economy

Just Cheap Labor? How China Became a Manufacturing Powerhouse

Many people have simple narratives about China’s rise as a manufacturing powerhouse. And this misunderstanding (ignorance?) is also the reason why the same people believe that multinational corporations are going to quickly move or re-shore factories out of China. The logic behind this narrative mostly boils down to, “China has cheap labor and thus became a manufacturing giant.”

For starters, if poverty is the sole requirement to become a manufacturing center, obviously every other developing country would have performed well. Consider this: while China and India have almost the same population, China’s manufacturing is almost 10x India’s. Thus, let’s analyze this phenomenon more closely.

China’s growth in manufacturing over the last forty years has been nothing but astonishing. Consider that, in 1980, US manufacturing output was almost five times as large as China’s. However, just thirty years later — in 2010 — China surpassed the US as the world’s #1 manufacturing country. This was also quite momentous, since the US had been the manufacturing leader for the previous 110 years!

One more astonishing data: in the last one year, China’s trade surplus in manufactured goods was … whopping $1 trillion.

Of course, cheap labor made a big difference in the 1980s, 1990s and even until 2006 or so. However, after that, China’s wages caught up with other middle-income developing countries. Now, Chinese wages are 2.5x higher than in Mexico or 5x higher than in Vietnam.

Thus, while the Chinese wages tripled over a decade (2008-2018), China’s share of global manufacturing value added almost doubled from 15% to 28%!

So, obviously, there’s lot more than cheap labor. In fact there are dozens of holistic factors that make a country a successful manufacturer. (Not all of them are positive — for example, lax environmental laws — but that’s the dark side of manufacturing). Understanding these will help see what a daunting challenge foreign companies will face in finding new countries to replace China.

There’s no one magic bullet, and all the ten factors listed below are critical:

**1. Skilled, Productive and Disciplined Labor: Yes, more than being cheap, even the lowest paid workers must have all these three qualities. The people making shoes or assembling gadgets still need skills and consistency. Products and requirements change all the time, and the workers should be able to adapt. Moreover, these people must show up every day and work diligently. In many countries, you can’t find such high-quality workers.

**2. Medium and Hi-tech Manufacturing Factories: A plastic toy or a bulb may seem very simple, but there’s a lot of chemistry, metallurgy, materials science and much more behind how to make them from raw materials. Now imagine TVs, car engines etc. Factories need very sophisticated engineers to make the products to specifications at the right cost. There’s a lot of innovation here behind the scene. Here’s a quick note from Tim Cook (Apple’s CEO) on this topic:

**3. Producing at Scale: Assembling 100,000 iPhones a day requires a totally different factory from the one that churns out 1,000 smartphones a day — every process will be different from end to end. Automation, smart factories, robots, and 5G will be increasingly crucial in the factories of the future.

Since 2016, China has been #1 in purchase of industrial robots. Last year, China installed more robots than US, Japan, South Korea and Germany *combined*!

**4. Elasticity and Flexibility: Can you handle a sudden extra request for 1 million new gadgets to meet demands for Christmas? Can you quickly switch from one version to a newer version of a product? For example, China was able to rapidly build huge mask factories and COVID19 testing labs within 2-3 weeks.

**5. Design to Prototypes to Products: Customers just come up with vague or highly complex product designs and then expect the manufacturer to do all the work. Chinese firms have so much talent and experience that they can often create a prototype within a couple of days. And these firms must be creative enough to suggest alternative designs and features. These are invaluable skills that just can’t be developed in a few months.

**6. Logistics: How do you make sure that the parts and raw materials are always available for the factories? How resilient, agile and efficient are your supply chains? How do you manage all the workers? How about testing and shipping out all the products on time? How do you work with customers from all over the world and deal with different languages, legal issues etc.?

**7. Infrastructure: The Chinese government has to make sure that the factories have land, electricity, water, buildings, warehouses, roads, Internet etc. And they must be affordable. These may sound easy to someone in the US, but developing nations like India or Indonesia may struggle to provide high-quality infrastructure. For example, until recently, massive power outages used to be very common in India. Check out this video below of the world’s largest container port in Shanghai. It is now automated and run by robots, autonomous vehicles and 5G. There’s no other seaport like this in the world.

**8. Transportation: Although this falls under infrastructure, it must be spelled out. A bullet train that reduces travel time by 60% … deep sea ports that can handle massive ships and millions of containers … new strategically located airports all over the country … freight trains that can travel thousands of miles (like from Xian, China to Barcelona, Spain) … these are monumental projects in which no country can match China. This is why Xi Jinping’s Belt and Road Initiative is truly visionary.

**9. Ecosystem: This is a unique success factor for China. There is an ecosystem for every kind of factory. For example, a clothing factory would greatly benefit if there are dozens of nearby factories that specialize in different kinds of materials — cotton, wool, silk, denim, nylon, polyester etc. Similarly, a smartphone company would like to work closely with other firms that specialize in microphones, speakers, cameras, screens, printed circuit boards etc. Other services experts such as international lawyers, marketing consultants, and designers are also indispensable. Without such 360-degree ecosystems, no country can expect to be a manufacturing superpower. Shenzhen, the electronics capital of the world, is a stellar example of such ecosystems.

**10. Tax Breaks, Subsidies, Incentives, Trade Agreements: Finally, you need a very smart and visionary government that plans 5, 10, 20 years in advance, makes huge investments, knows how to attract and keep foreign and domestic investors, provide tax cuts and subsidies, negotiate smart trade agreements etc. to create a win-win environment.

Elon Musk at Shanghai Tesla factory that was built in just one year!

So, these are the secrets behind China’s success. Other countries can try to replicate this model, but they need to be prepared to invest a lot and plan for the long term. While low-end manufacturing will move out of China because of high Chinese wages and China’s desire to improve its environment, Americans shouldn’t dream of quick decoupling or re-shoring factories. This is why 75% of US manufacturers in China say they won’t move any production out of China! Moving out of China in any meaningful way will take a decade … if other developing nations execute their manufacturing strategy flawlessly.

Bonus: China exported whopping 150 BILLION surgical masks to the rest of the world between March and September of this year. How? Even electric car companies like BYD converted some of their factory spaces into hi-tech and automated mask production: