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First Thoughts
  By Dan Gilmore - Editor-in-Chief  
  May 26 , 2011  

Supply Chain News: Rethinking China Part 2


The world moves awfully fast.

A few weeks ago, I wrote a column on Rethinking China, which basically argued this: that the US and other developed economies were basically shooting themselves in the foot with regard to their relationships with China.

Gilmore Says:

Last week, the respected consultants at Boston Consulting Group released a report predicting that by 2015 - just four years - all-in costs to produce and deliver goods from China to the US will be on par with making the goods in the US.

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Meaning, that while China is rightly seen as rising rapidly, soon to overtake the US as the largest economy in a few years by the International Monetary Fund (IMF) and others, that ascent has almost totally been paid for by the same developed economies that now seem to be in relative if not absolute decline.

China's economic growth has simply come from the huge trade surpluses it has piled up with most of the rest of the world - more than $2 trillion in trade surplus with the US since 1999, for example. 50% or so of China's GPG growth is coming from government spending on infrastructure, which is only possible because of those trade surpluses. Pundits come back marveling at impressive Chinese ports and highway projects, while US infrastructure keeps getting C or D grades from the Civil Engineers society, but a lot could have been here with that $2 trillion too, and the same is true for many other countries.

China can also make big investments in natural resources in South America, Africa and elsewhere, to its long-term strategic advantage, because of those huge surpluses and foreign currency reserves.

Lawrence Summers, Harvard university Professor and former high level government official under Presidents Clinton and Obama, recently said that "When someone writes the history of our time 50 or 100 years from now...It will be about how the world adjusted to the movement of the theater of history towards China." But again I say, because Western nations handed it the money to make the move.

China has in just a few years dramatically changed trading relationships the world over. The chart below shows how China has rapidly moved to being the number 1 or 2 trading partner of an incredible number countries, and how its share of global exports has climbed 500% from 1990 to 2010, now enjoying over 10% world market share.


Source: The Wall Street Journal


The impact is dramatic everywhere. For example, as the Brazilian economy matured, it was planning to become more of a global force in manufacturing. Now, 80% of Brazil's exports to China are agricultural or mineral/oil products, while it imports an increasing percentage of the manufactured goods it consumes from its new largest trading partner. Brazil, Australia, Canada and others mature and developing economies are sending oil, ore and other commodities to China and getting back finished goods.

So what turns out to be good for any individual company - lower costs from outsourcing to Chinese manufacturers - is in total bad for the country (I think). And supply chain is at the heart of that, since we lead the charge to find lowest total costs sources, and manage the complexity of making it happen.

So, that mostly summarizes my part 1. In part 2, I was going to ponder a bit on what to do about it, and still will, but in just the past few weeks has come some interesting news.

Many have commented that the rise of China in manufacturing has been different than say the threat Japan appeared to pose to the US in the 1980s (and much touted itself, by the way). First, it was Japanese companies directly that posed the challenge, supported by its "industrial policy" the West lacked, and Japan's network of closely linked companies.

China, on the other hand, was fueled not so much by Chinese companies directly, but by Western companies hiring the Chinese to do the work - labor arbitrage. Many compounded the situation giving up much technological know-how to their emerging Chinese competitors through carelessness, short term thinking, or government coercion, but the results were the same regardless.

Other noted that the ease of going global today made it possible for China to exploit its advantages in ways other up and comer were never able to do in the past. Chinese intense "cost engineering" was also a potential mortal threat to many Western manufacturers.

Two weeks ago, however, William Fung, CEO of Hong Kong-based trading giant Li & Fung, said we will see some dramatic changes in China over the next five years, and he is someone who really ought to know.

He predicts that Chinese wages will rise 80% over the next five years - a dramatic jump. Ironically, China's turn to a major economy with double digit GDP growth has been perhaps the key factor in rising global commodity and food prices. Inflation is running about 5% there. The Chinese government needs therefore to keep wages rising to keep up with this inflation, or risk civil unrest.

Then last week, the respected consultants at Boston Consulting Group released a report predicting that by 2015 - just four years - all-in costs to produce and deliver goods from China to the US will be on par with making the goods in the US.

BCG says that by that time, Chinese labor costs will have rising from about 9% of the US average today to about 17%. That, plus a falling value of the US dollar versus the Yuan and other factors we will soon reach "a point of indifference between producing in the U.S. and producing in China," says the company's Hal Sirkin. (We will do a more in-depth review of this report in next week's On-Target newsletter.)

