Global Emerging Markets (GEMs) : China, South Korea

The End of Outsourcing?

Charles Krakoff — Mon, 03 Oct 2011 20:07:00 GMT

Foxconn International Holdings, the world’s largest contract manufacturer of electronic components, made notorious last year by a rash of employee suicides at its Chinese factories, recently published its half-yearly financial results, which showed that its annual labor costs per employee have risen by a third over the past year, to $2,900.

Foxconn, 71% owned by Hon Hai Precision Industry of Taipei, and which also assembles products for Sony, Dell, and Hewlett Packard, employs an estimated 400,000 people at its two factories in Shenzhen (Hon Hai, with 800,000 employees, is the 10^th-largest employer in the world). These people, most of them young, many of them women, work 11-hour shifts, seven days a week. According to the New York Times, Mr. Ma Xiangqiang, a 19-year-old Foxconn employee who jumped to his death from a Foxconn dormitory in January 2010, had worked 286 hours in the month prior to his suicide, including 112 hours of overtime, more than three times the legal limit. By all accounts, Foxconn is not a fun place to work, combining some of the worst features of military service, summer camp, and prison, but the problems facing Foxconn are far from unique.

Coastal China is in many ways a victim of its own success. China’s explosive industrial growth of the past 30 years, much of it concentrated in the Pearl River Delta in Guangdong Province, adjacent to Hong Kong, has lifted hundreds of millions of people out of abject poverty and introduced many of them to the temptations of consumerism. Rising living standards have been accompanied by increased awareness of the world and demands for more personal freedom. Workers no longer accept unremitting drudgery as an inevitable norm. Foxconn has responded in two ways: one, by increasing salaries, and the other, by setting up factories in Western China, where wages are lower and labor militancy so far nonexistent. China’s government has encouraged companies to set up factories in the interior, partly to reduce the strain on coastal cities’ infrastructure, but also to dissipate the kind of worker discontent that could quickly turn political. These are at most temporary expedients. Neither is a solution to the rising cost of doing business in China. Western China may offer lower wages, but the additional cost of moving components and assembled units thousands of miles within China may negate any labor cost savings. More fundamentally, Foxconn’s travails call into question the sustainability of China’s current export-dominated economic model.

It’s a fair bet that logistics – transporting the many components that go into an iPhone or an iPad and then getting the finished product to market – accounts for a much higher proportion of the final cost than the assembly work itself, which most analysts estimate at less than one per cent of the retail price. As the cost of Chinese assembly rises and the negative publicity associated with worker suicides and sweatshop working conditions intensifies, a company like Apple or HP might start to question whether assembling its products in China makes sense. With overtime and bonuses, a worker in a Chinese electronics factory can earn $500 a month. This is a lot less than the $3,000 or so a U.S. worker might get, but then Chinese manufacturing labor is far less productive. Shifting iPad assembly from China to the U.S. might raise unit costs by a few pennies, a small price to pay for greater control over their supply chains, while moving it to, say, Mexico, might even reduce the cost. No wonder the Financial Times said that “Hon Hai and its offshoots are looking like relics from another era.” No wonder, too, that Foxconn has reportedly been considering a $12 billion investment in Brazil, where import duties have raised the cost of an entry-level iPad 2 to nearly $1,000, as compared to around $400 in the U.S. The higher cost of Brazilian labor is insignificant compared to the savings in import duties, and a Brazilian-made iPad, just like a Brazilian-made Ford Fiesta, can also sell for a competitive price in the U.S. or Europe.

If China is no longer the cheapest place to manufacture or, as seems to be the case with Foxconn’s factories, its cost advantages are outweighed by other considerations, where does this leave Chinese manufacturing and the Chinese economic model? China continues to excel at making products like shoes and T-shirts, for which labor represents a much bigger share of the cost than for an iPad. But even in these product groups, a combination of lower labor costs and special trade preferences has caused a lot of production to shift to places like Vietnam, Bangladesh, Nicaragua, and Haiti. At some point, however, the world will run out of cheaper manufacturing locations. Once Vietnam and Haiti accede to the ranks of middle-income countries, where will the sweatshops move? Burundi? Somalia? It seems unlikely.

These developments prove only that present trends never continue indefinitely. The current fear of an unstoppable Chinese manufacturing juggernaut, which will end up like the victor in a game of Monopoly, owning all the money and all the property and manufacturing everything the rest of the world consumes, is no more valid than the old fear of an unstoppable Japan.

These developments also indicate that the doctrine of comparative advantage – the one economic theory that is neither obvious nor trivial – will reassert itself. Even if China had an absolute cost advantage in manufacturing of every imaginable product, which it clearly has not, it would still make sense for it to specialize in production of goods or services in which it is relatively more efficient. This mix of goods and services will change over time. China is likely to remain a formidable exporting power, but as its economy matures and its labor costs rise, its exports will shift from cheap, labor-intensive manufactures to goods and services containing higher added value, following a similar trajectory to that of Japan, Taiwan, and South Korea. More cars and flat panel displays and fewer T-shirts.

Does this mean an end to outsourcing? Not at all. But what is outsourced, and from where, will continue to change. Expect China, just now starting to export cars, to be building car factories in the United States 15 or 20 years from now. Expect Apple to shift assembly of its iPads from China back to the U.S. or perhaps to Mexico, where it can shorten its supply chain and better control quality. For now, your undershorts and T-shirts will continue to be made in Haiti or wherever else labor is cheapest and trade preferences greatest. For just about everything else, all bets are off.

Chinese Prostitutes and Don Corleone: The Underside of Asia's New Scramble for Africa

Charles Krakoff — Thu, 19 Aug 2010 13:01:00 GMT

I owe the title of this piece to John Hempton, an Australian who writes the excellent Bronte Capital blog , who told me that the number of visits to his site increased a hundredfold when in 2008 he published a piece with the title “Hookers that cost too much, flash German cars and insolvent banks: an introduction to Swedbank’s Baltic homeland.” It was a long and complex analysis of sovereign risk and bank insolvency in the Baltic States, and ultimately fascinating, but he probably wouldn’t have snagged more than 50 readers without that title. Let’s see if it works for me.

Several years ago I was talking business with a Frenchman in Antananarivo, the capital of Madagascar, and the topic turned to the very visible Chinese presence in the city, where they were building a soccer stadium, among other projects. He was one of those expatriates who has lived in a place for years and years, and knows everyone and everything. The Malagasy people were getting fed up, he said, with the Chinese taking over every economic activity in sight. Even the local bar girls – and Madagascar has some stunningly beautiful women – were now facing stiff competition from Chinese hookers. I didn’t undertake my own investigation, but I am not surprised. The Chinese, and, to a lesser degree, other Asians, are everywhere on the continent, and the people are not happy about it.

This is hardly a new story. I can recall in Botswana in the late 1980s, the Chinese putting up some kind of building in Gaborone. The locals were far from thrilled, even though the Chinese were paying for the building themselves, with no obvious strings attached. You could drive along at nine o’clock at night, four and a half hours after most Batswana had gone home and started drinking beer, and there would be the construction site, lit up like a carnival, with Chinese workers clambering all over the place. The stories and rumors spread. They brought all their own workers and hired no locals. They brought their own cooks, who planted their own vegetable gardens, and bought nothing in the local shops. They worked 12 hours a day, six days a week. Botswana had become some kind of battleground in Cold War geopolitics, contested by the Americans, the Russians, the South Africans, and the Chinese. The Chinese seemed to be winning, but who could really tell?

There was some element of envy in this. No Botswana citizen would work seventy hours a week, but people felt some unease at a bunch of foreigners throwing their customary indolence – nowadays it would be called work-life balance – back in their faces. It never did become clear exactly what the Chinese were after in Botswana, and maybe it was really all about Cold War geopolitics, though they are still there, investing in agriculture and building industrial estates.

The same story has repeated itself all over Africa, and it is not just the Chinese, though they are way out in front of their other Asian competitors like South Korean, Taiwan, and Malaysia. The resource play is the big story: oil in Sudan and Nigeria, copper in Zambia, rice plantations and timber in Madagascar and Mozambique, just about everything you can think of in Congo and Angola. In other countries it’s harder to see what the game is. What exactly are the Chinese hoping to get out of Ethiopia? Or Sierra Leone? It helps to remember that the Chinese – and to a large degree most East Asians – are famous for taking the long view, and that the combination of new resources and new markets – the classic justification for colonialism – probably explains most of it.

