Changes in labor organization and regulation in China are providing a unique perspective on China's systematic move up the production ladder and its embrace of higher-skilled industries.

In a landmark agreement, employees of a Wal-Mart outlet in Shenyang, capital of Liaoning Province in northeastern China, last week signed a collective labor contract with the retailing giant. Under the agreement, employees' salaries will be raised by an annual rate of 8 percent in 2008 and 2009, and standards for minimum pay, paid vacation, social security and overtime pay were agreed to. The International Labor Rights Fund (ILRF) Blog has hailed the contract as a stepping stone for Walmart's ongoing labor organizing efforts in China (as well as for its influence on the All China Federation of Trade Unions), the successes and challenges of which China Labor News Translations have been documenting at length.

The ILRF Blog has pointed to draft labor regulations proclaimed in Shenzhen in June as evidence of the persisting trend towards collective bargaining and legislation in China; and this trend, in turn, as an indication of China's growing conviction that it must move up the production ladder, focusing on higher-skilled industries - or be stuck forever competing with its poorest neighbors for the cheapest manufacturing orders.

The IHLO (Hong Kong Liaison Office for the international trade union movement) in June investigated the impact of the Labor Contract Law in the preceding six months of implementation, and concluded that the real impact of the new law has not been its negligible overall impact on labor costs, but rather the way it makes it harder for companies to avoid paying benefits to their employees or to circumvent implementing existing labor legislation. And this encapsulates government policies aimed at transforming China's traditional reliance on low-cost labour and labour-intensive industries to the development of higher-value industries. This process requires companies to invest in employee training, and makes it harder to routinely flout labor regulations. With such incremental developments, the organizational and regulatory outlook for labor in China provides ongoing insight into more long  term transformations in the Chinese economy.

There are many reasons today why Assembled in America makes more sense than Made in America, even though the latter, as Gail Dutton writes at World Trade Magazine, signifies innovation, quality and reliability. Based on the experiences of commodity leader Mark Thompson from plant genetics leader Pioneer Hi-Bred International, Dutton extrapolates ten basic premises why companies today would logically take recourse to global sourcing, ranging from the geographic availability of materials and technology and varying costs of goods and labour, to the value of joint ventures and the wisdom of establishing additional sources of supply. Under such basic formulae the process of outsourcing and especially the phenomenon of low-cost country sourcing have expanded significantly over the last thirty years.

Yet there are indications that global sourcing is set to enter a critical phase, or a strategic inflection point brought on by structural changes and altered estimations of cost and risk.

The impact of high and rising energy costs is currently a fundamental issue complicating (as Bob Ferrari puts it at Supply Chain Matters) the interrelationships and flow of goods across global supply chains, which he believes will ultimately structurally alter supply chain and sourcing strategies. Supply Chain Digest has even raised the specter of a so-called Perfect Storm developing in transportation with oil prices at unprecedented levels and other energy costs also on the rise. This all contributes to complexity in the supply chain and the the advent of risk mitigating fever, or a regulatory choke hold as supply chains become fast, cheap and out of control.

An AMR Research Study (see press release) recently found the U.S. (35%) and China (28%) to be the regions with the most supply chain risk for manufacturers; and rising transportation costs (51%), volatile commodity prices (43%) and weakening consumer spending (37%) were identified as the top supply chain concerns. A study released this year by Marsh, however (see also Sourcing Innovation blog), served to quantify the extreme degree risk has increased in global supply chains in the last few years, with 73% of North American risk managers indicating their supply chain risk has risen since 2005. Yet most businesses are ill-prepared to handle the rising risk levels, with only 35% reporting that their supply chain risk management was moderately effective.

Notwithstanding the substantial risks in global supply chains, manufacturers are still increasingly looking to their supply chains to boost profits and cut costs. Procurement Leaders last week reported research conducted by Archstone Consulting which found that over 80% of manufacturers have responded to the current economic climate by devising aggressive agendas to boost sales and cut costs. Todd Lavieri, CEO of Archstone Consulting, explained that

In the past, manufacturers simply used their supply chains as a means to control costs by improving efficiencies. Now, they are using their supply chains as a mechanism to boost revenue and improve customer satisfaction through capabilities like better management of highly customized products, quicker delivery times, and more integrated services.

