Is low-cost country sourcing set to become a victim of the rising costs of oil?

A new article from Purchasing.com reports on an Economics and Strategy Report from CIBC World Markets in Toronto, whose chief economist believes that the rapidly rising costs of transportation may be reversing globalization as businesses are forced to look closer to home for suppliers. Claiming that rising costs will once again make the world rounder, the article notes that the combination of global raw material costs and high energy costs in China have led to receding Chinese exports of such products as steel, furniture, footwear, metal goods and industrial materials. Interpreting the CIBC World Markets Report as a sign that transport costs are erasing China's labour savings edge, the Montreal Gazette cites from the report that it currently costs $8,000 to ship a standard 40-foot container from Shanghai to the North American east coast, up from just $3,000 in 2000, and at $200 per barrel of oil, the cost to ship the same container is likely to reach $15,000, making the cost of moving goods the largest barrier to global trade today.

While the greatest impact of rising oil prices is on poor, oil importing countries, record prices even have energy producers concerned. During talks between energy producers and consumers held in Rome in late April, OPEC oil ministers insisted the problem has nothing to do with short-term supply but is rather the result of a weak U.S. dollar. Yet in October last year China Dialogue analyzed the findings of a German energy study produced by the Energy Watch Group (EWG) which found that petroleum output peaked in 2006 and henceforth would drop annually. Expecting world oil production to fall by as much as half by 2030, the study envisioned apocalyptic consequences when extreme shortages of fossil fuels and rising demand lead to economic restructuring and social breakdown. In China, the rising price of oil is particularly daunting, as Donald Straszheim comments at Forbes.com, because while its strong economy has been a key driver inflating prices, China has a burgeoning appetite for oil with demand growing 65% faster than the U.S. and four times faster than India, complicated by China having to import over half of its oil while controlling retail prices with inflation in excess of 8%. 

Cargonews reported this week that, in response to the dizzying rise of bunker fuel prices, shipping lines have shredded almost all of last year's customer contracts, in contrast to previous years when contracts were usually extended for another year. As fuel prices are making it hard for lines to make a profit, oil price shock has replaced the traditional arm wrestling at the negotiating table over the rates for the peak season from July through October. Hence more emphasis is being placed on volume discounts, guaranteed sailing dates and shipments, and long-term pledges by shippers.

Dan Gilmore at Supply Chain Digest recently analyzed the cost impacts of rising oil prices on supply chain network design. Incorporating the analysis of MIT professor and supply chain thought leader Dr. David Simchi-Levi, who used data from a real consumer goods company, it was found that every $10 per barrel price increase of crude oil amounts to a 4-cent per mile increase in transportation costs in the U.S., yet when the price of crude oil surpasses $150, things really start to change:

At that point, rising transportation costs start to significantly impact both where products are made and what the distribution network looks like...Rising oil prices would have the effect of changing the way we think about outsourcing and offshoring, after 10 years of a mad rush to China and other Asian locations.

Yet if $150 is an ominous benchmark, Gilmore expects that we will blow past $200 in a heartbeat, so with some fitting hyperbole of the doom that awaits us, Gilmore likens the impact of rising fuel costs to an unwitting frog in a pot of water being slowly heated:

We're being boiled alive, but may not realize it until its too late. The US economy and our supply chains can be very resilient, but at some point in both, something has to give. 

Asia News Network recently profiled Zheng Xiaoqiong, an acclaimed poet and rural migrant worker whose works strongly feature images of iron. Life, she says, feels just like a piece of iron; working iron machines in Guangdong 'left physical and mental scars on her and her co-workers', and Zheng now utilizes iron's sense of 'shrillness and toughness' in her poetry. A former clinic assistant from Sichuan, Zheng made the trek to Guangdong and after a few months of 'hideous experiences' finally settled in a factory making metal tools. Writing her first poem while recovering from losing a fingernail on the assembly line, Zheng subsequently published volumes depicting the hardships of migrant workers. While being criticized by some for 'coarse language, naïve devices and disorderly arrangement',  Zheng says she draws inspiration from the 'rhythm of her heart' and from a force none other than rock 'n' roll, paying 'close attention to the beats.'

Iron and metals are quintessential images of how China's landscape has been made to dance to the tune of industrialization. In its recent investigative series on China entitled Choking on Growth, the New York Times outlined how China, intending to re-create the West's industrial revolution, has not only become the world's factory but also its smokestack, absorbing

most of the major industries that once made the West dirty. Spurred by strong state support, Chinese companies have become the dominant makers of steel, coke, aluminum, cement, chemicals, leather, paper and other goods that faced high costs, including tougher environmental rules, in other parts of the world.

