On April 16, 2019, Aakash Sachter writes on Quora:
In the words of Tim Cook: “The popular conception is that companies come to China because of low labor costs. I’m not sure what part of China they go to, but the truth is China stopped being the low labor cost country years ago. That is not the reason to come to China from a supply point of view, the reason is because of the skill.”
Let us look at the concept of labor or the involvement of labor in an every-day product. Let us compare 2 products: a plastic fork vs a plush toy. Although both products fall on opposite spectrums of the consumer life cycle (one disposable whilst the other one is reusable), both are sure to be made in China.
A plastic fork is made from food-grade Polystyrene (PS) plastic pellets or beads through a process known as plastic inject molding. In here the pellets are heated in a molding machine to a viscous state and are injected into a mold. The mold produces multiple sets of forks within a matter of seconds and from there on it’s as simple as detaching the forks from a sacrificial (?) holder or tool (this is also made of PS and in most cases is recycled). From here the product is moved into packaging and then sent out of the factory for export. A fully automated machine can be set to run continuously 24 hours a day with very little monitoring by a worker, thus being a low labor product.
Now, let us look at that plush toy. The stuffed animal is comprised of textile material for the cover, stuffing, two eyes and a nose. The material must be cut into pieces, sewn together and stuffed. The nose, eyes and mouth are sewn onto the material together and stuffed, requiring skilled labor(-). The cutting of the pieces may be done by hand or by machine, but the pieces are sewn together by a worker using a high-speed sewing machine. Next comes the insertion of stuffing – this is rather complex for a machine to do, as such the insertion is done by hand and the insertion point is also manually closed. It is evident that this requires much labor, therefore, this type of a product is considered a high labor product with labor contributing 70% of the total cost [1]. In the end, much like a fork, the product is moved and packaged for export.
Because labor is only one part of the total cost of a product, and in many cases it’s as low as 20% of the total cost, – this must indicate that there may be other factors at play in making Chinese products, such as the fork. If labor were the only factor, then most of the “plush toy/labor intensive” industries would have shifted to other countries – but only some industries already have e.g. Bangladesh, Vietnam and Mongolia to name just a few. To that extent, manufacturing of plastic forks could possibly return to the USA; but that’s not happening.
Industrial production does not take place in isolation, but rather relies on networks of suppliers, component manufacturers, distributors, government agencies and customers who are all involved in the process of production through competition and cooperation. The ecosystem of doing business in China has evolved quite a lot in the last thirty years. Here are the additional factors, including labor, that affect the overall cost of manufacturing and thus make Chinese exports cheaper:
A. Commendable supply chain: Supply chain activities transform natural resources, raw materials, and components into a finished product that is delivered to the end customer. No country, at present, has a supply chain more sophisticated yet flexible than China. China’s biggest advantage is their domestic availability of most of the raw materials required to manufacture a given product [2]. Not only are private entities involved in the process of outputting raw material for manufacturing. Rather, many Chinese State Owned Enterprises (SoEs) actively control and output raw materials for small factories to transform into ready-made goods. If the government is involved in such activities, it is safe to assume that this is an active industry that requires not only oversight and monitoring, but active involvement. Access to affordable raw materials helps bring down manufacturing costs to a considerable extent. As a result, having suppliers who are local to the manufacturer has gained importance as a way to cut costs[6].
B. Rebate upon Export: The export tax rebate policy was initiated in 1985 by China as a way to boost the competitiveness of its exports by abolishing double taxation on exported goods[7]. China is one of over 150 countries that utilize a Value Added Tax (VAT) system. It is a tax only on the “value added” to a product, material, or service at every state of its manufacture or distribution. The VAT rate is generally 17%, or 13% for some goods. Chinese companies receive a VAT refund from the government for materials of products produced for export. Basically, factories that export do not pay any VAT on goods or raw materials used made for export – further subsidizing raw material costs. American imports to China are charged a VAT, but the U. S. doesn’t have a VAT to charge Chinese imports. Moreover, Chinese manufacturers work with far lower profit margins than those in the U.S.
C. Efficient Infrastructure and Logistical Access: In its fast-paced effort towards industrialization, China has built many ports (big and small), roads and railroad access. Such a system is not secluded to the big cities (Tier 1 or Tier 2 cities), it connects all of them, including Tier 4 cities or small towns used as industrial manufacturing zones. Having an efficient logistical system allows for cheaper travel costs –the cost of units (kilometers or miles) per currency (dollar or RMB) decreases. Also, an efficient infrastructure reduces overall downtime. Such is the case of India, as pointed out by Vaibhav Mandhana [3]: “Given the poor roads, a shipment from India’s north can take a week or more to reach India’s south. Sometimes it is quicker and cheaper to actually get a shipment from Shenzhen than Kolkata. Time is money and all those delays add to your cost. If I could get something in two days, I could sell it immediately rather than wait two months to sell it [add up the interest costs]”
“The road freight from LA to Nevada will cost you a lot more than the sea freight from China to LA.”[5]
D. Subsidized Utilities and Availability: Within China’s industrial areas many fixed and variable production costs are heavily subsidized. For example: electricity and water are subsidized up to 30% compared to normal household or commercial zones. Moreover, the local government gives support with land access at competitive rates, creating jobs in the area. This further helps to diminish the cost of the end product – after all you have access to cheaper land, water and light (What manufacturing does not require these? – Hell, even mining bitcoin does!). In non-industrialized or not fully industrialized countries (Indonesia, Vietnam, India), access to water and electricity remains a critical issue, until today. “In Coimbatore and other industrial places, you get power for like eight hours a day. That means the machinery lies idle for sixteen hours and that wasted capacity adds to the cost.”
