China Issues
Monday, May 16, 2005
There’s been a lot of discussion about China lately. For one thing,
we are going to see more and more manufacturing move out of the United States.
It does not make any sense to put a factory in the US when you can manufacture
so much cheaper in China. It is my guess that product design and logistical
control will also move out of the United States.
Manufacturing in China versus the US or México
A couple of years ago I was at the Flextronics plan in Guadalajara, Mexico.
They gave me a detailed tour of the plant. We spent about four hours walking
around.
Flextronics is a company that we categorize as
a "CM." “CM” stands for “contract manufacturer."
For example, they make a very large percentage of all of the cell phones
that are manufactured in the world. They do not put their name on the products
they manufacture. Instead they make cell phones for brands such as Kyocera,
Sony Ericsson, or Motorola. With most consumer electronic items, hardly
any recognizable brand manufactures their own stuff anymore. For example,
HP does not make their printers or personal computers. Instead, they outsource
the manufacture and assembly. It is much cheaper to outsource them than
build them internally. The brand owner can be much more flexible if they
contract for the fabrication of their products. Flextronics can do the design,
source the materials, assemble the product, and then manage the distribution.
They are doing this for a lot of companies that used to manufacture in the
United States.
At any rate, let's get back to the story about Flextronics in Guadalajara,
Mexico. As I was walking around this beautiful 170-acre manufacturing campus,
it felt to me like there is something missing. I could not figure out what
was different about the Guadalajara campus versus other American electronics
and industrial parks. This industrial power was similar in many ways to
those that are all around Silicon Valley, California. This property had
several brand-new buildings and a beautiful soccer field centrally located
in the middle of the campus. What it did not have -and took me a long time
to figure out -was parking lots. It did not have any parking lots because
the workers were transported to the plant on company-owned buses. They could
not afford to own cars because their wages were not high enough. So, the
company brings them to work every day on buses. As I walked to the cafeteria,
I noticed that many of the workers were having breakfast. They were eating
company-provided burritos for breakfast. So as part of the pay/benefits
package, the workers received a trip to work and home, and also one hot
meal.
The Flextronics folks took me over to the Xbox line. The Xbox is a game
machine designed by Microsoft. Microsoft, like most other companies, does
not make their own equipment or games. Instead they contract out the manufacturing
of the Xbox to Flextronics. As they walked me down the Xbox assembly line,
the plant manager said, "Unfortunately, these are leaving here. They
are moving the manufacturing of the Xbox to China."
I asked the plant manager why the Xbox was no longer going to be manufactured
in Mexico. He said that it was much too expensive to make them in Mexico
because the labor costs at the Guadalajara plant were substantially higher
than the plant the Xbox was moving to in Shenzhen, China. The Guadalajara
plant manager also told me that at the Flextronics plant in China there
were no buses to transport the workers to the plant. Instead, the workers
live in dormitories owned and operated by the company.
If the cost of manufacturing the Xbox is too high at a plant in Mexico where
the workers wages are not high enough for them to afford their own cars,
it is unlikely that there would be any place in the United States where
it could be manufactured economically. There is no way that American factories
can compete effectively with low-cost technologically competitive Chinese
factories. It is not just the unskilled labor in a Chinese plant that is
low cost. Skilled labor is also much cheaper. Engineers that design the
flow of product through the plants, or even design the product itself, are
much less expensive than an engineer in Guadalajara, San Jose or Reno.
Is China going to be the Most Powerful Country in the World?
Does this mean that China is going to put the US out of business? Probably
not. They're a lot are reasons why China, which is clearly ascending in
power, may not dominate the 21st century as many experts believe it will.
There is an excellent essay in Gary Becker and Richard Posner’s blog
that speaks to this issue. You can find this article at the following URL.
http://www.becker-posner-blog.com/archives/2005/04/index.html
Gary Becker wrote a column every week for the last 10 years or so in Business
Week before quitting to write the blog mentioned above. He is a Nobel prize-winning
economist at the University of Chicago. It is Becker's thesis that the phenomenal
growth of China's economy will not last. He compares it to Japan's economy
which looked incredibly strong in the late 80s and early 90s. Since then,
Japan's economy has been basically stagnant.
