In previous commentaries penned on Supply Chain Matters, I have noted the implications of increased labor activism and subsequent raising wage rates within mainland China. Even last week, the financial news media continued noting incidents of new work stoppages occurring within China’s automotive plants, now involving Japanese brand Toyota as well as Honda.  Much financial media and blogosphere commentary revolves around the recent decision from the government of China allowing the Chinese yuan to “tolerate a gradual appreciation” within currency markets.  The combination of these two significant developments has caused some to declare that the era of cheap manufacturing in China is coming to an end.

My view is that it is too early to be making such broad reaching statements, or more importantly, significantly altering supply chain strategy.  Both developments, in my view, are driven by pragmatic business and political considerations.  The raised labor activism and consequent wage hikes are driven by the reality that workers within China’s major Pearl and Yangtze River coastal manufacturing regions are becoming more frustrated with their economic plight, and the government of China, thus far, is de-facto not interfering with this new wave of labor activism. Foxconn, China’s largest manufacturing employer’s recent announcement of doubling base pay for employees was the benchmark event that has led to more demands for wage increases in other industries.  The real question, however, is when or if these increases will be passed on to major manufacturing-driven customers.

The long awaited government decision to allow the Chinese currency to appreciate against major currencies such as the U.S. dollar was a political decision, timed to come out just prior to this weekend’s G-20 Economic summit meeting.  Many long-time political observers have noted that the word “gradual” is the operative word, and note China’s senior economic leaders have managed to allow the yuan to appreciate no more than a certain percentage in any given year, and that will most likely continue.

More important to the currency decision is the potential that foreign imports, such as consumer electronics, could become more attractive within China’s huge market. Additionally, as noted, the very goods that U.S. and Europe based firms manufacture in China might now become more affordable for China’s evolving middle class consumers.

Thus, in supply chain strategy context, both developments should be evaluated in the primary context of future product demand within China’s internal market, and secondarily, any impact that may come in the overall cost of manufacturing.  A recent Financial Times article (free preview account may be required) makes the observation that the increased pay raises will only accelerate a move of manufacturing from the coastal region to other interior regions.  For instance, Chongqing is becoming the new base for the electronics industry.  Foxconn is reported to be in talks with the local government in Zhengzhou, the capital of Henan province, to build its next mega-plant in that region.  If other component suppliers continue to shift their manufacturing to the interior regions, than a new manufacturing hub will be created.

My advice to manufacturers is to continue to monitor developments, but also differentiate supply chain strategy within China on the basis of first supporting China’s internal market potential, and second, as a hub of competitive manufacturing cost.  It’s apparent that China’s desire to be a world leader in more high technology areas such as autos, electronics, information technology and alternative energy manufacturing will continue, and a more pronounced shift within manufacturing toward the interior regions will occur.

As always, the notions of manufacturing cost are a tradeoff of direct labor vs. material cost.  The combined occurrence of increased labor activism and a floating Chinese currency should be viewed on long-term impact to material cost.

What’s your view?

Bob Ferrari