China's no longer cheap: From Low-Cost to High-Tech

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Chen Weiliang, President of Foxconn International, Taiwan's biggest company and the largest contract manufacturer of electronics worldwide, last week announced that the company will be moving its factories from Shenzhen to northern Chinese provinces such as Hebei and Shanxi, where the average salary is more than 60% lower than in Shenzhen. In addition, Chen said Foxconn will be opening new factories in low-cost markets like Hungary and India to reduce the pressure caused by cost increases

Foxconn's move away from Shenzhen echoes a current chorus of detractors about the fact that China is not so cheap anymore. In the 2008 eyeforprocurement Low-Cost Country Sourcing Report (available for download here), a full three-quarters of respondents were still sourcing goods from China. Yet 42% of responding companies indicated they were now sourcing goods from Eastern Europe (where Foxconn also plans to produce from), up from 24% in 2007, clearly reflecting this region's emergence as a serious challenger for the world's leading low-cost centre of production. Compared with 2007, almost double the respondents (34%) this year also pointed to Mexico as one of their low-cost countries of choice.

China's gradual climb out of low-cost production is contrasted by the steady rise of its high-tech companies and their growing statute in foreign markets. In a paper (see Econpapers reference) measuring and explaining China's competitiveness and impressive export performance, three US scholars tracked the spectacular record of Chinese exports since 1990, expanding at more than twice the rate of growth of world trade. High-tech exports from China like office machines, telecom, electrical machinery and parts, moreover, have been growing much more rapidly than traditional Chinese export products like clothing and footwear (though the latter remain quantitatively important). And the explanation for why China has, in comparison with other East Asian countries, become a dominant exporter is clearly not monocausal, but hinges on the coincidence of several factors such as a favorable exchange rate, low wages and supplies of unskilled labour, the reduced cost of communication and transportation, the flow of foreign direct investment, the large scale of the potential Chinese domestic market, and the encouragement of Chinese foreign trade policy. Yet especially important, the authors concluded, is the fact that Chinese producers have become much more proficient at meeting world requirements for quality and product design. 

While acknowledging that Chinese private sector high-tech and electronics companies have improved their productivity, using scale to dominate the home market, The McKinsey Quarterly for July 2008 remains skeptical about these companies' current abilities to export their success and effectively absorb the drastically increased costs this entails, in particular marketing, R&D, and labor costs. Yet Supply Chain Digest recently outlined ideas presented in the book Dragons at Your Door: How Chinese Cost Innovation is Disrupting Global Competition by Peter Williamson and Ming Zeng, who pointed to a new generation of Chinese competitors using not just low labor costs but also total cost innovation in product design and the supply chain to gain competitive advantage.

Despite the difficulties, it seems to be a question of when, and not if more Chinese companies will successfully compete abroad.

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China is moving up the value chain. There is no doubt about that and with increasing volatility in the oil markets, there will be a trend to focus more on global opportunities as opposed to simply focusing on China.

That being said, China is becoming more efficient in terms of its productivity and quality. More and more manufacturers are obtaining the necessary certification to export to certain countries (such as Australia) with high quality standards. China is still absolutely vast and the manufacturing base is massive and covers a wide range of product categories. There is no doubt that cost arbitrages in the Eastern bloc countries exist but looking at the Euro (such as in Poland), it has appreciated by over 20% against the dollar over the past year. Countries that are not yet part of Europe and are looking to become part of the EU will have to confront that and other issues such as minimum wage etc.

All in all. Interesting times. It is those that have a presence on the ground in China or wherever are those that will benefit.


Barry Author Profile Page said:

Interesting times indeed. Thanks for your valuable input SP.

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