QC Newsletter

July 7, 2010

More Surprises from China

Last month we discussed Honda’s recent surprising troubles in China. Parts factory workers struck over wages and caused Honda to shut down their four final assembly plants. Subsequent reports ranged from “strikes were over and things are great (again)” to “unrest continues and this is just the beginning.”

There have been additional companies brought into the fray, including Toyota, which also had to stop production repeatedly due to strikes at suppliers. We’ve all heard about Foxconn, the world’s largest contract electronics supplier, and their sad experience with a cluster of worker suicides at their campuses in China.

My sense is that there is a sea change going on in the factory sector. People are seeing the impact of their work all around them, but do not feel they are realizing many of the benefits themselves. That is a recipe for trouble, or at least some sort of accommodation. And accommodation means higher labor costs going forward for at least the multinationals, but probably across-the-board.

Last weekend I read a piece in the New York Times about how three, young, college-educated technology workers were living in a space about the size of my daughter’s college dorm room. Despite this, they could barely afford the rent (which excluded their own bathroom—that costs extra). We are having a similar sort of problem here in the U.S. with recent grads, but it is in an environment where everyone is aware of the severe recession we just experienced. In China, with GDP continuing to soar, how do you explain this?

Another surprise this month was the decision of the Chinese government to allow the Yuan to float, at least within some relaxed boundaries. It is not clear exactly what this means. However, many protectionists have complained that the Chinese were unfairly keeping the Yuan low relative to the dollar. This has the effect of making Chinese goods cheaper than they should be in the U.S. and U.S. exports to China more costly than they should be.

The same would be true with respect to any developed economy. We may soon find out how the market votes on this. Whatever percent impact there is on the relative valuations, it will have an immediate, direct effect on the cost of goods in trade. From the perspective of an importer of goods to the U.S., if the value of the Yuan goes up say, 15 percent, costs will go up that amount very quickly. On the margin, if a decision to source in China was close, it just became uneconomical.

But taken together, these factors could have a large impact on international trade and the industries we EMS companies serve. There are many people talking about bringing back production to the U.S. (including some of our customers). That said, the standard analysis will still be true: If the product has high labor content, if demand is reasonably stable, and if there is sufficient volume, it will make sense to produce it in China. But in those cases where the analysis is not so clear, production will probably stay in the U.S. and maybe even come back.

Of course for the adventuresome, if China gets too expensive, there is always India, Bangladesh, or somewhere else to explore.

--Jeff Cosman