It was an interesting first six months of the year for the Chinese economy. The effects of the stimulus plan for 2008-09 contributed to easy credit, rising inflation and skyrocketing real estate prices—effects that the government was forced to try to rein in this year.
Since May, major Chinese cities Beijing, Guangzhou, Shanghai and Shenzhen have announced that they planned to increase the full- and part-time minimum wage from 10 to 20 percent. Meanwhile, the government allowed the renminbi to appreciate gradually in June after months of speculation and overseas pressure.
The consequences for foreign manufacturers based in China are perhaps no more keenly felt than they are in Guangzhou, the capital of Guangdong Province and where most of China’s factories and migrant workers can still be found.
Guangzhou, with its humid climate and seemingly constant gray skies, is rich and urban and attracts foreigners and migrants from all over China looking for their big break. Yet companies in this manufacturing hub have been struggling as the global financial crisis saw lower demand, while rising wages and labour shortages inevitably escalated production costs.
‘They’re obviously going to have to become more competitive,’ John Evans, managing director of Asia foreign direct investment advisory firm Tractus says on how manufacturers can cope with rising costs. ‘China has been a base where you could operate without being that efficient. While some companies are very efficient, the vast majority of Chinese companies aren’t.’
Evans says that the rising costs could ultimately prompt increased competition from other low cost manufacturing areas. ‘We’re already seeing that, not only for attracting investment but just competing with goods.’
Analysts predict that rising costs will inevitably push low-end manufacturing to evolve, something that in the long-run is in line with government goals of weeding out the weaker players and shifting the country more into high-value manufacturing.
According to Stanley Lau, deputy chairman of Federation of Hong Kong Industries and chairman of its Pearl River Delta Council, companies should be responding by offering higher salaries and better welfare conditions to retain workers. Speaking in March he said considering the pace of the country’s economic growth, labour shortages and wage increases are natural, and he advised Hong Kong businessmen to work to upgrade their businesses.
For some companies, though, labour costs aren’t the overriding concern.
According to Fred Yang, president of China operations at major US-based electrical and mechanical motion control components manufacturer Regal Beloit, in his firm’s sector labour costs are ‘only three to five percent’ of total costs. He says that for his firm, the biggest cost is a result of the currency exchange rate and he notes that the renminbi’s appreciation has had a noticeable effect on overall costs for Regal Beloit.
For some firms hit by escalating costs, moving to less developed parts of China is becoming an attractive option. Foxconn, a major electronics manufacturer and maker of Apple’s iPhone, told state media that it’s considering transferring operations to Tianjin in northern China where the minimum wage is currently about $135 compared with $295 in Shenzhen.
Since 1999, the government has been trying to entice investors to look beyond the major cities and invest in its Western regions following its ‘Go West’ campaign. But some firms remain unconvinced by the policy.
‘The biggest problems I see with the movement to the West, although it’s a stated government policy, is that the government hasn’t clearly articulated the real incentives to do that, and the transportation logistics network is still not very sophisticated. Therefore there are higher costs,’ Evans says. ‘And it’s not so much the cost of trading the goods and inventory, because most companies will absorb that inventory cost. It’s the inefficiencies and the difficulties of the transportation network, be it rail or trucking.’
In fact, despite government efforts, many companies are still choosing to stay in developed cities where the infrastructure and labour pool is more developed. ‘Relocating to cities besides Beijing, Shanghai or Guangzhou is actually harder since it’s more difficult to find qualified people,’ says Philip Lao, chief financial officer of pharmaceutical company Shanghai United Cell Biotechnology.
So, is moving overseas a viable option instead? For Regal Beloit, which also has operations in Indonesia, Malaysia, Australia, Thailand and India, operations in China are still the most cost-effective.
‘One time we looked at Vietnam, but it seems that the supply chain in Vietnam isn’t ready yet and also the local market demand isn’t up yet,’ Yang says. ‘If you bring all your raw material to Vietnam…the savings in labour will easily be offset by transportation.’
‘It doesn’t make a lot of sense,’ he continues. ‘Some other firms are doing that because there’s domestic consumption. So in order to have good access to the market, sometimes its best to manufacture that product in the Vietnam market. In that case it makes sense.’
But the fact that China is still cost-effective hasn’t stopped foreign investors from raising other concerns over the cost of doing business in the country. In recent months, multinational executives have been more vocal in questioning Chinese policies on foreign investment, including senior executives from BASF, Siemens, General Electric, Google and Microsoft.
According to the Amcham-China Business Climate Survey released in March, the majority of US companies operating in China consider its regulatory environment to be the most problematic challenge they face, with ‘inconsistent regulatory implementation’ cited as a top concern
For Yang it is changes to labour laws that have proven to be the most challenging. ‘It’s not the direct salary increase that’s the issue. It’s the flexibility they took away,’ he says. ‘Business goes up and down and you need to manage the size of your workforce. A company hasn’t as much flexibility to do so as they used to.’
Evans says that for him, the most challenging aspect of doing business in China is keeping up with the overall speed of economic growth—and the changes it inevitably brings. ‘You have a regulatory environment that has gotten easier from the past and has gotten much more transparent,’ he says. ‘But it’s still not easy and it takes a long time to get through all the necessary processes.’