After China: Where's The New Frontier?

After years of hearing people say how much deflation China has exported, I believe they may start singing a different tune soon. The fact is, China was the lowest cost producer of everything.

However, as I noted in one of my past memoirs, that is no longer the case as countries like Vietnam, Laos, Cambodia and even Indonesia stand by the sideline waiting to undercut China on labour prices.

That is not going to change the fact that over the past decade, billions of dollars of investments have gone into China to ensure that every company looking for a low cost manufacturing base has one in there.

The cost of moving away (currently) offsets any advantages of relocating these manufacturing bases and as such, with recent increases in costs, companies will have to bear the brunt of it, if not able to pass on to consumers or end customers.

However, for new factories, companies are no longer automatically considering China, and are seriously looking at other countries in the region.

In addition, existing factories in China are forced to absorb higher costs, especially with new expansions as it does not make economic sense to relocate the factory overseas.

Costs And Turnover Are Rising

In June, I visited 16 companies which had manufacturing bases in China, and although revenues are rising, costs are rising, faster.

On average, labour costs have risen 15% over the past year and are forecast to increase by 15% per annum for the foreseeable future.

Although that's fast, it's obviously not fast enough because staff turnover at factories in China is averaging 20-25% per year.

Some factories, mainly smaller ones, according to the companies I met, are experiencing a turnover rate of up to 50%, which is especially acute since the Chinese New Year.

Depending on which industries, materials costs have risen by an average of 10-30%. With higher oil price and freight rates, transportation costs have also risen 5-15%.

Obviously the appreciating currency will also play a role, with China's renminbi having appreciated by 4.8% over the past 12 months.

With these kinds of statistics, it is enough to put off any corporate planning manager or business owner from considering locating their production base in China.

Now material and transportation costs are normally a variable that is not easily controlled, as such, labour costs (and proximity to end customer) is probably one of the main factors that will determine relocation.

In fact, after recent cost rises, one of my investors, who has a production facility in China and Thailand noted that if it hadn't been for the Thai baht appreciation, his cost of production in China and Thailand wouldn't have been that different.

With expected continuing appreciation of the renminbi, that should equalise soon.

The Bottomless Pool

According to latest estimates, there are 1.3 billion people in China, and an estimated 758m people of working age. However, the reality is that is not enough. The Chinese think tanks are predicting that there is:-

:: Negligible 0.4% growth in workforce over the next three years

:: Not enough workers (relative to demand) by 2010

:: Zero growth (in absolute numbers) by 201

:: To shrink by 2021

Of the estimated migrant pool of workers, there are only an estimated 52m compared with initial estimates of 100-150m.

So where have these workers gone? Well, they have stayed at home because there are now more jobs back home.

There are many more jobs available now, including in agriculture because farm prices have continued to rise and some families prefer to have their only child working closer to home.

The one child policy has been very successful in slowing China's population growth, as there are now fewer babies making fewer babies.

In addition, because of the tendency for chinese families to favour sons, through various methods of unnatural selection, the ratio of boys to girls in China has risen to 114 boys for every 100 girls at the end of 2005.

In some areas of China, like Guangdong and Hainan, where the practise has been rife, unofficial estimates are close to 130 boys for every 100 girls.

For delicate manufacturing processes, industries in general prefer women from ages of 20-30 years old, something that China is seeing less of every year.

The Next Investment Boom
Like it or not, globalisation is here to stay. Consequently, I believe the outsourcing trend will not only continue but will pick up pace.

If one firm has already started to outsource, it's inevitable competitors will follow.

Hence, if a Chinese factory is getting as competitive as a Thai or Indonesian factory, why not go with a Thai or Indonesian factory, which may only have a worker turnover rate of less than 10% and which does not have the wage inflation the Chinese factories are currently facing.

Still, the world needs a low cost production base somewhere, and if it's not going to be China, then it has to be somewhere else.

If Not China, Where Next?

Vietnam has been touted as the next best location, however, if we look at the base of potential worker pool, we can see that not only Vietnam has a pool of young workers but in fact other countries in southeast Asia as well as most of the countries on the Indian continent have a large population weighted towards the younger generation.

A pool of available labour force alone doesn't make a good workforce, as regulations, attitudes and aptitude are just as important.

Going forward, I believe that the Association of Southeast Asian Nations (ASEAN) will not only be considered a viable alternative to China as a low cost manufacturing base, but will also be seen as a good potential base to sell into China.

With the recent signing of the China-ASEAN free trade agreement, goods manufactured in ASEAN will only be subject to a 5% Chinese duty (and vice versa), making ASEAN a potentially attractive base to export from.

Corporate and Social Responsibilites

Unfortunately, not everyone has the same opportunities as you and me.

There are still children who will probably never make it even to a level where they can be accepted for work in manufacturing industries.

In some cases, these children are taken advantage of in so called "sweat shops" or quite often end up in less desirable professions, including blackmarket activities.

I am pleased to say that after our inaugural board of directors' meeting, we have agreed to allocate 2.5bp of our annual management fee to causes which we believe in. This will include providing shelters and school facilities for less fortunate children in the Indochina region as well as activities to help neutralise our Carbon footprint.