“Comparative Advantage”, which helped China become the world’s manufacturing hub, may now be starting to work against China, based on a growing body of evidence. But before we delve into this further, what does it (Comparative Advantage) mean?
In simple terms, it means that each country or region should produce, manufacture or create what it can do most “efficiently” (= using the least amount of raw materials or inputs).
In more rigorous economic terms, from an MIT article,
David Ricardo’s concept of “comparative advantage” is one of the most famous and venerable ideas in economics. Dating to 1817, Ricardo’s proposal is that countries will specialize in making the goods they can produce most efficiently — their areas of comparative advantage — and trade for goods they make less well, rather than making all kinds of products for themselves.
As a thought example, Ricardo proposed, consider cloth and wine production in England and Portugal. If English manufacturers are relatively better at making cloth than wine, and Portugal can produce wine more cheaply than England can, the two countries will specialize: England will concentrate on making cloth, Portugal will focus on making wine, and they will trade for the products they do not produce domestically.
For the last couple of decades, as many erstwhile manufacturing hubs in the US realized, China was a prime illustration of this principle (in addition to companies’ greed, as some would argue) in action. Because labor in China was cheap, substantially more so (anywhere from 60 to 90% cheaper than in the U.S.), many low skilled jobs and some moderately skilled ones too, migrated to China. Entire factories sprung up to make everything from toys to phones to American flags.
But now there is growing evidence that parts of China are beginning to see the other side of this economic principle in action.
China’s reliance on cheap labor has powered the country’s economy to unprecedented heights. But China’s manufacturing sector is running into problems these days: squeezed from one end by places with even lower labor costs, such as Laos and Vietnam, and yet struggling to move to higher ground making more advanced products because of competition from developed nations such as Germany and the United States.
What this means is that just like their American and Western European counterparts, Chinese companies and workers must now move up the “value chain” and begin to produce products that require high degrees of skills and are not easily transferable to lower wage countries.
The alternative is a future where other lower wage Asian countries become the world’s next generation of foundries and factories.
Yet another alternative, which should cause substantial cheer in the American heartland, if fully realized, is a slow and eventual return of at least some manufacturing and related jobs back to the US, as an article in The Economist noted, back in March:
Joerg Wuttke, a veteran industrialist with the EU Chamber of Commerce in China, predicts that the cost to manufacture in China could soar twofold or even threefold by 2020. AlixPartners, a consultancy, offers this intriguing extrapolation: if China’s currency and shipping costs were to rise by 5% annually and wages were to go up by 30% a year, by 2015 it would be just as cheap to make things in North America as to make them in China and ship them there… In reality, the convergence will probably be slower. But the trend is clear.
That article goes on to argue that what may prevent both alternatives from becoming reality in the near future or even for another 15-20 years, is that China provides not just cheap labor but amazingly efficient supply chain logistics as well as ecosystems of suppliers. While supply chain logistics are no doubt key, the supplier ecosystems are more key – because having other companies near by that can supply all the parts that you need does wonders to inventory management, costs and efficiencies. This is something that is difficult to reproduce elsewhere easily.
Still, these are early warning signs. Or signs of hope. It depends on who you are and where you are.