China/US labour costs to converge by 2015

A new analysis by The Boston Consulting Group (BCG) forecasts US manufacturing will experience a “renaissance” as the wage gap in China shrinks.

May 9, 2011

CHICAGO: The sun may not be setting on North American manufacturing after all, according to a new analysis by The Boston Consulting Group (BCG). It forecasts the sector will experience a “renaissance” as the wage gap in China shrinks and certain US states become some of the cheapest locations for manufacturing in the developed world.

It all comes down to the math and the availability of skilled labour. The report, from the consulting group’s Chicago office, notes wages in China are rising 17% per year while the value of the yuan continues to increase. And in the US, flexible work rules and government incentives are making states such as Mississippi, South Carolina and Alabama increasingly more competitive as low-cost bases for supplying the US market.

“Workers and unions are more willing to accept concessions to bring jobs back to the US,” noted Michael Zinser, a BCG partner who leads the firm’s manufacturing work in the Americas. “Support from state and local governments can tip the balance.”

Adjusting for US workers’ relatively higher productivity, BCG says wage rates in Chinese cities such as Shanghai and Tianjin will be about 30% cheaper, and since wage rates account for 20% to 30% of a product’s total cost, manufacturing in China will be only be 10% to 15% cheaper than in the US. The advantage drops to single digits or zero when you factor in inventory and shipping costs.

“We expect net labor costs for manufacturing in China and the US to converge by around 2015,” said Harold Sirkin, a BCG senior partner. “As a result of the changing economics, you’re going to see a lot more products ‘Made in the USA’ in the next five years.”

That’s not to suggest wages in China aren’t cheaper on average, but BCG cautions against placing too much emphasis on the averages.

“In the US we have highly skilled workers in many of our lower-cost states. By contrast, in the lower-cost regions in China it’s actually very hard to find the skilled workers you need to run an effective plant,” added Doug Hohner, a BCG partner who focuses on manufacturing.

The global consulting company expects products most likely to come back will be those that require less labor and are churned out in modest volumes (such as household appliances and construction equipment). High volume, labour-intensive goods such as textiles, apparel and TVs will likely continue to be made overseas.

Sirkin advises executives who are planning a new factory in China to make exports for sale in the US should take a hard look at the total costs.

“They’re increasingly likely to get a good wage deal and substantial incentives in the US, so the cost advantage of China might not be large enough to bother – and that’s before taking into account the added expense, time, and complexity of logistics,” he said.

BCG notes some US companies have already realigned supply chains that serve the North American market, including Caterpillar Inc., which built a 600,000-square-foot hydraulic excavator manufacturing facility in Victoria, Tex. NCR Corp. is bringing back production of its ATMs to Columbus, Ga. to decrease time to market, increase internal collaboration and lower operating costs. And toy manufacturer Wham-O Inc. has brought back half of its Frisbee and Hula Hoop production from China and Mexico.

But even as work shifts back to the US, BCG said China will continue to play a major role in global manufacturing. First, investments to supply the huge domestic market in that nation will continue.

Second, in the absence of trade barriers that prevent offshoring, Western Europe will continue to rely on China’s relatively lower labor rates since the region lacks the flexibility in wages and benefits that the US enjoys.

Third, even though other low-cost countries—such as Vietnam, Thailand, and Indonesia—will benefit from companies seeking wage rates that are lower than China’s, only a portion of the demand for manufacturing will shift from China.

Smaller low-cost countries simply lack the supply chain, infrastructure and labor skills to absorb all of it, Hohner noted.