Sunday, May 22, 2011

Labor Arbitrage is Disappearing for Outsourcing Manufacturing to China and Services to India

I've reported recently (see posts here and here) about the Boston Consulting Group's prediction of a pending manufacturing renaissance in America because the labor arbitrage gains from manufacturing products in China are starting to shrink and will eventually disappear.  Cost advantages for manufacturing are starting to shift back to America because of rising wages in China, along with rising prices there in general and an appreciating currency. 

A story in today's Washington Post is predicting the same erosion of labor arbitrage for outsourcing service-sector jobs to India:

"India’s outsourcing giants — faced with rising wages at home — have looked for growth opportunities in the United States. But with Washington crimping visas for visiting Indian workers, some companies such as Aegis are slowly hiring workers in North America, where their largest corporate customers are based. In this evolution, outsourcing has come home.

Tata Consultancy Services, for example, is ramping up its North American presence in major deals with Citibank, Dow Chemical and Hilton Worldwide. It plans to hire more than 1,000 Americans in 2011 and to base 10,000 of its 185,000 global employees in the country."

MP: Wages are increasing 11% per year in China and by 10% in India, which means that labor costs there are doubling every 7 or 8 years if those wage increases continue.  Wages in the U.S. are rising by only 1.9% annually and at that rate it would take 37 years before wages would double here.  At some point, the labor arbitrage advantages for China and India have to disappear.  BCG predicts that “Sometime around 2015, manufacturers will be indifferent between locating in America or China for production for consumption in America."


At 5/22/2011 10:46 AM, Blogger Jason said...

I am not sure about the timeline Prof. Perry. For example, for automotive electronic assemblies, there has been no cost advantage for 5 years. Yet manufacturing continued to move to China.

The reason is cost of capital and cost of risk. As a result, investors/companies are far more reluctant to invest in a plant in the United States. I witnessed this first hand.

I have no doubt that a crossover will occur. I think that it will have to become significantly more expensive to manufacture in China and other low cost labor nations before a true renaissance takes place here.

And a militant NLRB can move that timeline out even more significantly.

At 5/22/2011 11:09 AM, Blogger Buddy R Pacifico said...

Labor arbitrage may be shrinking but other factors are also be at work:

Tax Credits for U.S. manufacturing.

Very difficult bureaucracies in India and China.

Intellectual property rights indifference / malfeasance in India and China.

Outsourcing problems, in products and engineering, that undermine a company's reputation and profitability.

Unwillingness of U.S. companies to give expertise away in exchange for access to markets -- with only minority stake in joint concern with local governments (China).

At 5/22/2011 11:35 AM, Blogger morganovich said...

Very difficult bureaucracies in India and China.

do you realize how much easier it is to build a factory in china than in the US?

environmental regs, osha, unions, building inspections, permits etc?

you can go from a green field to operating in 4 weeks in chine. it's more like 16-36 in the US.

At 5/22/2011 12:29 PM, Blogger Rufus II said...

The American Sun Belt is looking better, and better.

Before I built in China I'd have to consider the possibility of an American Populist backlash leading to Tariffs on Chinese goods. Unlikely, maybe, but still to be considered. I'd hate to be caught out on the wrong side of That bet.

Also, transportation costs are going up. Might be a factor in Some cases.

Then there are the "unknown, unknowns." Three Gorges Dam? Fukushima?

A lot to consider.

At 5/22/2011 3:38 PM, Blogger Benjamin Cole said...

The Chinese Communist Party, 750,000 members strong, still owns controlling shares in all publicly traded chinese companies.

Inevitably, graft, corruption, ossification will set in. Like any U.S. federal civilian or military agency. Coprolite.

Thankfully, the US private sector still witnesses creative destructionism.

We may become again the manufacturing platform of choice--and I agree with Morganivich, that free manufacturing zones need to be set up in the USA that allow immediate construction of manufacturing facilities, with pre-provided utility hook-ups etc.

For the sake for a few billions of dollars, we could probably attract hundreds of billions of dollars of business here--if we keep the USA dollar at an exchange level that enhances trade.

At 5/22/2011 3:53 PM, Blogger James E. Miller said...


"As I read the article it looks to me like the driving force behind this limited return of work to the US is that the reputation the Indian call centers have developed for poor performance has turned into an impediment to new business."

Okay, so after being provided relatively cheap service through call centers in India, those centers are now being looked at as a detriment to businesses because of the quality of service and yet that somehow works itself into an argument against free trade? Or you kidding me?

So rather than businesses having the option of outsourcing, they should instead be financially or legally forced to hire American workers? How is cutting off options to consumers good for consumers in the end? Perhaps if we impose a 200% or more tariff on imports than we will be forced to pay each other for goods. Say goodbye to being able to purchase cheap things, add to savings, and invest in more higher order goods.

At 5/22/2011 4:31 PM, Blogger Rufus II said...

No one said it wuz easy.


At 5/23/2011 1:06 AM, Blogger PeakTrader said...

Much of economics is counterintuitive. The U.S. has benefited tremendously from free trade, in part, because consumer surplus has been grossly understated.

If the true benefit of consumer surplus was reflected in the trade balance, U.S. trade deficits would actually be trade surpluses.

However, we may benefit less, because the net gains of domestic production may be more than offset by the net losses of domestic consumption.

So, although a "manufacturing renaissance" will contribute to GDP, it can also contribute to lower living standards.

At 5/23/2011 1:18 AM, Blogger PeakTrader said...

And to explain how U.S. trade deficits are actually trade surpluses:

If someone is willing to sell you something at half price, then you may buy three units instead of one unit (given your budget constraint).

So, for example, you'd import three units for $15 and export one unit for $10, creating a $5 trade deficit.

However, you really exchanged your $10 good for three $10 goods, or $30, i.e. a $15 surplus (because you paid $15 for $30 worth of goods).

At 5/23/2011 7:44 AM, Blogger Jason said...

However, you really exchanged your $10 good for three $10 goods, or $30, i.e. a $15 surplus (because you paid $15 for $30 worth of goods).

Peak, I understand your argument. However, the goods we import are worth less once the consumer has taken delivery. For instance, a TV bought for $1000 is worth less once it is out of the box. Most imported goods used prices behave similarly. Perhaps only things like jewelry or oil (commodities) wouldn't. Doesn't your argument assume the intrinsic value of the good stays fixed?

At 5/23/2011 1:03 PM, Blogger Free Trader said...

I think this is Jeff Rubin' s prediction.

At 5/23/2011 1:52 PM, Blogger PeakTrader said...

Jason, consumer surplus is the difference between what you're willing to pay for a good and what you actually paid.

If you favorite box of cereal sells for $4.99, you may buy one box.

However, if it's on sale for $1.99, you may buy three boxes.

Consumer surplus doesn't diminish after you open and eat your cerreal.

Luxury goods, e.g. a $1,000 TV, normally have less consumer surplus than normal goods.


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