Question: What do Lightening McQueen, a Nike sneaker and an iPad have in common? Answer: China. Chinese products seem to be everywhere: the majority of tags, labels and stickers display the legend “Made in China.” The Western consumer may ask, “why is everything made in China?” Some may think the ubiquity of Chinese products is due to the abundance of cheap Chinese labor that brings down the production costs, but there is much more to it. Here are five reasons China is "the world's factory.”
China is home to approximately 1.35 billion people, which makes it the most populous country in the world. The law of supply and demand tells us that since the supply of workers is greater than the demand for low-wage workers, wages stay low. Moreover, the majority of Chinese were rural and lower-middle-class or poor and until the late 20th century when internal migration turned the country's rural-urban distribution upside-down. Immigrants to industrial cities are willing to work many shifts for low wages.
China doesn’t follow (not strictly at least) laws related to child labor or minimum wages, which are more widely observed in the West. However, this situation may change. According to the China Labour Bulletin, from 2009 to 2014 minimum wages have almost doubled in mainland China. Shanghai’s minimum hourly rate is now up to 17 yuan ($2.78) per hour or 1,820 yuan ($297.15) a month. In Shenzhen the rate is 1,808 yuan per month ($295.19) and 16.50 yuan ($2.69) per hour based on an exchange rate of 1 yuan = $0.16. The huge labor pool in China helps to produce in bulk, accommodate any seasonal industry requirement, and even cater to sudden rises in the demand schedule. (For more, see: Do Cheap Imported Goods Cost Americans Jobs?)
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 business ecosystem in China has evolved quite a lot in the last thirty years. For example Shenzhen, a city bordering Hong Kong in the south-east, has evolved as a hub for the electronics industry. It has a cultivated an ecosystem to support the manufacturing supply chain, including component manufacturers, low cost workers, a technical workforce, assembly suppliers and customers.
For example, American companies like Apple Inc. (AAPL) take advantages of supply chain efficiencies in the Mainland to keep costs low and margins high. Foxconn (the main company which manufactures Apple products) has multiple suppliers and manufactures of components that are at nearby locations, and it would be economically unfeasible to take the components to U.S. to assemble the final product. (For more, see: China’s Economic Indicators.)
Manufacturers in the West are expected to comply with certain basic guidelines with regards to child labor, involuntary labor, health and safety norms, wage and hour laws, and protection of the environment. Chinese factories are known for not following most of these laws and guidelines, even in a permissive regulatory environment. Chinese factories employ child labor, have long shift hours and the workers are not provided with compensation insurance. Some factories even have policies where the workers are paid once a year, a strategy to keep them from quitting before the year is out. Environmental protection laws are routinely ignored, thus Chinese factories cut down on waste management costs. According to a World Bank report in 2013, sixteen of the world’s top twenty most polluted cities are in China. (For more, see: Boom or Bust? The End of China's One-Child Policy.)
Taxes and Duties
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. Exported goods are subject to zero percent value added tax (VAT), meaning they enjoy a VAT exemption or rebate policy. On the other hand, the U.S. doesn’t have a VAT and import taxes are only applicable to certain goods like tobacco and alcohol. Consumer products from China are exempted from any import taxes. Lower tax rates help to keep the cost of production low. (For more, see: Top 6 Factors That Drive Investment In China.)
China has been accused of artificially depressing the value of the yuan to provide an edge for its exports against similar goods produced by a U.S. competitor. The yuan was estimated to be undervalued by 30% against the dollar in late 2005. The Chinese yuan has, however, been steadily increasing in value against the dollar over the past few years. According to the Bank for International Settlements, the real appreciation of the yuan between the end of 2011 and March 2014 was about 7%. China keeps a check on the appreciation of yuan by buying dollars and selling yuan, a practice that has swelled Chinese foreign exchange reserves to approximately $4 trillion. (See: Why China's Currency Tangos With The USD.)
The Bottom Line
In the recent times, pundits have wondered if China will lose its spot as "the world's factory” as emerging economies offering cheap labor and rising wages dull China's competitive edge. The availability of cheap labor is just one of the many factors that have made China a manufacturing hub, however, and it will take more than cutthroat desire for emerging economies to set up a business ecosystem that can compete with China's. For some time to come, China will be "the world factory” with its low production costs, huge labor pool, vast talent base and business ecosystem.