With China Forecast To Reach Wage Parity With The US In Five Years, Is A New Manufacturing Golden Age Coming To The US?
A rather controversial perspective on "reverse labor mobility" has recently seen a revival following the release of BCG's analysis: "Made in the USA, Again: Manufacturing Is Expected to Return to America as China’s Rising Labor Costs Erase Most Savings from Offshoring" which claims that "within the next five years,
the United States is expected to experience a manufacturing renaissance
as the wage gap with China shrinks and certain U.S. states become some
of the cheapest locations for manufacturing in the developed world." While this topic, as we will shortly see courtesy of SocGen is far from taken for granted, could be the deus ex machina that could provide the historic jobs boost to Obama's second presidential campaign (should he get that far), it could also explain the eagerness of the Fed to continue exporting US inflation to China. If the latter is indeed the case, it would mean that the Fed will do everything to continue flooding the world with excess liquidity if for no other reason than to see Chinese inflation reach an out of control state, and wages explode, in an outcome that would ultimately undo the great manufacturing job outsourcing phase that marked the 1990s and 2000s. If successful, it would indeed lead to a second US renaissance in manufacturing jobs. However, will China allow its economy to lose the competitive wage advantage it has held for decades over the US, an outcome which would culminate in riots, as unemployment in the billion + nation goes parabolic. Of course, the conspiratorially minded can imagine a scenario in which the inflationary transference plan concocted by the Chairman has one goal and one goal only: to cause labor cost parity between the US and China in the shortest amount of time. The only two question in this case are: how long until China realizes what is going on, and how will it react?
With Chinese wages rising at about 17 percent per year and the value of the yuan continuing to increase, the gap between U.S. and Chinese wages is narrowing rapidly. Meanwhile, flexible work rules and a host of government incentives are making many states—including Mississippi, South Carolina, and Alabama—increasingly competitive as low-cost bases for supplying the U.S. market.
“All over China, wages are climbing at 15 to 20 percent a year because of the supply-and-demand imbalance for skilled labor,” said Harold L. Sirkin, a BCG senior partner. “We expect net labor costs for manufacturing in China and the U.S. to converge by around 2015. As a result of the changing economics, you’re going to see a lot more products ‘Made in the USA’ in the next five years.”
After adjustments are made to account for American workers’ relatively higher productivity, wage rates in Chinese cities such as Shanghai and Tianjin are expected to be about only 30 percent cheaper than rates in low-cost U.S. states. And since wage rates account for 20 to 30 percent of a product’s total cost, manufacturing in China will be only 10 to 15 percent cheaper than in the U.S.—even before inventory and shipping costs are considered. After those costs are factored in, the total cost advantage will drop to single digits or be erased entirely, Sirkin said.
So which industries would be the first to see a boost as jobs start to trickle back to the US:
Products that require less labor and are churned out in modest volumes, such as household appliances and construction equipment, are most likely to shift to U.S. production. Goods that are labor-intensive and produced in high volumes, such as textiles, apparel, and TVs, will likely continue to be made overseas.
“Executives who are planning a new factory in China to make exports for sale in the U.S. should take a hard look at the total costs. They’re increasingly likely to get a good wage deal and substantial incentives in the U.S., so the cost advantage of China might not be large enough to bother—and that’s before taking into account the added expense, time, and complexity of logistics,” said Sirkin, whose most recent book, GLOBALITY: Competing with Everyone from Everywhere for Everything, deals with globalization and emerging markets.
Indeed, a number of companies, especially U.S.-based ones, are already rethinking their production locations and supply chains for goods destined to be sold in the U.S. For some, the economics have already reached a tipping point.
Just who are these brave souls who are foresaking Chinese zero wage over US minimum wage?
Caterpillar Inc., for example, announced last year the expansion of its U.S. operations with the construction of a new 600,000-square-foot hydraulic excavator manufacturing facility in Victoria, Texas. Once fully operational, the plant is expected to employ more than 500 people and will triple the company's U.S.-based excavator capacity. “Victoria’s proximity to our supply base, access to ports and other transportation, as well as the positive business climate in Texas made this the ideal site for this project,” said Gary Stampanato, a Caterpillar vice president.
NCR Corp. announced in late 2009 that it was bringing back production of its ATMs to Columbus, Georgia, in order to decrease the time to market, increase internal collaboration, and lower operating costs. And toy manufacturer Wham-O Inc. last year returned 50 percent of its Frisbee production and its Hula Hoop production from China and Mexico to the U.S.
Needless to say, US unions are ecstatic, which is why Obama would obviously be firmly behind such a concoction:
“Workers and unions are more willing to accept concessions to bring jobs back to the U.S.,” noted Michael Zinser, a BCG partner who leads the firm’s manufacturing work in the Americas. “Support from state and local governments can tip the balance.”
Zinser noted that executives should not make the mistake of comparing the average labor costs for production workers in China and the U.S. when making investment decisions. The costs of Chinese workers are still much cheaper, on average, than comparable U.S. workers, and some managers may assume that China is a better location. But averages can be deceiving.
“If you’re just comparing average wages in China against those in the United States, you’re looking at the problem in the wrong way,” Zinser cautioned. “Average wages don’t reflect the real decisions that companies have to make. Averages are historical and based on the country as a whole, not on where you would go today.”
