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We Call It: “Arbitrage”

March 15, 2012

So what happens when a company decides to relocate manufacturing (or any other function) to an area because the labor cost is low?  Well, the short story is that the labor cost eventually rises as more people are employed by more companies, and the cost savings goes away.  Witness the latest example in Western China courtesy of The Register:

Digitimes said that, according to industry sources, Quanta Computer, Compal Electronics, Wistron and Inventec among others had already relocated some plants to Chongqing and Chengdu.

However, they are reportedly getting cool on the idea after the local authorities failed to cough up with payments promised to the manufacturers to compensate them for the higher costs incurred by moving production to the two cities.

Lest you think this is the kind of blog to complain about companies looking for government handouts, I’m okay with the practice as long as the company and the government both realize what’s happening.  The government is subsidizing employment and driving costs up at the same time, and the company eventually finds that the investment is a diminishing return and needs to seek other ways to cut costs.  To me, that’s just an acceleration of the cycle of business life.  Yes, it’s dumb on both sides, and there are plenty of other ways to make life for the company easier while still getting people employed… that’s a different post.

There’s a comment in the article that China pushes for a minimum 13% wage increase every year, which would mean that salaries double in five years.  You have to assume that employment is also growing at the same time in any given company, so the company has to build in a plan that effectively grows the cost of people at about 30% to 40% (there are fixed costs beyond salary that probably won’t go up as fast), which is a pretty painful shock to someone looking to get both columns to rectify.  The result of such an effect in a given location is predictable:

Earlier this month, Philippine trade secretary Gregory Domingo reportedly revealed that the south-east Asian nation is hosting more fact-finding missions from foreign firms than ever before, with rising labour and production costs in China one of the key drivers.

Most people dumped the Philippines a decade ago for China, and let’s not forget that India has a bunch of people and space, as well as an education system that can churn out workers as fast as China.  It’s mostly the incredibly lousy infrastructure that’s keeping India back at this point.

In a world where cost is king, this will be a continuing issue, and you should expect stories of new factory cities springing up all over the Asia and the Pacific.  In the meantime, don’t expect to see the end of China’s manufacturing rule anytime soon.  There are still a lot of people to be employed, and there’s still a pretty good deal chain in place to keep the buildings opening for the near future.

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