Yet while the mass shift of industrial production has brought environmental and public health concerns to the fore in China, its factories produce and export many of the goods once made in the West, enabling many wealthy countries to decrease their carbon emissions. Emphasizing the unsustainale nature of conventional models of development in China, Dale Wen at China Dialogue this month drew attention to the way China's desire to attract industries has resulted in highly-polluting Western companies receiving special treatment in China, while the environment is played off against maintaining cost advantage. This situation, she says,

has directly led to the environmental crisis that we now see in China. It also enables developed countries to plunder these late-developers [i.e. China]... (R)esource-intensive, highly-polluting manufacturing industries have been transferred to China by developed countries, China is not just the workshop of the world - it has become its kitchen, sewer and rubbish tip.

The countries of the west, according to Wen, are the real 'bad guys', as are large corporations damaging China's environment in their pursuit for wealth.

And with high demand there's a lot of wealth to be had in China's mining sector. In the words of The Economist,

In recent years, thanks to China's rapid industrialisation and its voracious appetite for metals, mining companies have also produced mammoth profits, boasted gigantic valuations and undergone a series of outsized mergers and acquisitions.

The mining sector has recently been drastically altered, however, with the emergence of a major Chinese player, the state-owned Chinalco, which bought a stake in leading Anglo-Australian mining company Rio Tinto. In the estimation of Reuters, the new Chinese upstart is likely to do business very differently from the established companies, 'increasing supply by rushing through riskier projects to feed China's voracious appetite for raw materials.'  One of these is copper, of which China is the world's largest consumer, using an estimated 4.5 million tonnes of the metal a year, or about a quarter of global production. During China's pre-Olympic building boom, high demand has led to organised gangs in Australia stealing copper cabling worth millions of dollars and selling it to China, resulting in train delays and pilfered power cables and phone lines. A large part of copper in China is used domestically as China develops its power infrastructure, yet a lot of it is also exported in products like power cables and air-conditioners. China's copper imports fell 5% in February, however, and on the back of the slowdown in U.S. export orders, Chinese metal fabricators face a lackluster outlook for the second half of 2008.

As China ultimately faces the prospect of being the world's factory, its smokestack, its kitchen, sewer AND its rubbish tip, it resembles Zheng Xiaoqiong's estimation of life as no more exciting than a piece of iron. And while reciting her lines over some rock 'n' roll beats (always a light in dark times), Zheng might well have come across this song by Chinese rock band Second Hand Rose (二手玫瑰),

They've driven me to be a model worker
They've driven me to be a businessman
They've driven me to be a poet
They've driven be to be a worthless man

Let the farmers be the first to strike it rich
Let my pretty people be the next in line
Let my servants be the first to strike it rich
Let my artists be the next in line

A crowd of pigs take to the sky
A mob of pirates drown on a beach
They've turned my son into cold hard cash
Flowers bloom, then wither on the river bank

(Thanks to paper-republic.org).

[For continued coverage on the mining sector see the Metal Miner blog]

In what could have been a regrettable case of unintended double meaning, or 双关 (shuang guan), Chinese officials last week delivered news of how suspicious, inflammable liquids in an aircraft toilet nearly facilitated a terrorist attack. I would not be so presumptuous to assume that the toilets on China Southern Airlines are unusually unpleasant places (see for instance Mutant Palm's expose of the airline, blocked on mainland), but in my experience toilets on public transport in China are generally places to enter with extreme caution (except perhaps on the all-new 300 k/m per hour bullet train between Tianjin and Beijing. As a resident of Tianjin, kudos to the Ministry of Railways for making my journey to Beijing soon only 30 minutes, short enough likely not to need to go).

The suspicious liquid on the China Southern Airlines flight from Urumqi to Beijing, however, turned out to be gasoline (a particularly suspicious liquid indeed), which, the story goes, someone had been carrying around with ulterior motives. Yet one would think China Southern Airlines were happy in the end to pocket two cans of gas, as the consumption tax on imported fuel was raised by more than four fold on March 5 as part of efforts to limit energy use.

This is not the first incident involving suspicious liquids (especially the flammable types). When a British Airways Boeing jet crash-landed in London in January this year, and it turned out it had departed from China, quality fade expert Paul Midler smelled a rat. With suspicions of contaminated fuel and the possible presence of water in the tanks raised by the crash investigators, Midler thought somebody on the ground could easily have replaced 1% fuel with water, which could be a tidy saving of $2,000. So that's quality fade applied to gasoline: a very suspicious liquid.

With its commercial aviation market booming, China doesn't need a lot of water-tinged gasoline. The country's leading manufacturer of helicopters declared early this year it will be focusing more on developing civilian aircraft to cash in on growing demand, and China is also developing its first passenger jet, the ARJ-21, produced by the country's biggest plane maker, the China Aviation Industry Corporation I. Attempting to break into a very competitive aviation market (forecast to need as many as 3,400 new planes globally in the next 20 years) the 70-90-seater aircraft was showcased in December and delivery to the first customer is expected later in 2009. (The plane's chief designer, Wu Guanghui, sounded a hopeful note in the People's Daily last week, saying a total of 171 ARJ-21 jets had received internal orders, and talks were underway with foreign customers).

