Slide Show: China Prices
Where the Jobs Went
"The China price." They are the three
scariest words in U.S. industry. In general, it means 30% to 50% less
than what you can possibly make something for in the U.S. In the worst
cases, it means below your cost of materials. Makers of apparel,
footware, electric appliances, and plastics products, which have been
shutting U.S. factories for decades, know well the futility of trying
to match the China price. It has been a big factor in the loss of 2.7
million manufacturing jobs since 2000. Meanwhile, America's deficit
with China keeps soaring to new records. It is likely to pass $150
billion this year.
Now, manufacturers and workers who never
thought they had to worry about the China price are confronting the new
math of the mainland. These companies had once held their own against
imports mostly because their businesses required advanced skills, heavy
investment, and proximity to customers. Many of these companies are in
the small-to-midsize sector, which makes up 37% of U.S. manufacturing.
The China price is even being felt in high tech. Chinese exports of
advanced networking gear, still at a low level, are already affecting
prices. And there's talk by some that China could eventually become a
major car exporter.
Multinationals have accelerated the
mainland's industrialization by shifting production there, and midsize
companies that can are following suit. The alternative is to stay at
home and fight -- and probably lose. Ohio State University business
professor Oded Shenkar, author of the new book The Chinese Century,
hears many war stories from local companies. He gives it to them
straight: "If you still make anything labor intensive, get out now
rather than bleed to death. Shaving 5% here and there won't work."
Chinese producers can make the same adjustments. "You need an entirely
new business model to compete."
America has survived import waves before, from Japan, South Korea (news - web sites),
and Mexico. And it has lived with China for two decades. But something
very different is happening. The assumption has long been that the U.S.
and other industrialized nations will keep leading in
knowledge-intensive industries while developing nations focus on
lower-skill sectors. That's now open to debate. "What is stunning about
China is that for the first time we have a huge, poor country that can
compete both with very low wages and in high tech," says Harvard
University economist Richard B. Freeman. "Combine the two, and America
has a problem."
How much of a problem? That's in fierce
dispute. On one side, the benefits of the relationship with China are
enormous. After years of struggling to crack the mainland market, U.S.
multinationals from General Motors (NYSE:GM - News) to Procter & Gamble (NYSE:PG - News) and Motorola (NYSE:MOT - News)
are finally reaping rich profits. They're making cell phones, shampoo,
autos, and PCs in China and selling them to its middle class of some
100 million people, a group that should more than double in size by
2010. "Our commercial success in China is important to our
competitiveness worldwide," says Motorola China Chairman Gene Delaney.
By outsourcing components and hardware
from China, U.S. companies have sharply boosted their return on
capital. China's trade barriers continue to come down, part of its
agreement to enter the World Trade Organization (news - web sites)
in 2001. Big new opportunities will emerge for U.S. insurers, banks,
and retailers. China's surging demand for raw materials and commodities
has driven prices up worldwide, creating a windfall for U.S.
steelmakers, miners, and lumber companies. The cheap cost of Chinese
goods has kept inflation low in the U.S. and fueled a consumer boom
that helped America weather a recession and kept global growth on
track.
But there's a huge cost to the China
relationship, too. Foremost is the question of America's huge trade
deficit, of which China is the largest and fastest-growing part. While
U.S. consumers binge on Chinese-made goods, the U.S.
balance-of-payments deficit is nearing a record 6% of gross domestic
product. The trade shortfall -- coupled with the U.S. budget deficit --
is driving the dollar ever downward, raising fears that cracks will
appear in the global financial system. And by keeping its currency
pegged to the greenback at a level analysts see as undervalued, China
amplifies the problem.
America's Eroding Base
The deficit with China will keep widening
under most projections. That raises the issue: Will America's
industrial base erode to a dangerous level? So far the hardest-hit
industries have been those that were destined to migrate to low-cost
nations anyway. But China is ramping up rapidly in more advanced
industries where America remains competitive, adding state-of-the-art
capacity in cars, specialty steel, petrochemicals, and microchips.
