What costs are rising in China, and why?

Q: A growing number of media reports suggest that China's advantage as a low-cost destination for Western manufacturing is starting to wear thin. Techtronic Industries, the world's largest power tool maker, recently said it was looking to expand in countries other than China due to rising costs there. What costs are rising in China, and why? Are manufacturers reconsidering the country as a source? Is the balance between higher transportation/logistics costs and lower raw material/labor costs shifting to favor other countries? What are transportation logistics service providers to these manufacturers doing to help, either in moving clients to new locations or finding ways to keep China attractive?

The answer is provided by Ravi Ramamurti, Professor of International Business and Director of the Center for Emerging Markets at Northeastern University’s College of Business Administration.

China's labor costs were kept artificially low by the government, and migration from rural areas to manufacturing centers along the coast (e.g. in Guangdong province, next to Hong Kong) provided a steady supply of workers. Now with growing congestion in cities like Shenzhen and Shanghai the government is allowing wages to rise faster in the coastal cities, encouraging companies to move low-skill, low-wage jobs to smaller interior cities, and looking to replace it with higher value manufacturing jobs in the coastal cities.

This strategy is running into at least four problems. First, logistical costs of operating in interior cities are higher, and partly offset their labor cost advantage. Second, the interior cities do not provide the full ecosystem to support manufacturing activities, e.g. a toy manufacturer may not find a mold maker or machinery suppliers in those cities, compared to a place like Shenzhen. Third, it is much harder to find experienced engineers or manufacturing staff in interior cities. And, finally, senior executives don't want to live in the interior cities and dislike commuting from one of the major coastal cities.

As a result, China's cost advantage is eroding slightly. At the same time, companies are painfully aware that they are over-dependent on China as a supply location. Many toy companies or footwear and apparel companies, for instance, get 80-90% of their supplies from China. This is imprudent by any standard, but so long as every other competitor was following the same strategy, no one firm was willing to reduce its sourcing from China. The recent quality and safety scares about goods made in China may have finally woken up corporate directors to the risks of their China sourcing strategy. Therefore, it is likely that companies will increasingly look to reduce their China supply exposure. But this too is fraught with challenges and risks. Gradually, countries like India and Vietnam will attract a growing share of labor-intensive manufacturing jobs.