JUST CHEAP LABOR?

HOW CHINA BECAME A MANUFACTURING POWERHOUSE

Many people have simple narratives about China’s rise as a manufacturing

powerhouse. And this misunderstanding (ignorance?) is also the reason why the same
people believe that multinational corporations are going to quickly move or re-
shore factories out of China. The logic behind this narrative mostly boils down to,
“China has cheap labor and thus became a manufacturing giant.” Let’s analyze this.

China’s growth in manufacturing over the last forty years has been nothing but
astonishing. Consider that, in 1980, US manufacturing output was almost five times
as large as China’s. However, just thirty years later — in 2010 — China surpassed
the US as the world’s #1 manufacturing country. This was also quite momentous,
since the US had been the manufacturing leader for the previous 110 years!

Of course, cheap labor made a big difference in the 1980s, 1990s and even until
2006 or so. However, after that, China’s wages caught up with other middle-income
developing countries. Now, Chinese wages are 2.5x higher than in Mexico or 5x
higher than in Vietnam.

Thus, while the Chinese wages tripled over a decade (2008-2018), China’s share of
global manufacturing value added almost doubled from 15% to 28%!

So, obviously, there’s lot more than cheap labor. In fact there are dozens of
holistic factors that make a country a successful manufacturer. (Not all of them
are positive — for example, lax environmental laws — but that’s the dark side of
manufacturing). Understanding these will help see what a daunting challenge foreign
companies will face in finding new countries to replace China.

There’s no one magic bullet, and all the ten factors listed below are critical:

**1. Skilled, Productive and Disciplined Labor: Yes, more than being cheap, even
the lowest paid workers must have all these three qualities. The people making
shoes or assembling gadgets still need skills and consistency. Products and
requirements change all the time, and the workers should be able to adapt.
Moreover, these people must show up for work every day and consistently perform. In
many countries, you can’t find such high-quality workers.

**2. Medium and Hi-tech Manufacturing Factories: A plastic toy or a bulb may seem
very simple, but there’s a lot of chemistry, metallurgy, materials science and much
more behind how to make them from raw materials. Now imagine TVs, car engines etc.
Factories need very sophisticated engineers to make the products to specifications
at the right cost. There’s a lot of innovation here behind the scene.

**3. Producing at Scale: Assembling 100,000 iPhones a day requires a totally

different factory from the one that churns out 1,000 smartphones a day — every
process will be different from end to end. Automation, smart factories, robots, and
5G will be increasingly crucial in the factories of the future.

**4. Elasticity and Flexibility: Can you handle a sudden extra request for 1
million new gadgets to meet demands for Christmas? Can you quickly switch from one
version to another version of a product? For example, China was able to quickly
build huge mask factories and COVID19 testing labs within 2-3 weeks.

**5. Design to Prototypes to Products: Customers just come up with vague or highly
complex product designs and then expect the manufacturer to do all the work.
Chinese firms have so much talent and experience that they can often create a
prototype within a couple of days. And these firms must be creative enough to
suggest alternative designs and features. These are invaluable skills that just
can’t be developed in a few months.
**6. Logistics: How do you make sure that the parts and raw materials are always
available for the factories? How do you manage all the workers? How about testing
and shipping out all the products on time? How do you work with customers from all
over the world and deal with different languages, legal issues etc.?

**7. Infrastructure: The Chinese government has to make sure that the factories
have land, electricity, water, buildings, warehouses, roads, Internet etc. And they
must be affordable. These may sound easy to someone in the US, but developing
nations like India or Indonesia may struggle to provide high-quality
infrastructure. For example, until recently, massive power outages used to be very
common in India.

**8. Transportation: Although this falls under infrastructure, it must be spelled

out. A bullet train that reduces travel time by 60% … deep sea ports that can
handle massive ships and millions of containers … new strategically located
airports all over the country … freight trains that can travel thousands of miles
(like from Xian, China to Barcelona, Spain) … these are monumental projects in
which no country can match China. This is why Xi Jinping’s Belt and Road Initiative
is truly visionary.

**9. Ecosystem: This is a unique success factor for China. There is an ecosystem
for every kind of factory. For example, a clothing factory would greatly benefit if
there are dozens of nearby factories that specialize in different kinds of
materials — cotton, wool, silk, denim, nylon, polyester etc. Similarly, a
smartphone company would like to work closely with other firms that specialize in
microphones, speakers, cameras, screens, printed circuit boards etc. Other services
experts such as international lawyers, marketing consultants, and designers are
also indispensable. Without such 360-degree ecosystems, no country can expect to be
a manufacturing superpower. Shenzhen, the electronics capital of the world, is a
stellar example of such ecosystems.

**10. Tax Breaks, Subsidies, Incentives, Trade Agreements: Finally, you need a very
smart and visionary government that plans 5, 10, 20 years in advance, makes huge
investments, knows how to attract and keep foreign and domestic investors, provide
tax cuts and subsidies, negotiate smart trade agreements etc. to create a win-win
environment.

So, these are the secrets behind China’s success. Other countries can try to
replicate this model, but they need to be prepared to invest a lot and plan for the
long term. While low-end manufacturing will move out of China because of high
Chinese wages and China’s desire to improve its environment, Americans shouldn’t
dream of quick decoupling or re-shoring factories. This is why 75% of US
manufacturers in China say they won’t move any production out of China! Moving out
of China in any meaningful way will take a decade … if other developing nations
execute their manufacturing strategy flawlessly.