.S. market, shipping fewer goods than Mexico.

Many American companies find China's cost advantage elusive. Sending buying teams to China from their headquarters in the U.S., armed with drawings and specs in search of lower-cost sources, often doesn't work -- as American auto companies have recently learned. Small engine and low-end farm equipment producers, among others, have looked at taking production lines to China and found uneven quality and unreliable supply lines back to their U.S. customers outweigh the advantage of lower production costs. The higher technical- and inventory-support costs plus all the risks just aren't worth it.

Sourcing in China works best for companies which invest know-how and painfully nurture their China operations over sustained periods, and only a limited number of foreigner manufacturers have done this so far. Our research shows that companies committed to large-scale manufacturing in China think differently in several important ways from competitors without such commitments.

First, committed companies accurately cost the labor and capital costs of their products. Accounting statements may tell a finished-equipment manufacturer that factory payroll is only 10% of its costs, but when the full payroll cost of the purchased components and company overheads are added in, the total labor costs are typically 40% to 60% of the final product cost. And those labor costs are lower across the board in China. Production workers typically cost 5% of their U.S. counterparts, while good engineers and plant managers may cost 35%.

But what about higher U.S. labor productivity? True, American workers in capital-intensive factories can be several times more productive than their Chinese counterparts. That's because U.S. plants have replaced many factory workers with complex flexible-automation and material-handling systems. This has reduced labor costs but raised capital and support systems' costs.

Chinese factories reverse this process by taking capital out of the production process and reintroducing a greater role for labor. Parts are designed to be made, handled and assembled manually. This reduces the total capital required by as much as one-third. So output per worker is lower in Chinese factories, but the combination of lower wages and less capital typically raises the return on capital above U.S. factory levels.

American companies like Kodak or Copeland that develop several factories in China will see more cost savings than a competitor taking its first steps. Several factors working together explain this. These companies develop and improve their local suppliers. Their Chinese engineers learn the quality disciplines. And they become smarter in hiring people and designing incentives. The costs and benefits of manufacturing in China increase with scale and experience there, meaning that the more you grow the easier it is to continue to grow.

Second and counterintuitively, it usually makes more sense to send a distinctive new product line to China than an old, price-pressured one. The payoff from sending the latter to China is low. The many one-time expenses -- product and process redesign, new local suppliers to sort out, and the need to requalify the finished product with U.S. customers -- could wipe out any profit margin. But designing a new product for China makes sense for a company well down its experience curve there.

For instance, Tektronix's new oscilloscope was designed by U.S.-based engineers working virtually with their China-based tooling counterparts. Although some materials and components were imported, the product will have only one set of start-up costs and a lower capital investment to amortize.


Third, companies committed to production in China take a more realistic view of the risks involved. Supply-chain risks are often exaggerated by outsiders. As for country risk, again China's resilience and production security tend to look better to insiders. That was recently demonstrated when the outbreak of severe acute respiratory syndrome earlier this year caused few supply disruptions from China. And Chinese authorities regard foreign-owned plants as valuable assets not to be disturbed.

But some risks are not exaggerated, such as the need to protect intellectual-property rights, which deters many companies from bringing highly proprietary processes to China. Armstrong, the world's leading floor- and ceiling-tile manufacturer, keeps some material formulas and processes in the U.S. AMP, the world's leading connector producer, had no choice but to move to China because of the cost savings involved. So its proprietary inline plating process in China is done in a special secure enclosure with specially licensed employees. U.S. auto companies know their technology is leaking to Chinese joint-venture partners, but in return they get a head start in China's exploding market.

There are limits to what can move to China. Products where customer-driven innovation is frequent and critical will not go. Nor will those where customization and intimate user contact with the factory are required. Some American customers, especially publicly funded organizations, will insist on goods being produced in the U.S. The most persuasive barriers to movement will be customer-related, not technology-related. Production technology is often surprisingly mobile and divisible between locations. Large portions of leading-edge medical diagnostic equipment are being made in China, and jet aircraft engines will follow.

While China today has only 3% of the U.S. industrial goods business, its shipments are growing at 21% annually in a basically flat market. This penetration rate will be governed by the rise of capability of foreign-owned and operated plants in China, not by wage increases or exchange-rate revaluations. The cost differences are too great. In addition, China is becoming the world's largest market for some industrial goods, for example machine tools and power equipment. There are many reasons to make more things in China. As more companies discover this, the impact on American jobs will grow, making it an increasingly potent political issue.

There are limits to what can move to China. Products where customer-driven innovation is frequent and critical will not go. Nor will those where customization and intimate user contact with the factory are required. Some American customers, especially publicly funded organizations, will insist on goods being produced in the U.S. The most persuasive barriers to movement will be customer-related, not technology-related. Production technology is often surprisingly mobile and divisible between locations. Large portions of leading-edge medical diagnostic equipment are being made in China, and jet aircraft engines will follow.

While China today has only 3% of the U.S. industrial goods business, its shipments are growing at 21% annually in a basically flat market. This penetration rate will be governed by the rise of capability of foreign-owned and operated plants in China, not by wage increases or exchange-rate revaluations. The cost differences are too great. In addition, China is becoming the world's largest market for some industrial goods, for example machine tools and power equipment. There are many reasons to make more things in China. As more companies discover this, the impact on American jobs will grow, making it an increasingly potent political issue.
Source: Wall Street Journal
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