U.S. Multinationals Reconsider China-Based Manufacturing

June 24, 2011 Posted by China Briefing Reading Time: 6 minutes

Near term trends will see jobs return to the United States

Op-Ed Commentary: Chris Devonshire-Ellis

Jun. 24 – With about 50 percent of our firm’s China clients originating in the United States, we pay a great deal of attention to the politics, trends and sensitivities of the U.S. market. That they can often be described as “changeable” when it comes to China is an understatement. I recall one year visiting the U.S. Chamber of Commerce in one of the larger cities only to be practically shown the door when discussing U.S. businesses investing in China: “China is taking U.S. jobs away!” to the very same official 12 months later welcoming me with open arms: “We need Chinese investment!”

The political atmosphere tends to wax and wane in the United States, as it would with democratic procedures, however with the economy acting rather sluggishly, and looking as if it may continue to do so for some time, the political views of many have turned back towards the nation’s number one priority – looking after its own markets first.

It is a standard truism in government policy that one can’t have a thriving export market without a thriving domestic market, and to this end the United States looks set to lick its wounds and enter into a period of self-reassessment. That will almost certainly mean a gradual move towards bringing jobs, and manufacturing, back home. How that is done will be somewhat subtle, as China still represents – as it has done for over 100 years – a market for capitalists to dream about. I quote a U.S. Department of Commerce brochure dated 1921:

“…the reason why the prospect of selling goods to China provokes queries is because even the slightest modification in the prevailing mode of life is capable of creating an enormous market, and with the entire social structure in a state of flux and progress, trade possibilities are limitless.”

Little, it seems, appears to have changed on the face of it. But then again, that 1921 comment didn’t make any suggestion about relocating U.S. manufacturing bound for the U.S. domestic market to China either. That has been a far more contemporary shift as companies have faced ever increasing pressure to meet quarterly profit expectations or face punishment through a decline in share price.

The ruthlessness of Wall Street in determining an ever tightening and increasing spiral upwards of ever more demanding results is simply unsustainable, and so it has proved. Moving the entire production for U.S. consumers to China, or elsewhere, has in fact proved a false economy. Wall Street, simply put, is far too preoccupied with short terms gains. It’s partially this tendency and inherent structural fault in this most capitalistic of structures that has forced companies to shift production – and jobs – overseas. In doing so, U.S. manufacturers have ended up not really selling a U.S. product at all. They’ve been attempting to sell on little more than a well-known brand, while all the component parts that made that brand so iconic and valuable have been outsourced away. Corporate America would do well to examine Wall Street’s determinants for success or failure and allow companies some breathing space when expanding instead of brandishing a whip if their results don’t constantly improve every three months.

Meanwhile, American consumers – those same factory workers – get laid off and can’t afford to buy. The circle of U.S. companies seeking to cut costs has gone too far, as it often does in capitalist societies, and it needs to rebound somewhat back to producing in the United States, or at least for U.S. consumers. I feel that the prevailing winds of change dictate that this occur.

The argument is a little different for companies seeking to sell to the Chinese or other overseas markets. Clearly, it makes more sense and provides better cost competitiveness to both manufacture and sell close to the target market (as mentioned, something that was forgotten when it comes to the United States itself). Consequently, there is still a market for U.S. manufacturers in China, and such markets should be served largely by manufacturing processes in, or close to, that target territory. Yet China isn’t what it was either. Perhaps it never was. The era of Jiang Zemin and Zhu Rongji offering tax breaks and good deals to set up in China seem long gone. What were cheap wages are now rising at 20 percent annually.

For the first time in China’s new period of opening up, the operational costs of manufacturing in China are rising faster than profit margins. According to Chairman of Hong Kong’s Textile Council Willy Lin Sun-mo, it is now 10 percent more expensive to produce a garment in China than it is in Romania, a member of the European Union.

There’s renewed doubt too about the reality or sustainability of China’s domestic markets. Recent data from the Chinese government has shown the country’s retail market slowed to 16.9 percent in May this year, less than the average in any of the past five years.

“Consumption (in China) hasn’t taken off,” stated Patrick Chovanec, associate professor at Tsinghua University’s School of Economics and Management, in the South China Morning Post. “What has happened is a shift from exports to investment as a driver of growth.”

What should be going into consumable goods has been going into apartments. There’s also the question of the sustainability of China’s apparent recent consumer boom itself. Just as the United States was entering a recession, China overtook it as the largest vehicle sales market in the world. Yet what really made that happen in China was very cheap loans to auto buyers at rates subsidized by the government. Not surprisingly, everyone who could afford it suddenly possessed a car. But is that position as the world’s number one auto market sustainable? In my view, not once you take the incentives away.

All this is leading to a rethink of the way in which American politicians and manufacturers themselves are beginning to view the China market and, more importantly, the needs of the United States. In discussions I have held over the past month or so with many of our U.S. clients and friends, agreement has been pretty much consensual on the issue, although one specific statement stood out:

“Product has to have a definable, identifiable and sizeable proportion of American manufacturing.”

U.S. domestic economic and political drivers, I have the feeling, are going to be concentrating on this simple premise for some time to come, and it will change the way in which Corporate America does business with the PRC.

I suspect that view to be followed with a U.S. campaign to bring jobs, talent and innovation back to the United States from China, at least for U.S.-bound products. While China may always flatter to deceive in terms of the size of its own market, it is a member of the WTO and is committed to raising the standard of the livelihoods of its citizens. In the words of that 1921 missive, “with the entire social structure in a state of flux and progress, trade possibilities are limitless,” although I might be more inclined to change the final word to “measureable.”

So it’s not all bad news. But in terms of the global economy getting back on track, we need the United States to be in rude health. If that means the downsizing of some U.S. manufacturing plants in China, and taking part of that production facility back home, then that’s a small price to pay.

Chris Devonshire-Ellis is the Founding Partner and Principal of Dezan Shira & Associates, a foreign direct investment practice specializing in legal establishment and tax compliance issues for MNCs across Asia. The firm has been in existence since 1992 and has 19 regional offices throughout China, India, and Vietnam. Chris is also the Vice Chair of the regional UNDP business advisory council, and may be contacted via info@dezshira.com. Please visit the firm’s web site or download the firm’s brochure here.

Related Reading
Moving From China to India, Vietnam and Emerging Asia (Complimentary Report)
As costs in China begin to rise, an increasing number of companies are looking at either relocating, or considering moving part of their facilities to lower cost markets in Asia. This makes sense, China as a consumer market is beginning to become wealthier, while the lower production costs available elsewhere make sense for supplying the global market. In this special report we take a look at the operational costs of a typical factory in South China, and make comparisons between these are similar operations in India and Vietnam. We also take a look at Indochina – home to even cheaper labor, and additionally examine the legal and tax positions of China, India and Vietnam, looking at where future policies concerning attracting FDI are heading. As this new century moves onto its second decade, it is apparent that the rise of China has spurred other regional economies forward. With that comes choice, and this report will enable the Asia based executive to begin to consider markets beyond that of China’s borders. The opportunities are there.