Pop Goes China

by BILL WADDELL

It may have passed under your radar in the global economic hubub, but Chinese manufacturing is in the tank and sinking deeper.  While the economic meltdown threw a fair amount of gasoline on the fire, Chinese manufacturing was heading in the wrong direction well before the credit and capital markets went haywire.

The cost of labor in China is going up fast, fueled by inflation (before the economic debacle) and by Chinese government actions.  The goal of Chinese economic policy is twofold: first to draw in vast amounts of foreign - mostly American - cash.  They have obviously met that goal very well.  They also look to create jobs; after all they have 1 point 3 billion mouths to feed.  Here they have come up short - about 300 million mouths short.

To correct this the Chinese toughened the minimum wage and overtime laws at the beginning of '08.  The idea was to cut back on hours worked so manufacturers would hire more people.  The result has been about a 20-30% increase in labor costs, which was China's stock in trade.  Absent cheap labor, China is just a very, very far away place that manufactures stuff with dubious quality and absurd lead times.

Compound all  of that with their lead-in-the-toys and toxins-in-the-milk-and-baby-formula fiascos, which led to tighter regulation and enforcement, which resulted in even more cost increases.  Then throw in a taste of just how expensive Chinese logistics can be when oil is selling for over a hundred bucks a barrel, and the net result is 70,000 Chinese factories closing over the course of the last 12 months and more than 20 million more unemployed Chinese wrokers.

It will get worse for China before it gets better. In the long haul, China knows that their 'One Child Policy' presents a huge problem.  As a Chinese friend told me recently, "Our family trees are all upside-down".  By that, he means that as long as there are >2 children per family there will be more young people working than old folks sitting on rocking chairs.  One child per two parents, however, violates that basic law of math.  It is driving China to a population aging condition that makes the retirement of the baby boomers look like a minor blip.  Who is going to pay for the growing hordes of Chinese Geezers?

Add it all up and China's days as a low labor country are rapidly winding down.  This should come as no big surprise.  As I have often written, no country can build a long range economy on the principle of low labor costs. It simply cannot sustain.  India and Malaysia are already better deals, and Mexico is creeping back into the game.

Another guy I know who is in the business of beating the Chinese bushes to find sources for American companies put it this way: "They just don't understand that they can't survive any longer by saying 'You buy - it's cheap'".  What he meant was that the typical Chinese manufacturer knows and cares little about quality, customization, delivery performance, lead times ... all they know is low cost.  And they have been able to get away with dismal quality and customer service because they were so cheap and could ship in big quantities.  Now, as they lose that low cost advantage, they had better figure out the rest.  In other words, China had better get on the ball with lean manufacturing.

Ironically, this means that Mexico will get another shot at the brass ring.  They completely missed the boat in the 1990's when they were the low cost country of choice.  Instead of grabbing hold of manufacturing and taking it to a higher level, they were content to be a low labor cost enclave, and when they lost that edge, they lost it all. Mexico is beginning to look like they are worth another try - if they can stop shooting each other long enough to get serious about manufacturing.

Then next 5-10 years will be interesting.  We shall see if China figures out lean manufacturing fast enough and well enough to remain a global manufacturing player, or if they settle back into being a regional producer for their own sizable market and the countries nearby.  Given the dismal record of lean progress in China thus far, their prospects are not good.  The few true lean experts trying to help them like McCain Koo have had too big a job to swallow alone. 

Oh and that loud popping noise you hear from the east?  That is the sound of millions of bubbles bursting in the hallowed halls of the academic elite who have preached long, loud and eloquently that China will be the center of this flat world throughout the 21st century. It will also be interesting to hear the academic rationalizations for the failure of that prediction, and to hear their next grand global theory of why manufacturing is best performed anywhere but here.

You can read more about the evolving disaster in China in the Shanghai Daily, which I regard as about as good as you are going to get from still heavily censored China.

Comments

[John Hunter]

China manufacturing is suffering. I would still wager they will gain as a percentage of global manufacturing over the next 10 years. Maybe I will be wrong.

Lean manufacturing is the best option, and therefore manufacturing in the USA for USA needs is wise.

The one child policy will slow down economic growth. The effects on no one child policy would also be large, so the overall success of China may well be greater with the one child policy. The environmental problems are huge, and growing in China. You mention the problem of feeding 1.3 billion, well feeding more would be harder. More people would make that problem much worse...

The Chinese government and people are saving money. The USA government and people are deeply in debt and more so each year. My guess is relative consumption will increase in China much faster than in the USA over the next 30 years. Manufacturing for China's own needs (and Korea...) will likely grow and at very fast rates. The reduction in Chinese manufacturing for USA needs may well be less than the increase in other Chinese manufacturing (is my guess).

I still believe a strong China, much stronger relative the the USA than today, is a very likely situation 30 years from now. But it is also possible that does not happen.