Interestingly, BCG says this will not be true for European countries, where wages are higher in the developed countries and workers are less mobile. BCG sees a lot more US-made cars being exported back to Europe for this reason (note to self: be ready for more labor strife coming to Europe over next few years.)

So just when we reach the point where both right (e.g., Donald Trump, Paul Craig Roberts) and left seemed to have come to level of agreement that the current trajectory must be changed, are internal developments in China going to make it something of a moot point, just as Japan's supposed world dominance in the 1980s soon faded from view?

I say no, or at best, just partially. While the wage impact will change the dynamic to a degree, people overestimate the role of blue collar wages, missing that lower Chinese overhead is at least as big a factor in the total Chinese cost advantage. China has been intentionally giving up on low value goods anyways, which it long ago recognized were headed to Vietnam and elsewhere at some point, and has been focusing on higher value goods for several years.

Paul Craig Roberts, a well-respected former Reagan administration official, told me a few weeks ago that "Globalism is an act of national economic suicide," as it has been practiced to date. I am not sure I would go that far, but it is very hard to argue it has worked in our favor (or in Europe and Japan and frankly most countries besides China).

Roberts told me he had endorsed Ralph Gomory's solution, "which is to tax US corporations according to where value is added to their product. If they add value in China with Chinese labor, a high tax rate. If in the US with US labor, a low tax rate."

Would the cure be worse than the disease? We will explore that in a few weeks.

What is your reaction to Gilmore's Rething China Part 2? Do you agree with Fung and BCG that this situation will largely take care of itself? Or is that an overly optimistic prediction? Would a tax on value add be a smart approach - or worse than the disease? Let us know your thoughts at the Feedback button below.

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A very thought provoking subject!  Thanks for the content!
If Mr. Fung really believed China would be on even par with American manufacturing costs in just five years, he would have a strategic plan to move much of, or a great portion of his operations to Mexico or some other nation where costs could be controlled. Does he?
Would we be naive to think that "a great portion of the manufacturing" would return to the US?  Since transportation and raw materials are becoming a much greater part of the equation, it may make sense. Somehow the the "term" trade balance comes back into perspective to stabilize NOT ONLY the US economy, but that of the now Global Economy.
As you know....five years comes quickly in the real world.  The "smart" Companies have their Strategic plans laid out at least five years in advance.   Needless to say .....there must be a great deal of plan A, B, C, and D, contingencies .
Mark Shuda
Think Forward Consulting


You essentially ask if new taxes will solve the problem of the US balance of trade. It seems to me this question has been answered again and again.

If I may summarize the Quarter 1 2011 60-Minutes interview Lesley Stahl had with John Chambers Cisco Corp. CEO who has spoken frequently on the topic of taxes...

During the interview Chambers again lobbied once more in favor of a one-time reduction in the U.S. corporate tax rate of 35 percent so Cisco and other companies could bring profits home.

The term being used is “repatriation” for the money transfer. And Chambers said a lower [US Corporate tax] rate would bring hundreds of billions of dollars back. He then said that money would lead to investment and jobs here rather than overseas.
Stahl replied."You lower the rate from 35 percent to 20 percent. You lose something like $2 trillion in taxes. We have a horrible deficit crisis, debt crisis. That`s almost too much money to lose. What`s your answer to that?"

Chambers said: "My answer`s very simple: every other developed country in the world has already done this. I`m not asking [the US] to give me a favor, or a hand out.....All we`re asking is: Give us a level playing field. Get us close."

Cisco, is far from alone in the lobbying effort, which so far has not paid any dividends with the Obama Administration or even some leading Republicans.

In late April 2011, a number of [US] corporations formed a consortium to back what they are calling the “Win America Campaign.”

Backers include:
  • Adobe
  • Apple
  • Association for Competitive Technology
  • Broadcom
  • CA Technologies
  • Cisco
  • Cognizant
  • Consumer Electronics Association
  • Duke Energy
  • EMC Corporation
  • Google
  • ITI
  • Kodak
  • Microsoft
  • Pfizer
  • Oracle
  • Qualcomm
  • SoFTEC Finance & Tax Executives Council
  • TechAmerica
  • TechNet
  • U.S. Chamber of Commerce