Its uncertain, however, whether ARJ-21 is going to keep pace with Great Wall Motor Company, the largest producer of pick-up trucks in China. Great Wall is clearly extending its boundaries and told People's Daily on Wednesday it expects to sell 55.7% more pick-up trucks abroad this year, especially in North America and Europe, exporting a total of about 80,000 units. In December it was reported that China's motorcycle exports reached 7.27 million in the first eleven months of 2007, up 22% over the same period in 2006.

Some of these have really rocked the world of a few villagers in Laos, where (the New York Times reported in December) fruit farmers in the steep hills above the Mekong Delta have been able to purchase cheap Chinese models to transport their produce to the market at the local city of Luang Prabang. And where before improvised bamboo stretchers were the quickest way to get to hospital, the Chinese motorcycle has literally meant the difference between life and death for some. Until, that is, your Chinese bike starts developing maintenance problems, which (as the article put it) was a commonly heard complaint affecting the enthusiasm for Chinese goods. People with money, one local mechanic explained, buy Japanese motorcycles, but at least the influx of Chinese motorcycles (which usually need an overhaul within three to four years) has been good for mechanic shops in Luang Prabang, increasing from only a few a decade ago to more than 20 today.

The motorcycle mechanics in Bangladesh, where Chinese motorcycles are set to enter the market from this month, must be looking forward to the prospect.          

The People's Daily on Tuesday proclaimed that China and the E.U. were leading the 'Third Industrial Revolution,' a view espoused by Jeremy (or Jereny as horrendously misspelt in the article) Rifkin, an economist and author of 17 books on environmental, energy and economic issues. The E.U. and China, Rifkin posited, have made binding commitments to renewable energy. For its part the Chinese government pledged to have renewable energy rise to 15% of all energy consumption by 2020, which would supposedly make it a leading light in the so-called Third Industrial Revolution.

Facing menacing environmental concerns and eager to present itself as a progressive nation in sync (or harmony if you will) with the environment, China has invested in more environmentally-friendly policy initiatives (such as tax breaks for makers of greener products) and in providing technological support for developing efficient and sustainable energy from renewable sources (see description of report on China energy industry). Yet the impact of global supply chains on economic, social and environmental conditions in sourcing countries remains a battleground in the debate on corporate social responsibility.

In China, a slew of recent unsettling instances ranging from product quality and safety issues to cases of slave labour have, however, intensified pressure for ethical and sustainable sourcing. Ethically-sourced products, moreover, are moving into the mainstream, and market research has indicated that customers are increasingly seeking out greener products. A survey (see also summary here) conducted in 2007 of shoppers in 15 countries found that more than half of global consumers prefer to purchase products and services from a company with a strong environmental reputation. Shoppers in China, by the way, reported the greatest interest in environmentally responsible purchasing, with 67% preferring greener brands.

So if the customers want it, then surely they must be given it? Starbucks (and more recently Wal-Mart) famously put their best foot forward when the company implemented a scheme to pay farmers handsome prices for their crops, forging long-term relationships with them, offering technical support and contributing to social development programmes (see Food Production Daily article). There is undoubtedly a toll to pay for companies treading the path of sustainable righteousness, yet as added costs and the maintaining of ethical standards and codes of conduct are swallowed up in the unassailable trend of sustainable sourcing, we will advance further down the road of the imperative.

In a publication entitled Beyond Monitoring: A New Vision for Sustainable Supply Chains, the organization Business for Social Responsibility recently put forward a new organizing framework for companies to ensure ethical supply chains. Seeking to integrate labour and environmental considerations more fully into companies' procurement efforts and to re-emphasize the role of workers and governments, the framework rests on four pillars:

• Buyer internal alignment of purchasing practices with social and environmental objectives
• Supplier ownership of good working and environmental conditions in their workplaces
• Empowerment of workers who take a stronger role in asserting and protecting their own rights, and
  
• Public policy frameworks that ensure wider and more even application of relevant laws
  

So while we may think of the immeasurable ways the first two industrial revolutions changed our world and our planet, bringing great advances in our standard of life as well as damage to our environment, all I'll say is BRING ON NUMBER THREE!  

China's strength lies in its workers. Millions of migrants leave their homes and villages to work in factories and cities at low wages, for long hours, making the products that are snapped up and sent to every part of the globe. It is an unbeatable process that has been instrumental in catapulting China to the verge of superpower status as the 21st century unfolds. Most of these workers can expect to see their families only once a year, when they have to brave the spring break rush, which FT.com depicted on Thursday as the world's largest human migration (bigger even than the Islamic Hajj pilgrimage). Yet the worst snow and ice storms in 50 years have played havoc with China's power grid and transportation network, meaning that millions of migrant workers in southern Guangdong province greeted the start of the year of the rat still away from their homes. Desperate to relieve the strain on the country's rail network, the Chinese government attempted to entice workers to cash in their tickets and return to their factories for the holiday. Overworked, underpaid, and now even deprived of their holiday, China's migrants can take a bow.