That said, since this is a consulting report, it is probably wrong from beginning to end. As a logical check we decided to cross refernce with a SocGen report titled "China’s wage rises – the beginning of the beginning" which however reaches a diametrically different conclusion.
The discussion on China’s wage growth and its underpinning urbanisation trend has heated up again as the results of China’s sixth population census are released. Urbanisation looks advancing quicker than previously thought. Stories on wage growth and labour shortages have been hitting the newswire more often than ever before. However, we think China is still some time away from reaching the type of urbanisation rates that characterised Lewis turning points in Japan and South Korea during their most rapid periods of industrialisation and wage growth. We are probably just one decade into this multi-decade dynamic of real wages starting to rise in urban areas.
Digging into the report:
China reached its first Lewis turning point back in 2003. The income gap between rural migrant workers and agricultural labourers has provided a powerful incentive for the latter to try to find better-paid non-farm jobs. The massive labour flows out of rural areas eventually led to labour shortages in agricultural sectors starting in 2003 and 2004. Since then, rural wages have been growing significantly faster than urban wages. Between 2004 and 2010, the average wage growth was 3.5ppt higher in rural areas than in urban area. As rural areas supply low-skilled labourers, fast-rising rural wages largely determines the wage growth in those industries that relies on streamline workers. This is why we have heard so many stories about labour shortages in export-oriented coastal cities, especially in years when food inflation makes rural jobs more appealing.
The ratio of labour demand to supply hit a record high of 1.07 in the first quarter, up from 1.01 in Q4-2010. This quarterly survey of job centres in 100 cities is clear evidence that China’s labour market is very tight and tightening further. In response to the tightening labour market and the healthy gains in rural wages, provinces are forced to raise minimum wages by a significantly faster amount to attract surplus rural workers back into city jobs. Thirteen provinces and cities raised minimum wages by an average of 21% in Q1. Wages growth of this magnitude will continue to feed into higher manufactured goods prices.
China is still some years away from the Lewis turning point in urban areas. One of the most important results of China’s census, released in late April, is that the pace of urbanisation has been significantly quicker than previously thought. As of the end of 2010, 49.7% of the population lived in urban areas. That is 3pp, or 44 million people, higher than the NBS last estimate for 2009. But this is still some distance away from reaching the type of urbanisation rates that characterised Lewis turning points in Japan and South Korea during their most rapid periods of industrialisation and wage growth.
Another significant differentiating factor, in the Chinese case, is that the pace of urbanisation is suppressed by the population registration system. The latest census showed that four in every ten of urban residents did not hold a local registration, known as a hukou, up from three in ten of urban residents in the 2000 census. Hence, the actual urbanisation rate could be lower than 40%, if we exclude those who work in cities but do not settle there.
Another sign that China still has a big surplus of labour is the stagnant income growth for college graduates. Around 6 million students complete their tertiary or higher education every year in China. It seems they are not exactly riding the tide of rising wages as rural migrant workers. The Chinese Academy of Social Sciences, one of the leading think-tanks in China, showed in its report on China’s Population and Labour that salaries of those much better educated graduates are not much higher than the wages of rural migrant. The mismatch between supply and demand of white-collar jobs reflects the underdevelopment of China’s service sector. In 2010, services contributed to 43% of China’s total GDP, which was much lower than the levels Korea and Japan reached during similar phase of development.
All this means that the process of urbanisation and wage dynamics in China still has a long way to go. According to a research published by the US Bureau of Labor Statistics in 2009, Chinese manufacturing workers' hourly wage was only USD0.81 in 2006 - 2.7% of comparable costs in the US, 3.4% of those in Japan, and 2.2% of those in Europe. After five years of growth, inflation, and currency appreciation, we estimate that the wages of Chinese workers are still just around 5% of the levels in G3. If assuming an annual wage growth of 15% for another decade and total 20% appreciation of the yuan, China’s wage would be 25% of G3’s current levels. Indeed, it is still an ocean apart.
To reduce farm labour to 10% of the labour force (the point at which, judging by historical experience elsewhere, China may achieve worker-farmer wage equilibrium), the economy needs to create about 150 million new non-farm jobs. Even if the economy continues to grow at 8% per year, China might need 20-30 years to reallocate agricultural labourers and reach “full employment.” But this requires generating eleven million new jobs every year, including five million for farmers leaving the countryside and six million for college graduates. And these new jobs need to be the right types. Indeed, we are probably just one decade into this multidecade dynamic of real wages starting to rise in urban areas.
So there you have it: a consultant report, and a solid research report coming to two almost diametrically opposite conclusions: it won't be the first time. After all BCG was paid to reach a specific conclusion, whereas SocGen is merely trying to generate a market on either side of the issue. That said, even if BCG is 180 degrees off, the underlying proposition is certainly relevant: that the more the Fed exports inflation, paradoxically the faster the US manufacturing job base would see a long overdue renaissance. Which certainly means that the Fed will never stop with its monetary easing stimulus until such time as labor costs in the two countries, on whatever subjective metric is dominant, finally hit parity. The only question, as noted above, is what will China do in the interim as it realizes the Fed has put it in check - will China focus on developing its middle class, with an outcome being the mirror image of the current Nash equilibrium, in which the Chinese middle class would buy from the US, or will China defect before the "export country" to "consumer class" transition is complete and everything falls apart.
Alas, when dealing with two massively centrally planned regimes, we are confident whatever can go wrong, will go wrong...