Sociological Problem - Boys and Girls
Additionally, I think there are some interesting sociological issues in
China. For one thing, they have now had the "one-child policy"
in place for two generations. Because it is better in the Chinese culture
to have a son than a daughter, there are now many more boys than there are
girls. Some Chinese women have had abortions when they found out the child
they were carrying was a daughter, and Chinese orphanages are filled with
little girls abandoned by their parents. A couple of friends are flying
to China to adopt couple of little girls this fall.
This mismatch between boys and girls cannot be good in the long run. For
one thing, these boys are now probably the only grandchild of two different
sets of grandparents. As China's economy continues to improve and China
becomes a richer nation van it once was, the parents and grandparents will
be more able to spoil these little boys. So, you'll have little boys who
turn into big boys that have been catered to most of their whole life by
their parents and grandparents. These kids have no siblings or cousins.
When you think about a whole country full of these spoiled boys and remember
that there are not enough girls to go around for them, you can see the roots
of fairly serious sociological problem. Whenever you've got a bunch of men
and not enough girls around, you typically have trouble. Think about prison.
It could be ahead so we in the future the boys will start organizing in
groups and march around looking for trouble - and chicks. If it is a powerful
country that lacks women, it seems likely that the men that live there will
go beyond their borders to find some. At least, I think I probably would.
Based on the behavior that I see around the house, it is my belief that
the next generation of Rogers would likely act the same way.
The Numbers
The sheer numbers related to the Chinese economy are staggering. The Chinese
population is more than six times the size of the US population. There around
2 billion Chinese people. There are approximately 280 million people living
in the United States. We don't know for sure how accurate that estimate
of the Chinese population is, because there are a lot of folks living out
in the hinterlands that are difficult to count. At any rate, we know that
it is a much bigger country than the United States. And he eventually, the
market for products could be a lot bigger as well.
In the fall of 2003 there was an NBA exhibition game between the Houston
Rockets and Sacramento Kings. This was an exhibition game and not many people
and the US were paying much attention to it. It was a game in which Yao
Ming played for the Rockets. As most of you know, Yao is the starting center
for the Houston Rockets. The Chinese TV audience for this NBA exhibition
game was 300 million people. Now, there are a lot of people in China that
still don't have access to a television. But even though they're a lot at
Chinese folks that cannot get to a TV, the television audience for this
NBA exhibition game was larger than the entire population of the United
States. More people in China were watching a meaningless game between Houston
and Sacramento than live in the entire US.
Conclusion
Earlier today (May 16, 2005) and I heard the sad story of United Airlines
defaulting on four different underfunded employee pension plans. This default
will impact approximately 120,000 current and former United Airline employees.
The responsibility for these pensions now falls on the federal government
in the form of the Pension Benefit Guaranty Corporation. If many firms follow
United Airline's lead, the Pension Benefit Guaranty Corporation will not
be able to find all of the defaulted pensions.
Because of outsourcing manufacturing to China and shedding expense of American workers, there are likely to be more pension defaults. The two most horrifying specters on the horizon are General Motors and Ford potentially defaulting on their pension responsibilities. Older workers and retirees are a couple of important reasons why GM and Ford are not as competitive as they used to be. If those two companies default the US economy will take a big hit. The severity of this problem is more immediate and then the potential insolvency in the Social Security system. The magnitude may not be as great as the sole security problem in the long run, but coupled with the Social Security problem we could see a fair amount of trouble fairly shortly. Some of the companies that are selling products in the United States may totally disappear due to foreign competition. If that happens their pension funds may also disappear. If the courts allow a lot of firms to follow the lead of United Airlines we are going to see a draining of the Pension Benefit Guaranty Corporation resources.