In Sierra Leone, in fact, the main Chinese endeavor, apart from the stadium, is a huge sugar plantation and refinery on land granted by the government in a sweetheart deal. The Chinese sugar company, a state-owned enterprise whose offices are in the Chinese Embassy compound in Freetown, benefits from Sierra Leone’s generous duty-free quota for exports of refined sugar into the otherwise tightly-protected European market. It doesn’t hurt that Sierra Leone also has important reserves of titanium-bearing rutile ore, gold, diamonds, iron, and bauxite. In Mali, which has plenty of gold and is one of the world’s largest cotton producers, a Chinese state-owned company generously bought a loss-making textile mill from the government. There’s no chance it will make money – the machines are old and outmoded and probably weren’t the right ones in the first place – but the purchase put a few dollars into government’s coffers and keeps hundreds of otherwise unemployable workers from being put out on the street.

The Chinese build a road here, a stadium there, and bide their time. No strings attached. And if they have to bring in cooks and girls for the well-being of their workers, so be it. And if the Chinese girls do some freelancing in the local bars, well we all believe in the free market now, don’t we? The people, though, are not happy.

In May 2009, when Madagascar’s democratically-elected but increasingly autocratic President was overthrown in an Army-backed coup led by a 36-year-old former disk jockey, the proximate cause was an imminent deal under which the Madagascar Government was about to grant a 99-year lease of 1.3 million hectares (more than 5,000 square miles, an area the size of Belgium and nearly half the country’s arable land) to the Korean conglomerate Daewoo to grow oil palm and maize to supply growing Korean demand. Other examples abound, including an abortive Chinese plan to invest about $800 million in a project to resettle as many as 10,000 Chinese farmers in Mozambique’s fertile Zambezi River valley to grow rice for export to China. Not all these stories are necessarily true, and not all of them are necessarily bad news for Africa – some of these projects could increase African self-sufficiency in food production – but there is a growing sense of unease among many Africans that they are being sold down the river by their own leaders to a new set of colonial masters, who promise to be no better than the first lot.

Should we in America be terribly worried about all of this? No. The fear is based on one of these “if current trends continue…” panics. Remember how, by 1980 the earth was going to face a Malthusian crisis? Remember how, by 2000, Japan was going to have overtaken the United States as the biggest economic power in the world? Remember how the price of oil would never again fall below $100 a barrel? Or rise above $20 a barrel? How the Dow Jones average would hit 36,000 by 2010? These predictions never came true because current trends never continue. If China’s economy continues to grow at more than 10% a year for the next 50 years, then maybe China will control all the resources in the world. But China’s economy won’t. It can’t. In spite of its amazing economic and technical prowess, China already faces skills shortages, rising wages, labor unrest, and an out-migration of some jobs to cheaper countries like Vietnam. And even if by some miracle China did sustain that kind of growth over the next half-century, remember when you used to think what it would be like to have all the money in the world? At some point we all realized that if one person gets all the money in the world, it’s the same as having no money at all. People would start using something other than money. Wampum, perhaps. It would be like bankrupting all your opponents in Monopoly. When you do that, the game is over, and people wander off and do something else, leaving you to enjoy your worthless hoard.

But I worry for Africans. Fifty-odd years after the colonial experiment ended, much of the continent has little to show for its independence, and many of those old enough to remember start thinking that life under the French or the British or the Portuguese wasn’t so bad compared to what came next. But recolonization, by the Chinese or anyone else, is no solution.

One day the other shoe will drop. As Don Corleone says in The Godfather, “Someday – and that day may never come – I’ll call upon you to do a service for me. But until that day, accept this justice as a gift on my daughter’s wedding day.”

Just as many of the Don’s beneficiaries came to regret the devil’s bargain they had made, so too may many African countries come to regret the deals they are now making with Asian investors and the governments that back them.