Why China Labor Costs are Increasing – and Why It’s Good for U.S. Manufacturers

In August 2012, the Wall Street Journal reported that labor costs in China had risen 150% since 2004.[1]  Most analysts expect the trend to continue.  During that same year, wages in China’s Pearl River Delta, considered the geographic heartland for China manufacturing, rose 10.4%.[2]   A 2011 Boston Consulting Group study predicted that wage and benefit increases of 15% to 20% per year will cut China’s cost advantage over wages at lower cost U.S. states from 55% in 2012 to 39% in 2015.

Much of this increase in China labor costs is driven by the simple law of supply and demand.  According to the Asian Development Bank, the working age population in China increased from 407 million in 1978 to 786 million in 2004.  This surge in population created a huge supply of cheap manual labor at precisely the same time that China was ramping up its manufacturing and exporting capabilities.  But the one-child policy, instituted in 1979, had an unforeseen consequence – it has led to a precipitous decline in the number of new laborers entering the workforce.  In 1975, there were six children for every elder in China; by 2035, if present trends continue, there will be one child for every two elders.  The working age population is expected to decline by 7 million per year through at least 2020.[3]

In November 2013, when it finally recognized the approaching demographic train wreck, the Chinese government loosened the one-child policy, allowing an estimated 11 million couples to apply for approval to have a second child.  But the expected baby boom is not materializing.  Officials predicted the new policy would lead to 2 million new births annually, yet only 804,000 couples have applied to have a second child.[4]

Another ominous development is that the new, smaller workforce is predominantly male.  The one-child policy exacerbated a cultural preference for male descendants.  For every 100 female births in China there are now 124 male births, and in some provinces the ratio is even higher.  As the number of total available laborers decreases and the ratio of male to female increases, the workforce will become more demanding, increasingly mobile, and more willing to change jobs to chase higher pay.

Foxconn is a massive manufacturing and assembly operation in China that is second only to Walmart in total employees.  They are known primarily as a key piece of the supply chain for Apple’s iPhone.  In 2013, it was reported that yearly turnover in their Shenzhen Longhua facility was 60%.  Turnovers in most other factories in the same area average 40%.

The increasingly male-dominated workforce is also becoming more militant.  2,000 workers at a Foxconn factory caused widespread damage in September 2012, when they rioted and clashed with 5,000 police officers dispatched to the scene.  Explanations for the riot ranged from a conflict between workers from different provinces to dissatisfaction with pay and working conditions.

In April 2014, more than 30,000 workers at a Taiwanese-owned shoe factory in the southern province of Guangdong went on strike to protest the company’s failure to pay full social security and housing fund contributions. The factory produces athletic footwear for brands such as Adidas, Nike, Reebok and Timberland.   The strike is further evidence of the rising cost of labor in China caused by a shortage of migrant workers, and the increasing militancy of China’s factory workers. Both factors help to level the playing field for U.S. manufacturers competing with China.

At the same time that the labor force is shrinking, the number of jobs in higher paying manufacturing industries in China is increasing.  According to a 2011 report from consulting firm Accenture, average hourly wages for manufacturing workers in both the telecommunications and heavy manufacturing industries are 50% to 60% higher than wages in more traditional light manufacturing.  One importer told me that the China factory from which he sources his line of relatively inexpensive tote bags was forced to shut down for a time after the 2011 Chinese New Year because most of the workers simply did not return after the holiday.  He presumed that most of the employees had taken jobs in other better-paying industries.

As the shrinking workforce in China shifts to higher paying manufacturing jobs in the automotive and high tech industries, companies in light manufacturing will be forced to pay higher wages simply to keep workers.  These rapidly rising wages are creating an expanding middle class, and as factories increasingly turn to satisfying their demands, less factory capacity and labor will focus on exports. Will China’s anemic birth rate of the last 20 years continue to provide an adequate labor force to service both domestic AND overseas markets?  Keep in mind that most businesses will follow the path of least resistance, and it is always easier to service a domestic market than an overseas one.  My bet is that China manufacturers will service the domestic market first.

Media attention to dangerous or unfair working conditions at overseas factories has also played a role in increasing labor costs at those factories.  Major brands and big box retailers are now paying closer attention to the working conditions at factories in their supply chain to prevent adverse publicity.  Even before the tragic Tazreen factory fire in Bangladesh, Apple had been putting pressure on their largest supplier in China, Foxconn, to improve wages and working conditions at its factories.  This is largely due to a series of suicides and labor riots at their factories, and the subsequent bad publicity.   In October 2014, the U.S. Department of Labor reported that over 168 million children (a number which equals half the population of the U.S.!) are working in factories around the world, many of them forced to do so, and toiling in deplorable slave labor conditions.[5]  Brands can no longer turn a blind eye to such atrocities, given the glaring light that social media shines on them.

It is likely that the emphasis in China’s current 5-year plan on developing “strategic emerging industries” such as biotechnology, high end equipment manufacturing, and clean energy vehicles is simply making a virtue out of necessity.  In the near future, factory workers available and willing to take lower paying light assembly jobs in traditional manufacturing industries will be few and far between.  The labor shortage in China, and resulting increases in labor costs, will continue to put upward pressure on the price of manufactured goods coming from China for years to come.  Only time will tell, but not even a tightly controlled economy like China’s can suspend the law of supply and demand indefinitely.

So why wouldn’t importers simply shift their procurement to other emerging Pacific Rim manufacturing countries with lower labor rates such as Vietnam?  What about India or Africa?  Many are exploring the possibilities, but most of the countries hoping to compete with China do not currently have the infrastructure (highways, rail lines, ports) that are essential to moving the flood of goods that have been pouring out of China over the last decade.  In addition, even though China has a very spotty record when it comes to creating safe working conditions and complying with environmental regulations, other countries are even worse.  All of this is bad news for importers and for overseas manufacturing companies hoping to break into the U.S. market.  But it bodes well for U.S. manufacturers looking to take back U. S. market share from their overseas competitors.

[1] Orlik, Tom, “Made in China is Getting More Expensive, The Wall Street Journal, August 11, 2012, page B16

[2] Lahart, Justin, and Orlik, Tom, “Fade in China, Made in America,” Wall Street Journal, March 10-11, 2012, page B16

[3] Lommen, Yolanda Fernandez, ADB Briefs No. 6, October 2010, page 2

[4] Burkett, Laurie, “No Baby Boom After Shift in One-Child Policy,” Wall Street Journal, Saturday/Sunday, November 8-9, page A6

[5] http://time.com/3479472/child-labor/

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