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China's Growth Model Showing Its Age

China’s low cost manufacturing sector is widely seen as the single biggest contributor to the Middle Kingdom’s dramatic and much-ballyhooed economic rise. For many companies, locating manufacturing operations in China just made too much sense to pass up. One by one, companies with plants in the US, Europe, and even Mexico pulled up stakes to join in the great gold rush that was China.  Like Taiwan, Japan and South Korea, China was using an export-oriented growth strategy to power its economic growth.

Increasingly, though, manufacturers are finding that costs are rising and profits are being squeezed. As the FT reports, one such company, Foxconn, has posted figures showing that per employee costs are up by a third, with a total staff bill of $272 million — double the gross profit.

For Foxconn’s 71 per cent owner, Hon Hai Precision Industry of Taipei, this is nothing particularly new: rising wages on the mainland helped to drive the consolidated operating margin of the world’s largest contract manufacturer of electronic devices, spanning FIH and 22 other subsidiaries, from 4-5 per cent 10 years ago to a 1-2 per cent range now. Until the 2008-2009 crisis, though, rising sales more than offset that decline, keeping earnings per share ticking up by about a quarter each year. Not any more. Hon Hai missed profit estimates for the third quarter in a row this week. Full-year EPS is currently expected at about nine-tenths of its 2007 peak.

Raw materials prices are also a problem.  Chinese workers are facing higher food prices, driving their wage demands.  But the goods factories need are also expensive: raw material and energy prices are high.  The cost of the inputs manufacturers need, materials as well as labor, keep going up.

Normally, manufacturers could just pass those costs along to their customers, but that isn’t working right now.  With tough times at home, Americans are buying less and saving more, and the EU is not exactly in the middle of a consumer boom. The price of labor and raw materials is up; the price of finished goods can’t keep pace: profits shrink.

A single factory can’t do all that much about the price of electricity and iron, but labor costs can be cut.  Foxconn, taking cues from Asia’s other economic giant, Japan, is betting on robots.

[Foxconn chairman and chief executive Terry Gou] outlined the company’s ambitious automation plans at a Foxconn gathering late last week in Shenzhen, a coastal manufacturing centre in southern China. According to people who attended the function, the chief executive said the group would have up to 300,000 robots next year and 1m by 2013, highlighting the drastic changes China-based manufacturers are making as competition for labour increases.

Automating production in China not only brings down per employee costs, but it also frees up some money to better compensate and motivate the remaining workers. Even though China’s manufacturing boom has lifted millions out of poverty, much factory work is repetitive, stultifying, and sometimes dangerous, which has triggered a rash of worker suicides and social unrest.

Of course, if some manufacturers are seriously considering higher salaries and more robots, what’s the point of staying in China? Increasingly, many companies are asking that very question. Some have left for lower-cost Vietnam, a local China rival undergoing a twin renaissance in economic development and relations with Washington. Others, including Foxconn, are giving Mexico another look. And some are even coming back to the US.

There are still lots of desperately poor people in China on the farms and in the interior who are willing to work very hard in dirty, noisy and dangerous factories for not a lot of money.  The era of cheap Chinese labor is not behind us.

But the signs are multiplying that the export-led growth model at the heart of China’s economic miracle is reaching a point of diminishing returns.  This, ultimately, could mean more for the future of the world than the economic problems in either the US or the EU.

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  • bob sykes

    Ahh, the benefits of automation. All (as in all) industrialized countries are losing manufacturing jobs due to automation. This process has been going on a long time. Over the last 20 to 30 years or so, manufacturing output in the US has doubled, but worker productivity has tripled. Hence the job loss. The jobs did not go to China (also losing manufacturing jobs) or other countries.

    Eventually, a job in manufacturing will be about as common as a job in agricultural. Even less, if the Obama administration’s plans to shut down industry in the name of the enviroment succeed.

  • Jeff77450

    Someone has to design, build, maintain and to some extent operate the robots. All of that creates jobs.

  • Jim.

    Raw materials — finding new supplies if geopolitics stays stable, securing existing supplies of geopolitics take a turn for the worse — that’s going to be the major story of the early-middle 21st century.

    This planet does not have the resources to give everyone on it an American standard of living. Fortunately, America has led the way in expanding out into the solar system, and will hopefully continue to do so.

  • Jacksonian Libertarian

    The thing about the law of comparative advantage is that it isn’t static, and the advantages change constantly. So if what you have is an export model built on currency manipulation. Eventually the supply of dollars is going to grow so large maintaining the dollar’s strength against your own currency will be unsustainable. Rejoice you have arrived, and it’s time to go shopping with your ill gotten gains, sure you overpaid for the dollars, and the supply makes them worth even less than the overpaid price. But $1.15 Trillion is still going to burn a hole in your pocket, and America is ready to sell you Planes, Trains, Automobiles, Heavy Equipment, Chemicals, Pharmaceuticals, Medical Equipment, etc… and they take dollars.

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