In the face of such challenging conditions Chinese labor organization is politically weak and largely unorganized; the most explosive labour grievance in China, however, is simply not getting paid. Workers will endure very demanding conditions and the lack of independent unions, as long as they get paid, yet rampant problems of nonpayment of pensions and wages have led to persistent unrest among migrant workers. In its 2007 report on the Workers' Movement in China for 2005-2006, The China Labour Bulletin concluded that

China's workers' movement in 2005-2006 was characterized by continued disputes and protests by urban workers laid off from privatized former SOEs and also predominantly by migrant workers in the private sector... [T]he inability of the government and unions to enforce the law or effectively implement their own policies meant that the lives and working conditions of workers across the country for the most part failed to improve; indeed for many workers, the situation worsened... For migrant workers employed in the private sector, disputes and protests arose largely from specific and blatant violations of their rights. The single most important cause of labour disputes in this period was the failure of management to pay wages on time. Often an entire factory could go for months on end without being paid, and this led to widespread strikes, protests and street blockades.

Interestingly, Ching Kwan Lee* contended that although Chinese workers are aware of their common predicament and aspire to legal rights as citizens, they find the public identity of the "unprivileged masses" the most empowering and effective:

[T]he mode and logic of worker activism in China deviate from what are conventionally conceptualized as class citizenship struggles. Chinese workers' cellular activism is predicated not on horizontal social solidarity or the idea of a judicial, rights-bearing, individual subject, but on the moral and economic entitlements of the subordinate masses in a hierarchical political community led by the central state authority. As disadvantaged masses, workers want more, not less, state intervention and regulation to restrain the market.

Eventually China's seemingly endless supply of migrant labourers willing to work for long hours and low pay (and without even Spring break holidays) will recede. In fact, China Success Stories has listed rising labour costs as a major reason why souring from China will be more expensive in 2008, and FT.com on Tuesday quoted the chief financial officer of Hasbro (the world's second largest toymaker) saying the company expected a 14-15% increase in the costs of made-in-China products in 2008 due to higher labour-, commodity- and currency costs.

So at least China's migrants are getting a bit more pay, IF they get paid at all.  


* Ching Kwan Lee, "Made in China": Politics of Labor, Law and Legitimacy, Woodrow Wilson International Center for Scholars, Asia Program Special Report, No. 124, September 2004. (link)       

Note: This posting is an abridged version of an article by Julian Hewitt which originally appeared on The Beijing Axis website. The full verison of the article can be accessed here.

Two and a half decades of economic reform have placed China firmly on the path of rapid industrialization. China’s recent ascension to the World Trade Organisation has further hastened its opening up to the rest of the world.

At the same time, South Africa has also enjoyed a fruitful period of economic and political progress after many years of international isolation. However, it was only since the establishment of formal diplomatic ties in 1998 that these two regional leaders have begun to realize a significant growth in trade.

In 2006 China exported USD6.6 billion worth of goods (dominated by electronic equipment and textiles) to South Africa while it imported USD2.0 billion worth of goods (dominated by raw materials) from South Africa, according to South African Revenue Service figures. Official statistics from the Chinese Statistical Bureau paint a rosier picture, however, with Chinese exports to South Africa standing at USD5.8 billion and imports from Africa’s largest economy at USD4.1 billion.

China’s rapidly growing middle class is opening up new exporting markets for South African suppliers, and from a South African perspective, rising Chinese living standards are translating directly into more wines, fruit juices and fruit on local supermarket shelves. In addition, China is also becoming a focal point of international gold, diamonds and platinum sales, and on an industrial level South Africa is a large supplier of raw materials that help fuel China’s factory-floor economic model.

China presents big importing prospects for South African suppliers and retailers, yet sourcing of products from Chinese suppliers and maximizing China’s strength as a producer of the lowest cost goods is an avenue South African firms have not yet fully tapped into. Of course, trading with China is not without its pitfalls, even for companies with previous Chinese experience. Language and cultural barriers and often opaque importing and exporting processes serve to complicate business interactions and frustrate expectations between buyers and sellers. China is also a very regionally fragmented market, and this often requires specialized local knowledge of how to tap into potential Chinese business opportunities.

However, it is not without just cause the China commands daily media attention. The benefits of incorporating a China objective into your business’ importing or exporting plan far outweigh challenges on the way. China represents a competitive advantage and it not taken up, could easily be to your competitors advantage.