Rising factory wages in China are forcing manufacturers to find cheaper solutions abroad

Standing on a street corner near Foxconn Technology Group’s plant in Zhengzhou, Henan province, employee Wang Ke says he’ll quit if his wages don’t double.

“I don’t have high expectations. I know I’m a migrant worker,” says the 22 year old, who earned 1,600 yuan (HK$1,980) in December, after deductions for lodging. “But I want to make 3,500 yuan a month, net. That’s a fair price.”

Wang’s attitude springs from a labour-market squeeze across the country after China’s pool of young workers shrank by almost 33 million in five years – at the same time as industry added 30 million jobs. The resulting wage pressure means Foxconn pays the same basic salary at the Zhengzhou plant it built in 2010 among the corn and peanut fields of Henan province as it does in Shenzhen.

“China’s advantage in low-cost manufacturing will end much sooner than expected – I believe within five years,” says Shen Jianguang, chief economist at Mizuho Securities Asia. “Wages are rising faster inland than on the coast. More companies will consider moving to countries such as Vietnam, Indonesia and the Philippines.”

Higher pay and the relocation of factories are undermining China’s three-decade-old export model that concentrates production, cheap labour, infrastructure and supply chains in one place. The model allows savings that have made China the world’s supplier of low-end goods.

As manufacturing costs rise, however, price increases will be passed on to the rest of the world, says Tao Dong, head of Asia economics (excluding Japan) at Credit Suisse Group AG.

“The days of China as the anchor of global disinflation have ended,” Tao says. “When global demand picks up, global inflation may arrive sooner rather than later. This will affect everything, from the Italian housewife to Federal Reserve monetary policy.”

China’s pool of 15- to 39-year-olds, which supplies the bulk of workers for industry, construction and services, fell to 525 million last year, from 557 million five years earlier, according to data compiled by Bloomberg News from the US Census Bureau’s international population database. The number employed in industry rose to 147 million from 117 million in the five years leading to September 2012. 

The labour squeeze means wage costs inland are fast catching up with the industrial belt in the south and east. Average factory pay in Henan, about 800 kilometres from the coast, has risen 110 per cent in the past five years. In Chongqing, 1,700 kilometres up the Yangtze River, they have gone up 84 per cent. In the same period, salaries rose 78 per cent in Shanghai on the east coast and 77 per cent in Shenzhen’s province of Guangdong.

“The wage differential between inland and coastal regions is down by more than half since 2006,” says Jitendra Waral, a Bloomberg Industries analyst in Hong Kong.

Pay pressures are set to intensify with the supply of young workers forecast to shrink by another 20 million, to 505 million, by 2015, and by a further 22 million by 2020.

In Wuhan, the capital of Hubei province, Japanese automakers Nissan Motor and Honda Motor pay a basic wage of US$333 a month, compared to US$352 in Guangzhou and $317 in Shenzhen, according to an April 2012 report by the Japan External Trade Organisation.

The report also states that the average monthly pay for a factory worker in Guangzhou was US$352, compared with US$111 in Hanoi, Vietnam; US$82 in Phnom Penh, Cambodia; and US$78 in Dhaka, Bangladesh.

Nations such as Vietnam, Cambodia and Bangladesh are already reaping the gains of China’s rising factory pay. Foreign direct investment in Vietnam increased to US$7.4 billion in 2011, a more than threefold increase from five years earlier, according to the United Nations Conference on Trade and Development. In Cambodia it surged 85 per cent to US$892 million, and in Bangladesh, 43 per cent to US$1.1 billion.

Hong Kong-based bra maker Top Form International shuttered its factory in Shenzhen last year and is expanding production in Phnom Penh. “[We are] trimming down our expensive capacity in China,” Chairman Fung Waiyiu wrote in the company’s 2012 annual report.

Companies choosing to shift their factories inland to keep their China base and avoid higher staffing costs on the coasts are facing other challenges. Moving away from subcontractors and parts makers stretches supply chains and often increases transportation costs.

Jeans maker Yi Ding Hong Clothing shifted production to Huaxian in Henan in 2009 from Guangzhou, lured by tax incentives and cheaper land, says founder and chairman Kang Xunda. Two years later, Kang moved back to the coast.

“It cost us millions,” he says. “There were virtually no savings on wages and the logistics were a nightmare.”

Kang says he could find 30 suppliers on the coast for each one in Henan. “In Guangzhou, delivery promised in three days will be delivered in three days,” he says. “In Henan, delivery promised in a week can take a month.”

China still has benefits for manufacturers other than cheap labour, such as the scale of its domestic economy, superior infrastructure, proximity to component suppliers and established logistics networks, says Beijing-based Fred Hu, founder of private equity firm Primavera Capital and former Greater China chairman at Goldman Sachs Group.

The share of exports produced inland rose to 8.7 per cent in April last year, from 5.5 per cent in December 2010, Goldman Sachs said in a research note last December. Last year, exports from central and western China rose 22 per cent and 38 per cent, respectively, compared to a 5 per cent gain on the east coast.

After a leadership change last month, new Chinese Premier Li Keqiang promised on 17 March to open the economy more to market forces to achieve 7.5 per cent annual growth through to 2020.

International Monetary Fund researchers Mitali Das and Papa N’Diaye also say China’s cheap labour may last longer than five years. They wrote that the nation has a pool of 150 million unemployed or underemployed workers that probably won’t be exhausted until between 2020 and 2025.

Still, they add that forecasts may understate prospects of a labour shortage because the pool of workers below 40 years old will shrink faster than the overall workforce.

As farms in central China give way to factories, Tao at Credit Suisse estimates China will face a shortfall of almost 18 million workers by 2020. Cai Fang, head of the Institute of Population and Labour Economics at the Chinese Academy of Social Sciences in Beijing, says the shift of labour-intensive industry will only delay the loss of China’s comparative advantage.

“The surplus labour pool is diminishing,” he says. “Central and western regions cannot afford more factories of Foxconn’s size.”

Bloomberg