To be or not to be made there, that is the question.I have been visiting factories in Pearl River Delta, sourcing batteries and preparing manufacturing for the remote controlled MPEV and the solar umbrella. Here you see the almost campus like battery factory midway between Hong Kong and Guangzhou. It is one of three major factories of the sixth largest producer of batteries in the world.This area is the factory of the world, producing most of the world’s hard disk drives, toys,
and a good deal of things you find in stores in the US. It is a huge area, larger than the Southern California region around LA. Shall this region continue to be the workshop of the world, or this role be relegated to less expensive regions in south or southeast Asia?I remember visiting this region when I just graduated from MIT in 1982: it was miles and miles of paddy field just across the Hong Kong border. In less than thirty years, the population of Shenzhen has exceeded that of Hong Kong at more than 10 million, and the hinterland province of Guangdong has a population of almost 100 million.Herein lies the reason for its emergence: Hong Kong provided the excellent transportation infrastructure as well as manufacturing and trading expertise. China provided the land and labor resources. Hong Kong and the rest of the world provided the money. It started first when the manufacturing base of Hong Kong moved inland in the early 80′s. Yes, Hong Kong once had an influential export driven garment and toy industries. Since the 90′s, export growth has exploded, thanks to profit tax exemption and export rebates by the Chinese government. Bear in mind that then, and even now, China has a currency that is non-traded. If you produce goods in China, how can profit be repatriated if you cannot take the yuan out of the country? Well, you don’t, as the goods are shipped to Hong Kong before re-exported to the rest of the world. Hong Kong became the profit center, literally.Since the 2000′s, the region has gone high tech, with local grown auto and telecommunication industry. Multinational companies has moved in to take advantage of the manufacturing base, but more so the huge market of China. Domestic telecommunication companies such as Huawei and ZTE have dominated volume production of Internet and wireless devices and equipment. A nascent stock market provides the capital besides Foreign Direct Investment (FDI).Since 2010, the Yangtze River delta with Shanghai as its dragon head has taken over in terms of economic output the Pearl River delta combined with Hong Kong. Shanghai ports has exceeded in tonnage shipped than ports in and around Hong Kong.The logic is simple: the Yangtze River has a population and an area at least five times larger than the Pearl River. Since 2000, Taiwan has provided the management, money, and more important the high tech expertise across the Taiwan Strait to Shanghai. While similarly export driven in areas such as solar panels, the Yangtze River delta also is set up to meet demand of a huge domestic market of the Yangtze River where a majority of Chinese live.After visiting the Pearl River delta most of last week, I am going to spend the next two weeks, flying to the Tibetan area of Szechuang, then take the high speed rail through the 100 million plus population of Szechuan Basin through which the Yangtze flows through, then cruise from Chungking on the huge Three Gorges Reservoir created by the Three Gorges Dam at Yichong, and finally a bus ride from Yichong to the industrial and transportation center of the Yangtze River, the metropolitan city of Wuhan.I shall devote the next blogs to this journey, focusing not just on economic development along the Yangtze, but also the environmental disasters of severe weather changes that lately have dominated the news. Before that, let me discuss why I think the Pearl River delta shall retain its competitive advantage as the workshop of the world.Chinese industries are overwhelmed lately with three shortages: a shortage of sweat labor, a shortage of power supply, and a shortage of water resources. Sweat labor is becoming more expensive in the Pearl River delta. Power shortage also forces factories to close on scheduled outages, as power companies refuse to generate at government fixed below cost energy prices, while coal and oil prices have surged. Also, the Yangtze River drought has been so serious that the lakes along the mighty Yangtze has literally dried up.Recently, there is also a shortage of credit as the Chinese government has been tightening money supply after creating a deluge in 2008 to overcome the financial crisis then. China printed more money than the US Federal Reserve in QE1 and QE2, when trillions of dollars were created by the Fed just a book entry on Fed accounts. When QE1 and QE2 may not prevent a double dipping of the US economy, President Obama may bring on an equally futile QE3 before the next election.China prints money by telling banks, most of which publicly traded but largely owned by the Chinese government, to lend freely to public enterprises. In the hay days, there is little credit control, with little expectation that the money may be returned. Worse, government chooses “strategic” industries to lend to, e.g. high speed rail that costs trillions and solar panel industry that is handpicked by the government to dominate world production.Economic prudence fell by the wayside, as wasteful overproduction and speculation using freely handed out money feeds the frenzy. When much of that freely available money is used corruptly to make a quick buck, e.g. by speculating in the real estate market and driving housing prices to unaffordable levels by Chinese