Dave Rivers
Thornton NH


It is perfectly true that every CEO is driven and motivated by the bottom line. Hence the focus on “Labor Arbitrage” and we obviously do not only not tax offshore work but we are heavily subsidizing the move of both industry and services offshore. Should we quote GE or GM on this subject?
As a CEO, if I were to be taxed on my imported components I would simply move my headquarters offshore to where my manufacturing facility is currently situated (or Bermuda, here we come). There is no penalty for such an action and my shares can still be traded in the US.
It is true that I would pay duties on many items, but US duties are very low compared with the 95% and 100% on many finished products entering China (or Brazil with 9 taxes, and India), while the duty rate on raw materials, including specialized chemicals, is often zero or below 2.5%. China also benefits from the most favored nation duty agreements while still charging very high duty rates on imported finished products. Raising export taxes on raw materials and special chemicals would help, but will also impact our own labor market.
Hoping that Chinese labor rate increases could offset our higher rates is not really a good bet as we, the Logistics Industry, continue to lower costs of transportation. Thank goodness that China will need more oil than us very shortly. That will substantially increase transportation costs which will save us to some degree!
So no clear suggestions other than removing the most favored nation status and calculating a dollar for dollar offset on imported finished goods equivalent to the same rate charged by China on finished goods.

Applying graded income taxes could have quite a negative effect and the movement of corporate offices.
Tony Tyler
CEO eF3 Systems Inc.


I am in Shanghai now as I write this. I have not been to Shanghai for over 20 years. It`s as if the city of Chicago was built in 20 years in terms of buildings roads, housing, and municipal infrastructure. There is now a thriving middle class made up of professionals, small retailers, and people working for larger corporations. This transformation has extended itself to many other inland cities as well. I get the feeling that China will soon reach a point like the US did in the 20th century where the national market will be big enough to support job growth and exports, while welcome, will no longer be as important to the Chinese economy as they are today.
I agree that one of the major ways to stop good jobs leaving the US and keep US companies paying a living wage with benefits is to change our tax policies. The tax code should reward companies creating jobs in the US and penalize those that outsource them. What we have now is almost the opposite incentive. I believe a change in tax policy will actually improve the US economy as more spending and investing will be done by a middle class assured of permanent well paying jobs. Today`s job market uncertainty is slowing the Recovery, not marginally increasing taxes on the rich or corporations.
David Price
WMS Consultant


I appreciate reading your articles on China.  Thoughtful, complete and insightful.  And for people familar with China .... most is "spot-on".

I`ve been in China off-and-on for the last 8 years.  For the last 6 months, I`ve been on-site in Shanghai, Jinnan, Taishan, Ningbo, Changhouz, and Minhang Technical Development Zone.  Over this time, I`ve gained a tremendous appreciation for the Chinese culture and behaviours.  For sure, China is large with diversity of thought.  Yet, in most instances,  China is of one mind.  They, and each of it`s citizens, are bent on improvement.  Young families seek the means to make money, and accumulate wealth to send their child to the best schools.  People work all hours of day-and-night to simply make a few extra RMB.  Businesses looks for ways to use their income on the best projects  and to develop their employees and young managers.  Governments work to enable businesses to prosper via straight-forward and rapidly implemented policies to incentivise local growth consistent with a national 5 year plan.    

As you routinely observe, the growth here is phenomenal.  In all matters of industry and government.  That is not to say China does not have problems.  Issues consistent with other countries such as pollution, safety, worker rights, women rights, taxes, economic disparity, social equality, corruption, etc. are all challenges.  Yet, China seems better positioned to meet these challenges.  Why, because change is pervasive throughout the country and has been for centuries.  

In my view the key difference in China is leadership.  I`ll qualify my following comments. As a general rule, the quality of leadership from local to national levels is exceptional.  There may be out-liers, but in general, Chinese leaders take their responsibilities very serious.  They look for steady progress to the future rather than "the big bang" theory.  They are focused on their particular business, rather than the business of others communities, or nations.  They are thorough in their approach to problems and challenges.  They are quick to accept responsibility for their actions, rather than deflect consequences to others.  In short, the Chinese leaders in business and government is very pragmatic.  They are intolerant of poor performance.  Perhaps if our political and business leaders were more intolerant, America would have fewer failed business, fewer incompetent legislators and a sustained GPD greater the 3 %.

In summary, China will continue to grow, prosper, and likely remain inwardly focused on infrastructure, social well being, technology innovation and education.  They will likely spread their form of social responsibility worldwide.  Whether in medicine, finance, technology, business practices, governance, and leadership, the Chinese are changing at lighting speed.  I have no doubt, the western world will learn more over the next 25 years.  As China emerges on the world scene, I see a better place.