These plants are aimed at meeting insatiable demand in China. But the
danger is that if China's growth stalls, the resulting glut will turn
into another export wave and disrupt whole new strata of American
industry. "As producers in China end up with significant unused
capacity, they will try to be much more creative in how they deploy
it," says Jim Hemerling, a senior vice-president at Boston Consulting
Group's Shanghai office.
That's why China is an even thornier
trade issue for the U.S. than Japan was in the 1980s. It's clear some
Chinese exporters cheat, from intellectual-property theft and dumping
to securing unfair subsidies. Washington can get much more aggressive
in fighting violations of trade law. But broader protectionism is a
nonstarter. On a practical level the U.S. is now so dependent on
Chinese suppliers that resurrecting trade barriers would just raise
costs and diminish the real benefits that China trade confers. Also,
unlike Japan 20 years ago, China is a much more open economy. It
continues to lower tariffs and even runs a slight trade deficit with
the whole world -- which makes the U.S.'s deficit with China all the
more glaring. Hiking the value of the yuan 30% might help. But that's
unlikely. For one thing, Beijing fears what such a shift would do to
jobs -- and the value of its $515 billion in foreign reserves. The real
solution is for the U.S. to reduce its twin deficits on its own
-- but that's more America's issue than China's.
Meanwhile, U.S. companies are no longer
investing in much new capacity at home, and the ranks of U.S. engineers
are thinning. In contrast, China is emerging as the most competitive
manufacturing platform ever. Chief among its formidable assets is its
cheap labor, from $120-a-month production workers to $2,000-a-month
chip designers. Even in sophisticated electronics industries, where
direct labor is less than 10% of costs, China's low wages are reflected
in the entire supply chain -- components, office workers, cargo
handling -- you name it.
China is also propelled by an enormous
domestic market that brings economies of scale, feverish local rivalry
that keeps prices low, an army of engineers that is growing by 350,000
annually, young workers and managers willing to put in 12-hour days and
work weekends, an unparalleled component and material base in
electronics and light industry, and an entrepreneurial zeal to do
whatever it takes to please big retailers such as Wal-Mart Stores (NYSE:WMT - News), Target (NYSE:TGT - News), Best Buy (NYSE:BBY - News), and J.C. Penney (NYSE:JCP - News).
"The reason practically all home furnishings are now made in China
factories is that they simply are better suppliers," says Janet E. Fox,
vice-president for international procurement at J.C. Penny Co.
"American manufacturers aren't even in the same game."
Fox's point is important. China's
competitive advantages are built on much more than unfair trade
practices. Some 70% of exports now come from private companies and
foreign ventures mainly owned by Taiwanese, Hong Kong, Japanese, and
U.S. companies that have brought access to foreign markets, advanced
technology, and managerial knowhow. Aside from cheap land and tax
breaks in some areas, private Chinese manufacturers get minimal
government help. "The Chinese government cannot afford to offer
financial support to the export economy," says business professor Gu
Kejian of People's University in Beijing. And as capital floods in and
modern plants are built in China, efficiencies improve dramatically.
The productivity of private industry in China has grown an astounding
17% annually for five years, according to the U.S. Conference Board (news - web sites).
China needs U.S. imports, though not as
much as imagined when Beijing agreed to join the WTO. U.S. exports to
China have risen 25% to 35% annually in the past two years. But China's
exports still outstrip its imports from the U.S. by 5 to 1. The U.S.
sells about $2.4 billion worth of aircraft a year, and its
semiconductor exports tripled in three years. Otherwise the U.S. looks
like a developing nation. It runs surpluses in commodities such as oil
seeds, grains, iron, wood pulp, and raw animal hides. Meanwhile, the Chinese keep expanding
their export base. Chinese competition arrives so fast that it's nearly
impossible to adjust through the usual strategies, such as automating
or squeezing suppliers. The Japanese, South Koreans, and Europeans
often took "four or five years to develop their place in the market,"
says Robert B. Cassidy, a former U.S. Trade Representative official who
helped negotiate China's entry into the WTO and now works for
Washington law firm Collier Shannon Scott, which wages dumping cases on
behalf of U.S. clients. "China overwhelms a market so quickly you don't
see it coming."