Do we see a trend of several factors, other than labor, which affect the overall cost of the product? Hold on, there are more!
E. Bureaucracy: Barriers for entry in China, in this context, are extremely low. Although you need to fill out a huge number of papers (Customs Declaration Form, Land Annexation, Tax Filing, Compliance Related Documentation, Drawback/Rebate Forms, Annual Returns and etc.), the process is not complex. Relevant departments and accountability are there; you do not need to grease palms to get what you need; streamlined government policies are in place. Again, non-industrialized countries do not have many of these processes in place – they are in the early stages, whereas China has been through all this. I am not saying China is pure and not corrupt, there might be corruption in some cases, but the overall industrial process is so deeply rooted, that people just follow established guidelines. Greasing palms and running around places to get a stamp or a signature causes further delays (time is money) and increases overall costs. This is considered more as “Political Will” than bureaucracy; meaning the government’s will to allow you to do business is prominent thus reducing barriers for you to do business or manufacture or engage in services.
F. Technology and Automation/ Skilled Labor: It would be unreasonable to discard China’s interconnectivity between technological advancement and manufacturing capacity. They work hand-in-hand. Availability of the latest technology to manufacture products of a high quality on a large scale. And let’s be honest, scalability can be a very important factor in deciding price of a product. Apart from technology, China has a large population, thus having a bigger access to a wide talent pool. Availability to a greater talent pool decreases the overall demand as there is an oversupply – again, denting the costs of the product. If you recall, Tim Cook’s main reason for manufacturing in China is: the depth of highly skilled labor in the manufacturing space. To rephrase what Cook said: “No other country in the world besides China has the combination of an electronic component supply chain and large pools of skilled labor needed to make iPhones on the scale which Apple needs.”
G. Labor: It is comparatively cheaper to many so-called “developed countries”. You can have someone do the same labor task for a comparatively lower price than say Europe or the USA for that matter. This further brings down costs. As noted before, it is not the cheapest – but it is not the most expensive either. What is important to remember here is that labor in China, is skilled – although most laborers are not trained, but have learned by doing. When you outsource to China, you’re working with time-tested factories that have been producing quality products in similar industries as yours for years on end, and in massive supply.
Where a labor task might cost you $8-9 USD/hour in developed countries, it will cost you $450-500 USD for an entire month in China (8 hours a day, 28 days a month). If you do the math, that’s about $2.19 USD/hour. Countries like Indonesia a semi-skilled laborer will do it for half, $1.05 USD/hour – but the manufacturing process will be influenced by factors all the factors mentioned.
H. Local Government: Local government officials are appointed, not elected. Part of their job is to help the industries and they are measured by results. Furthermore, locals compete with each other. That means Suzhou is competing with Chengdu to attract industries, and so on. Hence officials are always using their local advantages to help, attract, and grow industries, such as providing low cast land, building industrial parks, and making sure that the support infrastructure (roads, electricity, water, etc.) even local housing and schools are there. Since these officials are not elected locally, their actions are much more efficient rather than dealing a motion to go through town hall meetings or waiting for a ballot to pass for months. The downside of such efficiency could be that some environmental studies were not complete or many local concerns are not addressed fully (All credit for how to local governments operate within China go to Mr. James Yeh ).
Here are few controversial factors, claimed by several sources:
I. Currency: There is the ever-present theory of currency manipulation among economists, where China undervalues their currency by an estimated 30%-40%, which simply makes every product that China ships out 30-40% cheaper than those of a potential American competitor. The Yuan is manipulated and pegged undervalued to the US dollar [2]. So the price quoted in US dollars( more exports are quoted in dollars), will be cheaper than normal; (This manipulation has affected the domestic price of the product and labor wages as it has been kept much lower than it should have been. The Chinese yuan has, however, been steadily increasing in value against the dollar over the past few years.
J. Compliance: The Chinese government does not bind itself with Intellectual Property issues. They allow the industry to investigate the products developed successfully elsewhere in the world. They then produce them in large quantities. Personally, there is nothing wrong in this benchmarking. Most industries do benchmark; especially in the automotive world. This saved the industry from expensive investments in R&D [4]. Although China has its own environmental protection agency, the environmental protection laws are generally lax and not enforced fully, especially at the local level. In previous years, Chinese factories cut down on waste management costs -further bringing down overall product costs. Things have been different lately, thanks to the strong efforts from the national government. Laws on IP and environmental protection are being enforced, especially after the Hangzhou G20 summit. There is still some belief that more needs to be done.
If cheap labor was in itself the key driving factor, a large percentage of the labor-intensive factories would have already shifted to cheaper labor countries and lower labor-intensive jobs would have returned to the countries such as the USA – because China is not the synonym for cheap labor anymore. But that’s not what we are experiencing; only certain jobs within the manufacturing field are moving to South East Asia. A huge chunk is there and is still able to reap the benefits of various factors. It will take more than a cutthroat desire for emerging economies to set up a business ecosystem that can compete with China’s.
