New Trend in Manufacturing – Cost of “Made in China” Rising Rapidly

During the last two decades, people in the United States have all discovered the new inexpensive products that are made in China. You can walk into any supermarket like Wal-Mart, K-Mart to high-end stores like Macy’s or even Gucci stores, you will find them. From the smallest stuff like cell phone covers, bracelets, toys to big items like the biggest crane in the world at the Harbor of Oakland. The trade deficit between the US and China has grown to hundreds of billions of dollars. This deficit has become another major arguing point in the push for the Chinese currency to appreciate rapidly. Most of the Americans see Chinese products as both a valuable part of life but also a potential threat of their lifestyle. However, “Made in China” will not be always cheap. If we look at the cost structure of most of the manufacturing plants in China, we can discover some new trends.

In China, there is a custom to divide people by the decade they were born, as I was born in the 1970s, I am a “70er”. The workers and labors that provided the US with cheap products were mostly 60ers and 70ers. They left their land and home in the 1990s and 2000s to the cities and provided enough labor for the influx of manufacturing facilities on the west and south coast of China. This group of workers, mostly born out of poverty, was willing to work for low wages, harsh conditions, and strict regulations. I have seen monthly salaries at 500 RMB (roughly 60 USD at the time), warehouses in the 110F, and head-to-toe search by security guards. According to some of my Taiwanese friends who own many of manufacturing facilities in Suzhou, their cost structure was absurdly equipment and asset-centric. Labor cost accounted for only 5 to 8% of their total cost, while their profit margin was always more than 20%. By old Marxism terms, I call them “the extortionist capitalist”. They ripped huge profits between the cheap labor in China and the huge market in the US.

The time is changing. As we move into the 2010s, the 70ers generation are returning to their homes and retiring. Two new generations, the 80ers and the 90ers, are coming to take on the roles of their forefathers. In addition, as more and more manufacturing facilities are moving to China, more and more are hiring to fulfill their thirst for cheap labor and profit margin. BUT, the 80ers and 90ers are different in many aspects. According to a recent survey, when the 80ers and 90ers decide whether to choose a job or not, the determining factor is “respect”. The term “respect” is defined in many ways. Respect with proper pay; respect with humane working conditions; respect with personal management; respect with less strict regulations but more goal-oriented. They want more personal freedom and more flexibility, well, they have learned well from the US.

During this trip in China, I have visited many of the same Taiwanese friends as I did before. And they all agree that their plants are not running at full capacity, even though they have enough orders from the US and other countries. They simply cannot find enough workers willing to take the salary and the working conditions that they offer. Some of them decide to pay the workers more and offer better working and living conditions, with some success. Their profit margin, however, has gone below 10%. And they all believe that they will add the extra cost to the new orders to come. I estimate a 10% to 20% percent hike for products coming from China during 2011 plus the additional cost of depreciating USD.

As a general trend, most of the plant owners I have talked to in Zhejiang and Shanghai are worried. They all face the same problem, domestic, foreign or joint-venture. To make it even worse, the new profit-based education system which was put together in the last 15 years by the Chinese Ministry of Education have produced many “so-called” college graduates. Most of the readers will probably not understand why I used the term “so-called”. The Ministry of Education divided the college system into many levels, for example, “level 1” schools are the Qinghua University, Beijing University, i.e., the old good schools; “level 2” schools are the new good ones, i.e., Beijing Law and Politics University; “level 3” and below are the crappy ones, mostly formerly known as “career schools” providing career-specific training parallel to regular high-school. For “level 3” college graduates, because the only thing they have after graduation is the degree certificate issued by the Ministry of Education, and they have learned very little during college because it was too easy; it is very hard for them to find “college-level” jobs. Each time I talked to these graduates, I felt like seeing a perfect package with a defective product inside.

As a personal experience, I once needed to hire a regular entry-level C++ programmer. If I were in the US, I could easily hire someone after going through 10 resumes and 3-4 interviews. It was entirely different in China, after going through more than 100 resumes, and called in for 20 interviews and to my surprise, only 1 knew answers to some very basic questions in C++ structure programming, most of them told me flat out that they knew nothing about C++ programming even though their major were “Programming”. This has become another trend in China, where good skilled labors are hard to find and need to be treated well, while there are not enough high-paid jobs for non skilled workers who are not willing to take less.

So the shortage of labor at the plants and the shortage of high-paid jobs create an interesting phenomenon – shortage of labor and shortage of job co-exists! If this trend continues, the divide will widen over time and thus create more social problems for the Chinese government. Well, the Chinese government guys are not fools; they have created a systematic solution – the new social welfare and insurance program for the entire population. Yes, you got it, what Obama is trying to do in the US, it was already done in China through the announcement of a series new laws, mainly the new Labor Law of China. According to the new labor law, all employers must buy insurance for all their employees, full-time or temporary, and the cost of getting insurance is shared between the employer and the employee; there is no “opt-out” for anyone, you have to buy it or you are in violation and could be hit with a huge fine. The cost for employee, at least in our town, is 160 RMB per month at a minimum, and for the employer the cost is 420 per month at a minimum. The amount is rising at about 7-10% per year. If the employee gets a high salary, the insurance is calculated at 30%, no matter who actually pays, the government will collect by the end of year. In reality, all costs are “absorbed” by the employer, thus compared with 4 years ago, all employers must pay an extra 30% for insurance. Over time, more and more local governments are enforcing this new law and more and more plants are lowering their profit projections to accommodate the cost while trying to fulfill their existing contracts. This will not sustain over time. The plants will be forced to divert most of the cost to the wholesalers in the US, and thus to the end consumers.

Of course, with this new insurance system, more people are putting money in than taking money out, so there is always a surplus at every Chinese government level. This is always good news for them because they always need more money to build more lavish office mansions, buy new cars and hire more security guards. BTW, if you have seen some of the local government buildings, you will be surprised to find them more stylish and modern compared with the ones in the US. In the little town where I reside, the local government spent 12 billion RMB to build the “most luxury county government building” in China. It has new become a tourist attraction. If you haven’t heard of it, search for “Changxing government building” on Google.

Who said the Chinese government never does anything for the people? They do sometimes perform. With the insurance money people putting in, they have created a complete social welfare system including the following:
 Medical insurance for all who participate in the insurance program, plus medical assistance for all peasants who have to (all) participate in the new rural medical insurance program
 Child-birth insurance
 Workers compensation
 Disability insurance
At least in my little town, people are happy with the new system, except for the hospitals and doctors and nurses. People who live below the poverty line, there is a standard of 400RMB per month, will get a supplement from the government. And of course people who manage all the above systems and insurances will get paid as well.

In addition, the government also encourages employers and employees to contribute to a “housing fund” which is very much like our 401K system since it is deducted before tax. Employees can borrow from the fund and buy apartments, I say apartments, not houses, I will explain in a different article on housing in China. Any surplus of this fund, which is also managed by each local government, can be used by the local government the way they see fit. Last year, the local government used the surplus to buy some Audis and Toyota Crowns for the officials, and bought some food and clothing for the seniors before the Spring Festival. And in the end, the plants pay for everything.

If we consider all the above facts, we can see that cost of labor in China has risen sharply over the past 4 years; my estimate is between 20(inland)-50(coastal)%. And the cost will rise at about 5-15% annually. If the Chinese government continues to push for more economic incentive program like the high-speed rail system, the cost will rise even faster since the new programs will compete with the plants for labor. Some of the manufacturing companies have seen this and are moving their operation either back to the US or to other countries like Vietnam to control their costs. This trend will continue. “Made in China” will no longer be the synonym for inexpensive, and the US consumer will have to find other ways for cheap products.