Steven D. Abbott



Thanks for writing. I can actually agree with most of what you said without coming to the same conclusion.
Just because China “earned” its current position does not mean that  a country has to stick to the status quo.  When you take one strategy and find it didn’t end up delivering the result you wanted, then it is necessary to change strategies. And yes, ultimately that means the consumer will pay more – which is exactly what Mr. Fung is saying is going to happen anyways, if you read his full comments.
If you read my first part of this, I referenced the “tragedy of the commons,” in which what is good for one person (or company) can be bad for all as others jump on the same strategy.
You can call it sour grapes, and maybe that’s right, but it may not still be too late to change the game. That was just the point.
Dan Gilmore

I think your arguments can be summarized in one phrase – “Sour Loser”. Supply chain is but a tool in the hands of the investor – the corporate giants who in their greed for more money and global market share have been sacrificing US jobs for the sake of corporate gain and all in the name of efficiency and globalization. Wasn’t it obvious when entire factories in the US were being closed and people laid off?
After enjoying low prices for almost 2 decades, I believe it is very unfair and selfish on your part to say that the West paid the money for Chinese growth as you have failed to recognize the humungous efforts put in by the Chinese workers who toiled in miserable conditions to enable consumers in the West to continue to buy goods at extremely cheap prices. Fact of the matter is that the Chinese earned their growth through hard labor and intelligent use of resources just like any other nation.

Yonus A. Siddiqui
Vice President Projects
e2e Supply Chain Management (Pvt.) Ltd.


I believe we all recognize that developed countries have ridden the wave of prosperity on the backs of developing nations. As we become one world we will inevitably see a leveling of wages, opportunities, etc. My hope is that we can raise the level for everyone while not drowning ourselves.
Jamie Elder


I say that it’s about time OUR pundits start shouting from the mountaintops how the U.S. is moving to reclaim/rescue its status as the world’s #1 economy.
McLain Oppy
Supply Chain Consultant
The Open Sky Group, LLC


This goes to the heart of my main point in your January 2011 “Guru Predictions” piece (First Thoughts, Jan. 21).  The U.S. needs to provide a combination of incentives and legislation to repatriate some of the work which has been sent to China and other locals over the past decade.  The biggest concern of the U.S. voters is not the war in the Gulf or whether government went too far in the bailouts, but rather the need to get a job, a roof over their heads, and to put food on the table. 
I do agree with Mr. Fung’s statements that over time there will be a balancing caused by risings in China, but changes over 5 years are not going to produce U.S. jobs in 2011-12.  Nor will they help the current administration get re-elected.
Steve Murray
Principal Consultant and Chief Researcher
Supply Chain Visions, Ltd. 


Think Tank groups have been pondering the “China Quandary” since business first started moving in that direction. Some have been correct and others not. To keep it real when wage earnings and the ability to spend those wages within the economy where the people live are removed, then the economy of the area shrinks. America sent work and jobs overseas, for some it was a good thing to do and helped people in these other areas, for others it enhanced the native corruption. For the country it left it took the financial stability. If people are not earning money they cannot spend – the usury system only works on spend. America is feeling this struggle now, though the symptoms have been showing for years. Americans love it because we support it, realize this, a person earning 10.00 an hour; it takes about 12 hours of wages to fill a truck tank. Ah.... but then we should be good citizens and get vehicles that require less gas, get better milage, then all we do is fill more often, which is more time dollars spent, the engines are not as long lasting and spend more on replacing the vehicle or repair work. Wonder what the ROI is on that long term?
To keep it real further, it is not the businesses or corporation who are the root cause of the migration of work, it is the consumer. Business exists to make a profit, and they can only make a profit if they sell something. The business has to sell, the consumer on the other hand does not have to buy, and with all the options out there the consumer can be very selective. So the consumer wants it cheaper, even in what is believed to be a strong economy. So in the effort to deliver this cheaper cost the making of the product goes elsewhere. This is the genesis of most of what we experience today. I am sure there are other agendas at work but this is still the meat of it.  So..…America did it to herself, it stands to reason we need to be responsible enough to figure out how to course correct. There is this to consider to….China will go through what we did, we have taught them well and laid the same foundation for failure we set for ourselves. History has taught taxation is not a solution, history has also taught us most situations that take of themselves it is not to the benefit of the people. But then, history repeats itself.
Stella Bray-Conrad

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