"Shock and Awe"
Georgetown Steel Co. is a case in point.
The Georgetown (S.C.) maker of wire rods used in everything from bridge
cables to ball bearings had battled Asian and Mexican imports for
years. But last year it shut its 600-worker plant, citing a tenfold
leap in Chinese imports, to 252,000 tons, from 2001 to 2003.
International Steel Group Inc. (NYSE:ISG - News)
has since bought the facility after U.S. anti-dumping duties on imports
and a rise in global demand helped hike domestic prices. The Gardiner
(Mass.) plant of Seaman Paper Co., a maker of crepe and decorative
paper, is highly automated. Yet Chinese imports have grabbed a third of
the market. It sells 81-foot streamers to big retailers for as little
as 9 cents each. That's below Seaman's cost of materials. "We thought
we could offset Chinese labor cost by automating, but we just
couldn't," says Seaman President George Jones III.
In bedroom furniture, 59 U.S. plants
employing 15,500 workers have closed since January, 2001, as Chinese
imports have rocketed 221%, to $1.4 billion -- half of the U.S. market.
Prices have plunged 30%. Dumping certainly seems to be one factor: At
its Galax (Va.) factory, Vaughan-Bassett Furniture Co. displays a
Chinese knockoff of one of its dressers that wholesales for $105 --
below the world market cost for the wood. But the main competition
comes from Chinese megaplants that sell directly to U.S. retailers and
can get a new design into mass production in two months. The new
Chinese factories of suppliers such as Lacquer Craft Furniture, Markor,
and Shing Mark, some of them Taiwanese-owned, employ thousands and are
so big they seem meant to build Boeing 747s, making most U.S. factories
look like cottage industries. "The first wave is shock and awe," says
John D. Bassett III, CEO of Vaughan-Bassett, whose sales and workforce
have shrunk even though it has boosted productivity
fivefold at its 600-worker Galax plant since 1995 by investing in
computer-controlled wood drying, cutting, and carving gear. "American
industry has never encountered (such) competition."
As component industries and design work
follow assembly lines to China, key elements of the U.S. industrial
base are beginning to erode. American plastic-molding and machine-tool
industries have shrunk dramatically in the past five years. Take Incoe
Corp. in Troy, Mich., a maker of steel components for plastic-injection
machines. "When the economy turned soft, we anticipated the business
would come back," says Incoe CFO Robert Hoff. "But it didn't. We saw
our customer base either close or migrate to China." The U.S.
printed-circuit-board industry has seen sales go from $11 billion to
under $5 billion since 2001. In that time, PCB exports from China have
more than doubled, to a projected $3.4 billion this year, says market
researcher Global Sources Ltd. (NasdaqNM:GSOL - News)
Most U.S. production of key electronics materials, such as copper-clad
laminates, has fled, too. "The whole industry is hollowing out," says
Joseph C. Fehsenfeld, CEO of Midwest Printed Circuit Services Inc.
in Round Lake Beach, Ill.
The migration of electronics to China
began when the Taiwanese shifted plants and suppliers across the Taiwan
Strait in the late 1990s. As recently as four years ago, though, the
U.S. exported $45 billion in computer hardware. Since the tech crash,
that number has slid to $28 billion as the industry headed en masse for
China, which is even more competitive than Taiwan. "All electronics
hardware manufacturing is going to China," says Michael E. Marks, CEO
of Flextronics Corp (NasdaqNM:FLEX - News).,
a contract manufacturer that employs 41,000 in China. Flextronics and
other companies are hiring Chinese engineers to design the products
assembled there. "There is a myth that the U.S. would remain the
knowledge economy and China the sweatshop," says BCG's Hemerling.
"Increasingly, this is no longer the case."