Small players: they are the weakest link (h/t Supplychainer).

This was the finding of an independent report commissioned by the EU, Evaluating Business and Safety Measures in the Toy Supply Chain, which concluded that China has taken steps to address safety concerns after the recalls of last year, yet small players all round - both among Chinese manufacturers and European importers - tend to be the soft spots in the supply chain. According to the report's independent expert authors, final product testing alone is insufficient to guarantee product safety (which instead has to be embedded in the entire supply chain), and Chinese enforcement authorities should continue to strengthen supervision of the Chinese toy industry, especially focusing on weaker manufacturers. One example of these would presumably be Guangzhou Dongxin Electronics Co., Ltd., which turned out to be the only substandard toy maker in a recent review of the Guangzhou market undertaken by the Guangzhou Municipal Quality Inspection Bureau before International Children's Day. (For children's apparel, however, the review found 30% of clothing to be substandard).

Yet because of these weak links in the supply chain and the substandard products that have menaced consumers, as an indication of how the debate on outsourcing has shifted, serious quality and safety concerns in outsourced products have led consumers and regulators to question whether products using global suppliers are of sufficient quality for end-users. And these intense discussions, as Ben Heineman writes at Forbes.com, have moved outsourcing to the top of the globalization agenda and focused attention on the need for more regulation. And while the role of sourcing countries, such as China, in setting and enforcing standards have likewise been emphasized, for Heineman this should not obscure the fundamental point with regulation, namely

Businesses are responsible for their products and must have sourcing disciplines which ensure their products are free of safety and quality defects...This basic responsibility exists whether the business is sourcing a finished product or components...or whether it sources from one supplier or must rely on second- and third-tier suppliers...

With today's elaborate global supply chains, moreover, the deverticalization of the manufacturing process through off-shoring and outsourcing does not change that ultimate responsibility of companies to take things in their own hands through all stages of the sourcing process,

from solicitation of bids to qualification of suppliers to monitoring, auditing and testing by the ultimate seller of the product before it enters the market. Due diligence...is required to navigate the many shoals of shoddy businesses in the developing world - and to pierce the first-tier supplier, drilling back to the practices of second- and third-tier suppliers.

In global supply chains, therefore, as Bob Ferrari points out at Supply Chain Matters, the only thing that companies cannot outsource is risk.

China's future path is a stark choice between four options, or trajectories as they call them, as laid out by The Foundation for Law, Justice and Society (FLJS) at the University of Oxford in a report (link from Asiabizblog.com) considering whether China's transition is 'stalled'. These four, under the strangely familiar banner of One Country, Four Perspectives, are so descriptive they require little further explanation:

• Liberal evolution
  
• Authoritarian resilience
  
• Imminent collapse, and
  
• Authoritarian stagnation
  

The report bulges with talk of calculating ruling elites, a political monopoly overriding the culmination of full market reform and ominous indications of the development of a predatory state and systemic risks. Ultimately, what's going on in China right now is called (deceptively harmonious-sounding)

...Partial Reform Equilibrium.

And basically, the choice from here onwards ranges between

• Evolving, like China's two-tiered household registration system which is set to be reformed to allow freer migration between cities and the countryside;
  
• Persisting, like the stinky smell from 10 branches of the Liaohe River, for which reason 200 small paper-making plants will be shut down in Liaoning this year; 
• Collapsing, like the roof of a slag pit in Liaoning; or
  
• Stagnating, like China's manufacturing competitiveness in some industries, at least according to more than half of the 66 foreign-invested firms surveyed by the Shanghai Chamber of Commerce.