To put this post in context I have been one voice repeatedly saying the belief in the decline in USA manufacturing was not based in fact.

It is good to have you posing again.

http://management.curiouscatblog.net/2008/10/30/global-manufacturing-data-2007/
http://engineering.curiouscatblog.net/2006/02/22/phony-science-gap/

[Tony]

The one child policy hurts a lot more than demographics -- it causes a large cultural shift (which I've seen first hand), since being an only child is very different from growing up with siblings.

To put it nicely, most only children are spoiled. That is not a good start for economic success.

[david foster]

"Mexico will get another shot at the brass ring"...also, of course, this is a big opportunity for American manufacturers. Much of the opportunity will be lost, though, because of the Obama administration's determination to raise energy prices and its promotion of adversarial labor relations.

[David Levy]

You guys have get it so right about LEAN in general, but are off the mark when discussing China.

It's very true that "buy our cheap stuff" is not a sustainable value proposition. But why assume that China can't or evolve away from that?

Yes, the cost of labor has been going up, but why assume that won't encourage (as I say it will) a move to higher-value production, the type which is sustainable?

Yes, the Chinese manufacturers are traditionally not lean, but why assume that, like elsewhere in the world, they won't start moving in that direction, gaining those competitive advantages?

I've been running factories here for about 10 years, and I've seen these very trends at work.

David

[Bill Waddell]

Thanks for the comment, David.

As I stated in my post, it will be interesting to see if China figures it out. My skepticism is not based on broad assumptions about lean and China so much as it is based on my own experience. While I am sure you have had much greater exposure to China than I have, I have made 13 trips to China over the course of the last 20 months, and have seen nothing to lead me to believe that China is gaining any lean traction.

Certainly, as you say, China is being presented with increasing motivation to get lean, but seeing is believeing as far as I am concerned and I have seen lean only in very superficial applications in China so far - kanbans, cells, etc... And the serious lean folks I know are reporting no increase in requests for their help from China. From my experience, lean exists in China only as long as there is an American boss pushing it. On their own, I have seen virtually no lean effort of Chinese initiative.

Time will tell - thanks again; I appreciate the expert commentary.

[david foster]

A huge problem that China has in going lean is simple geography...ie, the time taken by a sea voyage to deliver the products. This doesn't prevent internally-lean operations within a factory and its local supply chain, of course, but it does create problems from a total process (including the customer) point of view.

This is much less of an issue, of course, for products that are small/light/high-value enough to move by air.

Again, theoretically an opportunity for Mexico.

[David Levy]

Yes, with respect to the N. American market, transit inventories and lead times are a drawback, especially for high-value/low-margin products. In order to offset the effects of the downturn with total value, those of us manufacturing here in China must look to:
1. Higher-value production
2. Lean operations
3. Increased flexibility to efficiently produce low-volume/high-mix orders.

Also, we must be constantly improving our workforce by training and by offering highly competitive salaries and working conditions. Actually, increased spending on labor CAN improve competitiveness in the long run.

It's a challenging time for us in China. Makes life fun!

[Jason Yip]

The most interesting assumption here is that the North American and European rather than the Asian markets will be where most of the consumers are, which itself is based on the assumption that the US dollar will be able to maintain its purchasing power relative to Asian currencies.

[Bill Waddell]

Jason, I don't think I made that assumption at all. The premise is that unless China fixes some fundamental problems they will not be a major exporter to the U.S. or Europe - whether those markets are big or small.

That said, don't get too carried away with the notion that China will develop a great consumer market - at least not very soon. People seem to forget that China is still a communist country - basically a very oppressive dictatorship by committee. If they develop a thriving, spending middle class, it will be the first communist regime in history to achieve this. They will have to figure out something Russia, Cuba, all of the old eastern Europe SSRs and North Korea found to be impossible. The socialist wing of the Democratic party really wants China to succeed, but common sense, history and 'fundamentals of economics 101' all argue pretty compellingly against it.

If you were to travel to China you would see that they have a long, long, long, long way to go to get to even Mexico's economic level. Surpassing the U.S. or western Europe economy is not something that is going to happen in either of our lifetimes - unless and until their is a revolution in China (which may well happen sooner than many people think).

[John Hunter]

The "Communism" in China today is nothing like the Communism of the 1970's. You can look at Singapore for a similar transition to what China may well be in the process of right now. A socialist authoritarian regime saw that socialism wasn't working well and switched to a Capitilist leaning authoritarian regime. The same people stayed in charge. The economic model shifted. And they have done extremely well economically for decades.

There are still plenty of challenges for China to be successful. Corruption is a serious problem. I believe the economic growth in China will outpace economic growth in the USA over the next 10 years.

Will China reach the average standard of living in the USA in the next 30 years. No, I don't think that is possible.