A visit to Flextronics' campus in the
Pearl River Delta town of Doumen vividly illustrates Marks's point. The
site employs 18,000 workers making cell phones, X-box game consoles,
PCs, and other hardware in 13 factories sprawled over 149 acres. The
bamboo scaffolding is about to come down on an additional
720,000-square-foot factory nearing completion. Almost every chemical,
component, plastic, machine tool, and packing material Flextronics
needs is available from thousands of suppliers within a two-hour drive
of the site. That alone makes most components 20% cheaper in China than
in the U.S., says campus General Manager Tim Dinwiddie. Plus, China
will soon eliminate remaining tariffs on imported chips. In the past
five years, electronic manufacturing-services companies such as
Flextronics have cut their U.S. production from $37 billion to $27
billion while doubling their China output, to $31 billion. That's
likely to double again by 2007.
"Gravitational Pull"
China is even making its presence felt in
the U.S. market for networking gear, a bastion of American comparative
advantage. On Nov. 15, struggling 3Com Corp. (NasdaqNM:COMS - News)
in Marlborough, Mass., launched a data-communications switching system
for corporate networks of 10,000 users or more. It claims twice the
performance of Cisco Systems Inc.'s (NasdaqNM:CSCO - News)
comparable switch. At $183,000, 3Com's list price is 25% less. Its
secret? 3Com is settling for lower margins and taking advantage of a
1,200-engineer joint venture with China telecom giant Huawei
Technologies Co. This is the first high-end piece of networking gear
sold by a U.S. company that is designed and manufactured in China. For
the price of one U.S. engineer, the joint venture can throw four
engineers into the task of making customized products for a client.
Even if 3Com does not succeed, similar tie-ups are expected, which
could drive down prices of high-end gear sold in the U.S. Says 3Com
President
Bruce Claflin: "We want to change the pricing structure of this
industry." 3Com hopes this is the start of a whole line of networking
gear designed and made in China for the global market. Without
referring to China, Cisco CEO John T. Chambers says "we are starting to
see a stream of good, very price-competitive competitors, particular
from Asia."
The next step for China is critical mass
in core industries. Outside Beijing, Semiconductor Manufacturing
International Corp. (NYSE:SMI - News)
has just opened a chip plant fabricating 12-inch silicon wafers that
experts say is just two generations behind Intel Corp. (NasdaqNM:INTC - News)
A foundry that makes chips on a contract basis, this plant won't
compete directly with U.S. chipmakers. But with four more 12-inch wafer
plants due by 2006 and many more fabs in the pipeline, the U.S.
Semiconductor Industry Assn. warns that a "gravitational pull" could
suck capital, people, and leading-edge research-and-development and
design functions from the U.S.
Digital technologies aren't the only areas
where the Chinese have huge ambitions. In the past decade, U.S.
petrochemical makers have invested in little new capacity. But at a
three-mile-long site in Nanjing, 12,000 workers are erecting a $2.7
billion network of pipes and towers for China's Sinopec (NYSE:SNP - News) and Germany's BASF (NYSE:BF - News)
that by next year will be among the world's biggest, most modern
complexes for ethylene, the basic ingredient in plastics. An even
bigger complex is going up in Shanghai. "The Chinese understand
everything that scale means," says Fluor Corp. (NYSE:FLR - News)
Group President Robert McNamara, who lives part-time in Shanghai and
whose company has design contracts at both complexes. "When they target
an industry to dominate, they don't mitigate."
Can China dominate everything? Of course
not. America remains the world's biggest manufacturer, producing 75% of
what it consumes, though that's down from 90% in the mid-'90s.
Industries requiring huge R&D budgets and capital investment, such
as aerospace, pharmaceuticals, and cars, still have strong bases in the
U.S. "I don't see China becoming a major car exporter in the
foreseeable future," says GM China (NYSE:GM - News)
Chairman Philip F. Murtaugh. "There is no economic rationale." Murtaugh
cites high production costs and quality issues at Chinese car plants,
as well as just-in-time delivery needs in the West, as impediments.