urbanites, the government would abruptly turn off the money supply. Since 2010, the government has mandated that the banks keep more than 20% of the face value of loans they lend out as reserve cash within the bank. Certain banks therefore keep loans off the book. The Chinese government is keen to keep full employment, a cornerstone for social stability. It does so by boosting employment particularly in the export sector with cheap credit, export rebates (the government send rebate check of up to 17% of exported added value), tax vacation, and government protection of selected strategic industries. These policies bolstering trade arguably contributes to the trade imbalance between China and the US.Another so called “unleveled playing field” that the US refers to is the undervalued Chinese currency. The yuan has appreciated significantly since first unpegging from 8.4 yuan per US dollar in 2005 to6.8 yuan per US dollar in 2008 when the global financial crisis drove the Bank of China to reestablish the yuan dollar peg. Since late 2010, the peg is again adjusted to as low as 6.6 yuan per US dollar.But it is unsure whether the yuan remains undervalued or not. I recall during the chaotic days of the Cultural Revolution of the sixties, the yuan could almost buy a dollar, as the Chinese government literally robbed foreigners if they want to have yuan. But those days are gone, now the US government follow through with the accusation that China now robs US of jobs by “manipulating” an artificially low value of the yuan. ironically, the manipulation used to be in the form of buying up US dollar denominated asset such as, well, US IOUs called Treasury bonds.Given the huge economic ties between the US and China, economic forces work to bring things back to equilibrium. Chinese sweat labor no longer works for a measly wage and long hours. Late 2010, Foxcom which manufactures a large number of cell phones and all of Apple’s iPhones and iPads was forced to raise salary by a third overnight, after more than a dozen of Foxcom workers jumped off Foxcom dormitories. Inflation, stoked also by the huge money supply as part of the 2008 economic recovery effort, now creates almost double digit inflation, thanks also to the artificially low yuan.Come this Christmas, US consumers shall see huge price increase of imported Chinese goods at a Walmart near you. If any of the “unfair” Chinese trade practices ends, e.g. ending the export rebate that tends to lower your Chinese made everything or appreciating further the yuan, the american consumers shall foot the bill for our addiction to Chinese made everything.Could we shift our addiction to non-Chinese made everything? Not likely, and here is my conclusion of this blog. First, the knowhow to make everything really is everything when it comes to exporting. We americans have forgotten how to make things, as we are not willing to sweat it. Not that it is that important to make things, we can make a tidy profit by selling things instead, and much of the value of products sold these days resides in the brand, the innovation, the technology, and well, the way we sell.Look at the Apple iPad on which I am typing this blog out. Chinese sweat labor comprises something like 10 dollars in assembling the iPad, whereas Japanese components make up more than 70 dollars. Apple’s cost per iPad is somewhere around 150 dollars, and the rest of the 500 dollar iPad sale price is tidy profit for Apple. Nice!Second, it takes excellent infrastructure to support trade, which is lacking in most of the third world countries. Not so in China, it has the largest ports, the fastest trains, and an extensive freeway system to move goods around.Third, it takes a huge population. For a manufacturing base, 10 million people is nothing compared with say a 100 million, say the population of many of Chinese provinces such as Guangdong, Henan, Szechuan, Hubei and Hunan, Shandong, just to name the top few. Each is larger than Germany, willing to work for a fair wage as sweat labor. Though not as skilled, the Chinese labor force is getting a good education and training. While cities surrounding Hong Kong and Shanghai have a hard time attracting migrant workers, there is so much room for industries to move inland.Is this all bad news for the US? Not really. I have decided to manufacture some of my products in China, partly for cost issues but more for the quality of production there. However, I find the most important value resides not in the manufacturing but in the innovation. We can learn from Apple, which is more valuable than Microsoft and Intel as Apple never ceased to innovate to make products people want.Unfortunately, China does not encourage creativity and independence so crucial to innovation. The majority of the Chinese population is risk adverse, preferring to make a quick buck through copying others or taking the well trodden path. China has all the laws it needs, but the rule of law leaves much to be desired.Count on it: if you are successful, China will copy your success, with or more likely without your permission. You must have an eye on intellectual protection, but that is hardly enough in China. You must create other entry barriers, such as knowhow, brands, and distribution networks.Chinese production and Chinese market are quite different. Yes you can make in China, assemble and brand in the US, and sell first to the rest of the world other than China, following Apple’s example. The new iPads in Hong Kong are sold mostly to Chinese scouts who can sell them with a tidy profit in China, where the iPad is made but not sold. The question to my answer: Made partly in China for the US. Work smart, besides working hard.