Is Cheap Chinese Labor Over?

By Stephen D. Simpson, CFA | June 25, 2010 AAA

Bookshelves groan under the weight of materials written about how China has changed the global economy. Skeptics blame China for a "hollowing out" of American industry that has seen companies choose to relocate manufacturing China to take advantage of cheaper labor. Others point to the fact that lower labor costs in China have allowed Americans to prosper from cheaper Chinese imports and essentially live better by getting more for their money.

Regardless of your view of China's role in our economy, the reality is that the situation is always changing. With wages and standards on the rise in China, can American companies still exploit the leverage present in lower wage costs? (For more, see Investing In China.)

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Controversy Will Bring Higher Wages
There has been ample news coverage of late of a spate of suicides among the Chinese workers of Foxconn, a Taiwanese electronics company with operations in China. This company manufactures and assembles electronics for a host of American companies. Apple's (Nasdaq:AAPL) iPods, Dell's (Nasdaq:DELL) computers, and Intel's motherboards are only some of the products that are built in China due in large part to the lower wages.

While the working conditions at Foxconn's plants are certainly a serious matter, it is only a small part of the story. There have been an increasing number of strikes, union actions and general agitations in China over wages and working conditions in the last few years. Though this may seem unusual to those who believe China's government has firm control over its citizens at all times, it is a normal process of economic development. Pick up a book on the history of American labor in the early 20th century and you will see similar issues. (For related reading, see The Economics Of Labor Mobility.)

In other words, the call for higher wages from employers like Foxconn and Honda Motors is, to some degree, simply a part of the natural growth process as China moves towards a more modern and affluent nation.

Will Manufacturing Come Back Home?
Before people get too excited that rising Chinese wages will bring manufacturing jobs back to the U.S., a little perspective is in order. Even though hourly wages have been climbing at double-digit rates for many years, those wages are still in many cases are drastically below U.S. wages. So while a 10% increase in Chinese wages is a serious issue for an intensely competitive company like Wal-Mart (NYSE:WMT) with very thin margins, it is not going to repatriate industry to America.

Moreover, many of those who operate factories in China are responding to rising wages in the same way American companies did a decade or two ago. Companies like Honda are installing more automation into their factories - good news for ABB (NYSE:ABB) and Siemens (NYSE:SI) - in the hopes of reducing the manual labor component.

Additionally, companies are now looking beyond China's borders for even cheaper wages. Many companies, including some Chinese operators, are relocating manufacturing to countries like Vietnam, Cambodia, and Bangladesh to pursue even lower labor costs and even more cavalier attitudes towards worker safety and rights.

Does China Matter?
Over the next decade, we are going to see China move increasingly from a poor country with cheap labor to a country more notable for its growing middle class and improving living standards. That process will certainly be disruptive, but for every manufacturer like Apple that has to find a new "cheap" country, another company like Caterpillar (NYSE:CAT) or Procter & Gamble (NYSE:PG) will find its Chinese business even stronger. This means investors must remain nimble; look to Vietnam now if you want "the next China", but also keep looking for those companies poised to boom as the Chinese spend more of their money in the coming years. (For related reading, see Do Cheap Imported Goods Cost Americans Jobs?)

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