Burning Rubber
Don't tell that to Miao Wei, president of Dongfeng Motor Corp. On Nov. 7, Dongfeng and Honda Motor Co. (news - web sites) (NYSE:HMC - News)
announced that their joint venture will invest $340 million to boost
output of Honda CR-Vs and Civics fivefold, to 120,000, by early 2006.
The plant aims to achieve world standards by employing Honda's flexible
manufacturing system. "Honda will sell some of the Chinese-built cars
in Europe," says Miao. Nissan Motor Co. (NasdaqSC:NSANY - News) is also talking about exporting with Dongfeng.
China's carmakers are developing the
suppliers that one day could sustain exports. Auto-parts maker Wanxiang
Group in Hangzhou started as a tiny township-owned farm-machinery shop
in 1969. Now it's a $2.4 billion conglomerate that supplies the Chinese
assembly plants of GM, Ford Motor (NYSE:F - News),
Volkswagen, and others and also exports 30% of its output. In two
years, China will drop the rule that its auto plants buy at least 40%
of parts locally. Wanxiang is getting ready: It is opening a $42
million plant loaded with U.S. and European testing gear. And since
1995, Wanxiang has bought 10 U.S. auto-parts makers. "Our goal is to
acquire technology, management, and most important, to get access to
overseas markets," says Chairman Lu Guanqiu.
Some U.S manufacturers hope China will run
out of steam. This year, factories in Guangdong and Fujian faced
serious labor shortages for the first time. Red-hot demand has meant
skyrocketing costs for China's producers, most of which rely on
imported goods such as steel, plastics, and components. Energy
shortages have forced manufacturers to shut factories several times a
week. In almost any industry one can think of, vicious price wars are
biting into already razor-sharp margins. "There are so many small
companies competing that they crowd out all profit," says Beijing
University economist Zhang Weiying. Indeed, given the low emphasis on
profits and the unsophisticated accounting of many Chinese companies,
often their pricing isn't based on a full understanding of costs.
Having gotten as far as they can on cheap production costs, Chinese
manufacturers must develop their own technologies and innovative
products to move ahead -- areas in which they've made slow progress so
far.
The juggernaut will slow, but only
slightly. While salaries for top Chinese designers are rising fast,
they are still a fifth to a tenth of those in Silicon Valley. If
China's wages rise 8% annually for the next five years, says a Boston
Consulting Group study, the average factory hand will still earn just
$1.30 an hour by then. If China allowed the yuan to appreciate by
around 10% in the next year, productivity gains would more than offset
the higher costs, figures China expert Nicholas R. Lardy of the
Institute for International Economics. "I don't think revaluation will
have a significant impact," he says.
And Chinese producers are hardly standing
still. In a recent survey of Chinese and U.S. manufacturers by
IndustryWeek and Cleveland-based Manufacturing Performance Institute,
54% of Chinese companies cited innovation as one of their top
objectives, while only 26% of U.S. respondents did. Chinese companies
spend more on worker training and enterprise-management software. And
91% of U.S. plants are more than a decade old, vs. 54% in China.
Shanghai-based TV maker SVA Group, for example, has opened China's
first plant to make flat panels, a venture with Japan's NEC (NasdaqNM:NIPNY - News)
Corp. That is enabling SVA to secure a U.S. beachhead by selling
liquid-crystal display and plasma TV sets through channels such as the
online sites of Costco Wholesale (NasdaqNM:COST - News) and Target. Starting price: $1,600 -- 30% below similar models by Royal Philips Electronics (NYSE:PHG - News) and Panasonic (NYSE:MC - News).
More innovation. Better goods. Lower
prices. Newer plants. America will surely continue to benefit from
China's expansion. But unless it can deal with the industrial
challenge, it will suffer a loss of economic power and influence. Can
America afford the China price? It's the question U.S. workers, execs,
and policymakers urgently need to ask.
Business - BusinessWeek Online
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