Tuesday, July 7, 2015

Will factories move back from China to US?

A talk with Wharton's Marshall Meyer

Will factories move back from China to US?

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"A number of things are happening to drive up manufacturing costs in China," says Marshall Meyer, veteran Wharton School management professor and regular visitor to what we keep hearing will be the largest world economy. Notes from our conversation:

China faces an "incipient labor shortage." The economy advanced rapidly as its birth rate fell, enjoying a "Lewis turning point" (first identified by Caribbean-born Nobel Prize economist Arthur Lewis) when the number of non-working children and old people was low compared to the number of productive workers. That drives up, first rural wages - in 2003-05 -- then urban wages -- a 20% increase from 2007, without adjusting for currency fluctuations.

"In 2008 the world economy fell off a cliff, but wages continued to go up. The labor-contract law came in at the start of 2008. It will give workers in China rights like tenured professors here at Wharton, if they start to enforce it. Though this is China. It varies.

"The demography will be a killer, though. China's one-child policy yielded a long dividend. A bulge, in the most productive wage group. Beginning about now, China's population begins to age. Already the pyramid starts to look like Europe. It may start to look like Japan, with the largest age cohort in its 60s, and a weak safety net. This will throw a huge burden on everyone in China. In the countryside they can't get enough cotton-pickers. Tomatoes are rotting on the vine. They'll have to harvest mechanically."

Won't other Asian nations take up the slack? "The needle trades are migrating to Vietnam, to Indonesia. But those countries are like a single province of China.

"So yes, you could see some of the manufacturing migrate back to the U.S. The cost advantages are considerable. Logistics" -- transportation and scheduling -- "are going to be a huge factor."

But isn't this a global economy, a flat world? "We've underestimated the true cost of the global supply chain. In 2008 we saw that lengthy supply chains are vulnerable to collapse. It's a standard idea in operations research: small perturbations upstream lead to huge perturbations downstream." That year, it was the sudden inavailability of bank letters of credit, basic finance for exports, that stalled contracts, shipping and plants all down the line -- all the way to the closing of a basic shipping-trailer manufacturing company in Shenzhen: "The thing just stopped." 

Data? The Baltic Dry Index of shipping demand is at a "seriously low" point, which means "all the ships are losing money. There's a glut of capacity." New ships ordered in better times "are coming off the [shipyard] ways in China, flooding the markets. Lease rates, charter rates, are extraordinarily low. So someone's going to consolidate capacity. You know it's going to be the Chinese." Who will then profit hugely from the next shipping shortage, compounded by rebounding oil prices.  

Shipping shortages plus higher fuel costs equals a drag on global trade. Which helps revive local manufacturing everywhere. For example: Shanghai is home to steel mills, but it's not close to high-quality steel or iron ore; doesn't Australia make more sense as a manufacturing point? 

"They're talking about building a Northern railway in Autralia [the Boomerang project] to join coal to iron ore. That will take heavy indusry out of China. You don't need a lot of labor to make steel anymore. So steel production will go to Australia. Shanghai real estate is more valuable for commerce." 

"China will become a normal economy quicker than anybody thought, as a consequence of labor and logistic pressures. The big advantage in China is improvisation; everything's decentralized. It's all empirical. They see what works." Innovation "is a possible escape hatch" for China, like the farm mechanization that was long delayed to save rural jobs.

There's a social and political danger in this shift:  "It's not clear they can rebalance the economy soon. Medical care is a problem for them too. That's why the Chinese save so much money," especially in the five big state-dominated banks. "And what does the bank do with it? Give it to inefficient state-owned companies."

The major state-controlled banks have accumulated huge dollar reserves, and loaned to many potentially shaky enteprrises. Some Chinese regions have independent banking systems; those, too, have needed state help lately. 

So does China need more centralization and party control - or more local independence supporting private enterprise? "The Central Committee is meeting about this in contentious session. We don't know what they're going to do. The fight is ideeological," between the Chungching "very left" model which focuses on regional development, and the Guangdong export-driven model. "The left is well organized, it has the professors. The right is more scattered.

"Meanwhile some of the (data) we pick up is ghastly. Shipments, particularly in the south of China, are off 30 percent. There are a lot of closed factories. The idea that China is the next engine of global growth?" He shakes his head. 

"We don't now where the new government stands. It will have enormous consequences for us. My sources say 'Don't do anything for 18 months.' There could be a wave or reform. Or a cultural revolution, again... I am not totally pessimistic, but very cautious for the near term, until the governmental transition sorts itself out." 

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PhillyDeals posts drafts, transcripts and updates of Joseph N. DiStefano's columns and stories about Philly-area business, which he's been writing since 1989.

DiStefano studied economics, history and a little engineering at Penn and taught writing at St. Joseph's. He has written thousands of columns and articles for the Inquirer, Bloomberg and other media, wrote the book Comcasted, and raised six children with his wife, who is a saint.

Reach Joseph N. at JoeD@phillynews.com, distefano251@gmail.com, 215.854.5194 or 302.652.2004.

Reach Joseph N. at JoeD@phillynews.com or 215 854 5194.

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