An article today in the Wall Street Journal http://online.wsj.com/article/SB121479507619315069.html highlights the growing problem facing Chinese manufacturers who have competed on two key factors: the low cost of making simple things in China and the worldwide “rush” to move manufacturing to China.  Now, however, the demand for low-end manufacturing of products like textiles, shoes, household appliances and toys is under pressure. 

There are several key factors contributing to this change.  Inevitably, low-end products that require little investment or training historically seek the lowest product cost attainable.  Some are starting to move offshore from China, to places like Vietnam, India.  These countries have seen what can be accomplished, based on China’s experience, and are learning quickly.  Costs in China are increasing due to government regulation of worker conditions and environment — much of this at least partially in response to dissatisfaction with working conditions, safety and quality issues raised by consumers and governments, such as in the United States.  Another factor is a growing imbalance of supply and demand.  At a time when orders from the US are lessening, many factories have come online only in the past few years; there is arguably over-capacity.  Finally, the Chinese currency, the yuan, after being effectively pegged to the dollar for over a decade, has increased in value vs. the dollar by 20% in the past year.

Unlike the situation in other locations (for example, Mexico) that did not anticipate, and were left with few alternatives, when low-skill jobs, such as textiles and toy making moved away, we can with some confidence anticipate that China will aggressively look at ways to move up the manufacturing food chain to lessen the impact of these changes.  The culture is extremely fast-moving and entrepreneurial in the manfacturing sector, and both owners and government will be adverse to factory shutdowns and rising unemployment.  There is already a base of higher-tech product manufacturing to draw upon; as the quick profits of the low-end wane, the increased investment required for higher-end products begins to look more attractive.  This effort will involve retooling factories, training workers in more precision skills, and striking new deals with global firms to bring more advanced production to China.  One large motivation for both Chinese and global manufacturers is the vast local Chinese market.  Serving 1.3 billion people, it increasingly desires, and needs, more complex and expensive products, many of which have been imported up until now.

The implications for manufacturers in North America may be a new wave of competitive capability from China coming right around the corner.  The appeal will continue to be lower cost.  This time around, companies looking at this alternative will be able to draw on the startup experiences of industries that have already preceded them in moving manufacturing to China, both good, and bad. 

Those companies and governments that aspire to continue – even grow - manufacturing in North America should realize that a wakeup call is being sounded.  In situations where the productivity and competitiveness of North American-based manufacturing operations has been well-maintained, there is time to innovate and make further investments in plant, equipment and people to help ensure that manufacturing in North America remain globally competitive. 

However, as has been seen previously, when these investments have not been maintained, when productivity has lagged and innovation is low, the opportunity offered by a startup or outsourcing arrangement in China may be compelling.

Yesterday the “Wall Street Journal” published a front page article on the subject of growing nationalism as governments are contemplating new barriers to trade. For those interested in these trends, this article offers an interesting perspective. Of particular note is the following observation, “Some companies are seeking havens closer to home. As some U.S. corporations relocate operations from lower-cost spots in Asia, Mexico (emphasis mine) – which has a free trade pact with the U.S. – has seen a surge in foreign investment, up 21% last year to $23.2 billion.” Read more: http://online.wsj.com/article/SB120934738145948747.html

Will the price of goods shipped internationally by sea or air be rising? This question is posed by an article in the New York Times http://www.nytimes.com/2008/04/26/business/worldbusiness/26food.html?_r=1&ref=todayspaper&oref=slogin.

According to the article, in 1944 a treaty, the “Convention on International Civil Aviation,” was signed in Chicago. This treaty exempts from taxes fuel used for international transit of goods by sea and air. This treaty provides a significant fuel cost advantage for goods shipped internationally by ocean freighter vs. domestic shipment by truck, where the cost of fuel taxes is significant and growing.

How has this obscure treaty come to light, and why now? As concern for global pollution has grown, many are beginning to question the global transport of goods, such as food, and the impact on pollution from these activities.

Examples given in the article, highlight the tradeoff of labor and shipping costs in the processing of food. An example is cod caught in Norway, processed in China, and returned to European supermarkets. Processing costs in Europe would be $1.36 per pound, vs. 23 cents in China. Because of the very low cost of shipping the product, it is more cost effective to ship the fish back and forth. Another contributor to the rising attractiveness of international ocean shipping is the dramatic reduction of shipment times due to improved infrastructure in emerging nations. The article cites food grown in Africa, which can arrive from farm to stores in Europe in only 4 days, vs. 10 days only a few years ago.

It is true that ocean freighters are relatively efficient users of fuel, looked at the cost per pound/ton for a transported good. The example cited in the article measured this in terms of carbon footprint, and was for wine produced in France or California, and then sold in New York City. Transportation by truck from California to New York registered 1,426 grams of carbon dioxide per bottle, vs. only 447 to ship a bottle of wine, primarily by ocean freighter, from France to New York. Adding the tax advantage on top of this makes the use of international ocean shipping even more attractive.

This same cost advantage would apply to any products, such as electronics, shipped by international ocean freight.

The article points to efforts by the European Commission in Brussels to bring these air and ocean shipments under Europe’s emissions-trading program. Barbara Helferrich, a spokeswoman for the European Commission’s Environment Directorate, commented “We’re really ready to have everyone reduce — or pay in some way.”

The European Union has, through its environmental regulations, affected the worldwide industry in the recent past. In July 2006 the “Reduction of Hazardous Substances” directive of the European Union came into effect. This directive required the elimination of many substances from electrical and electronic products. Precisely because we now operate in a global economy, most firms responded to this directive by eliminating these substances in products sold not just into the European Union, but also into other parts of the world.

While this article highlights the global supply chain for food, the same issues will be faced by manufacturers who ship products back and forth over long distances for no reason other than to take advantage of lower labor costs.