Let's not throw out China's new lively intellectual class, however, whose influence (writes Mark Leonard in the March edition of Prospect magazine) is actualy amplified by China's repressive political system that can use intellectual debate as a surrogate for politics. In the long term China's one-party state may well collapse, yet although China is not as yet a fully open intellectual society,

it is so big, so pragmatic and so desperate to succeed that its leaders are constantly experimenting with new ways of doing things. They used special economic zones to test out a market philosophy. Now they are testing a thousand other ideas - from deliberative democracy to regional alliances. From this laboratory of social experiments, a new world-view is emerging that may in time crystallise into a recognisable Chinese model...

(For another encouraging political outlook for China in 2008, see Economic Observer's views on why this year will be a key point in Chinese history).

All of this cuts no ice for FLJS at Oxford University though. Which of the four 'trajectories' does their report consider, on balance, the more likely outcome in China? You guessed it:

Option number four!, with a gradual dissipation of vigour and momentum projected to set in. Ouch!  

When it comes to product quality in China, it is "still too easy to break the law." Reuters on Wednesday reported Chinese Vice Premier Wu Yi adding a cautionary tone to recent claims of success in a four-month government campaign against 'shoddy goods':

"...in a country with as many people as ours and an industry whose technical and management skills are uneven, you cannot expect to nurture good production and consumer habits in the space of a few months... (A)lthough this campaign has solved some outstanding problems, the results achieved have only been initial ones.

The Vice Premier outlined a long list of issues still confronting the country, including (quoting the Reuters report) "the plethora of small factories in remote areas which often fall beneath the radar and lack of awareness of quality problems among the Chinese public."

Silk Road International Blog recently profiled a factory in Jiangsu province with 20 years of international experience manufacturing two products "over and over" for a couple of large clients. Each employee does the same thing every day and there is little if any appreciation of quality control. And they are growing so quickly that,

while intentions are good, they are falling short in quality because of the inability of the 'family business' model to keep up with the new international level business they are attracting. They are going after bigger fish... appear(ing) bigger and more capable than they really are... The international standards/testing requirements are not even on their radar.

Unregulated factories in remote areas form part of the rural-urban disparity affecting the building of a harmonious society in China. Yet ultimately the responsibility of sourcing quality products from China lies as much with suppliers as with importers. China Sourcing News on Thursday reported the American Society for Quality conceding that much of the responsibility for quality problems resulting in Chinese product recalls lies with 'inadequate oversight' by U.S. importers:

...importing companies need to take more responsibility for their inadequate assessment of risks in dealing with foreign suppliers, insufficient supplier development activity and a lack of discipline applying quality basics with suppliers

who, in the case of China, include a plethora of largely unregulated factories who have little problem in breaking the rules.

With the new China Labour Contract Law coming into effect on January 1 2008, the December edition of China Briefing (req. registration) analyses the changes foreign invested companies in China must make to their employment contracts for all staff. Foreign investors are the prime target for legal and financial control mechanisms in China, and aiming to discourage employers from signing short-term labour contracts, the new labour law will have a direct impact on employment costs. Officially designed to improve employment relationships, clarify rights and obligations and provide more stability and security for employees, the law will in effect result in the abolition of fixed-term contracts as every such contract will require a severance obligation when expiring.  

And from the China Briefing blog yesterday, foreign enterprises in China seem set to lose their tax holidays as China moves to implement new corporate income tax regulations. As tax authorities have recently increasingly focused on foreign invested enterprises (FIE's), many of these enterprises have seen their tax holidays eliminated for breaching Regulation #43 of the new law, which dictates that once the tax breaks end, income tax should be submitted without delay and any changes affecting the tax payer within 15 days of the change should be declared. And taxpayers who no longer qualify for the tax breaks must pay up.

According to Steven Dickinson in Business Week, China has made 'remarkable progress in introducing a fully functioning civil law system... The Chinese authorities fully understand that economic development and development of a strong legal system go together.' Citing data from the Report on China Law Development published earlier this year, Dickinson pointed to a full 94,288 laws and regulations promulgated in China between 2001 and 2004 as an indication of a legal system being established in China which, once in place, 'will do its job of providing the guidance and legal certainty required of a modern market economy.'