The PRD’s Fleeing Manufacturers – Not

July 16, 2010


In the wake of the “Foxconn crisis”, media tell us that manufacturers are fleeing the Pearl River Delta in their thousands in search of cheaper production locations in Vietnam, Indonesia or Cambodia. They say that the jump in labour costs, combined with likely appreciation of the RMB, are undermining the region’s hard earned competitive advantage. What utter nonsense.

Let me start with a prediction: the Pearl River Delta will remain Asia’s largest and most competitive export manufacturing base for the next two decades and beyond. Some companies will establish manufacturing operations in places like Vietnam and Cambodia, but these will be hedging strategies linked with precautionary diversification, and will do nothing to dilute the powerful competitive advantage of manufacturing in the PRD. Some low value activity, focused mainly in garments and footwear, may be transferred on a larger scale, but this is manufacturing that the PRD can do without.

I can understand manufacturers making such migratory threats – after all, they have a keen interest in trying to keep wage costs as low as they can get away with. I can also understand why the media so gullibly swallow the threats – after all, it is anecdotally easy to find a migrating company that supports the thesis (I have been getting calls for months from journalists asking me if I had heard of examples of companies fleeing the high costs of the PRD). But this does not make the threats credible, and it does not take too long scratching through regional economic data to see how ludicrous the claims are.

First, even if companies really did want to move away from the rising-cost environment of the PRD, the “absorptive capacity” of any other economy in the region is negligible. At a macro level, the PRD’s GDP is just under US$500 billion. In Asia, only Japan, South Korea and Indonesia are larger. Vietnam’s and Bangladesh’s GDPs are 20% of the PRD – and that of Cambodia is barely 3% of the PRD. About half of the PRD’s economy is manufacturing, whereas in Indonesia it accounts for barely 27%, and in Vietnam and Bangladesh below 20%. At a micro level, the PRD has around 32 million manufacturing workers, where Vietnam’s total manufacturing workforce is a bare 6 million, with Bangladesh at 5 million and Cambodia a bare 700,000. Even Indonesia has a total manufacturing workforce of just 12.5 million – a bare third of that in the PRD.

Second, these tiny manufacturing labour forces have limited skills – and what skills they have are concentrated in garments, furniture and footwear. These make up 63% of Vietnam’s exports to the US, for example. Exports from Cambodia and Bangladesh are 90% garments. Even in Indonesia, where rubber, seafood and oil and gas account for just under a quarter of all exports, garments and footwear still account for 34% of exports. Vietnam may be able to boast – for example – that footwear exports to the US have jumped by 50% since 2006, but as a share of the US’s total footwear imports this means a jump from 5% to 7.4%. In the meanwhile, China’s share of US footwear exports has grown from 72% to 76%.

Third, anyone who flees the PRD over inflationary fears is foolish in the extreme. For most of the past decade inflation in Vietnam, for example, has been persistently on the wrong side of 20%.

And these factors take no account of the critically important but slightly more subtle factors that have led to the massive manufacturing concentration in the PRD

  • like high levels of productivity (average output per worker in the PRD was estimated in 2008 at more than US$22,000, compared with US$8,000 in Vietnam and US$4,000 in Cambodia);
  • like a highly efficient and trustworthy logistics infrastructure, getting goods reliably and quickly from the PRD factory to the port;
  • like massive clustering of linked enterprises and worker skills;
  • like a large domestic market as an ultimate destination for goods currently made for export.

However successful a journalist might be in digging up evidence of an anecdotal departure, regional data contradict departures on any meaningful scale. Guangdong’s exports in the first five months of this year were 34% above those for the same period in 2009, while the processing trade – almost all of it in the hands of foreign companies – jumped 30%. A HK Trade Development Council study published just a month ago discovered in a survey of companies planning to set up new factories that 46% were still choosing to locate in the PRD. Most that were looking elsewhere were looking to China’s interior provinces, in particular the Yangze Delta region, rather than to south east Asia.

What sensationalists tend to forget is that Hong Kong manufacturers have for decades adopted a strategy of locating a factory operation away from China as part of a hedging strategy. In the 1980s, as manufacturers first took up the opportunity move factories to the Mainland, China sat outside the World Trade Organisation, and were at the mercy in the US of an annual Congressional battle over whether Chinese exports would escape penal duties by getting conditional Most Favoured Nation (MFN) status. As the US Government regularly altered country of origin rules to placate the powerful US textile lobby and frustrate the relentless rise of Chinese imports, so Hong Kong’s garment companies thought it wise to make sure they had at least one factory that could claim a country of origin other than China. There is no reason to believe the hedging going on today is any different from the hedging that went on in the 1980s and 90s.

The simple reality is that the PRD has built a gigantic manufacturing cluster that offers a reliability and cost effectiveness that remains the envy of the world. It operates on a scale that cannot be emulated anywhere else in the world – except, perhaps in India at some point in the distant future.

This leaves consumers in the west facing an uncomfortable reality: the 30-year era of China’s “deflationary gift” to the world, when its exporters were able to drive down costs consistently year after year, has come to an end. As Chinese workers demand – and get – better living wages, and as the Renminbi strengthens, this must lead to rising price tags for the great majority of the China-made consumer goods so devoured in western markets.

The upside is of course that China’s consumer markets are set to grow rapidly as Chinese workers have more spending power. But my bet is that the main beneficiaries of this growth will be manufacturers in China or south east Asia. If President Obama hopes to boost US exports, he may have to look elsewhere.

 

* The translated Chinese version was published in Ming Pao on July 16, 2010.

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