The Beginning of the End of Cheap Labour for Sri Lanka’s Manufacturing Rivals?

By Anushka Wijesinha, Research Officer – IPS

Labour pains have blighted Chinese and Bangladeshi manufacturing in the past month, leading to questions arising on the sustainability of their economies’ low-cost labour status.

In the Bangladeshi capital Dhaka, over 15,000 garment factory workers that make Western branded clothes blocked key roads in the latest in a string of protests demanding higher wages and better working conditions. The strikes began in four factories, owned by one of the country’s leading garment manufacturers, and then spread to hundreds of factories in the country’s garment factory corridor, causing much of them to be shut down for days following the protests. It is the latest in a series of violent protests over low wages in Bangladesh’s more than 4,500 garment factories – the key employer in the impoverished economy, employing more than 3 million workers.

Bangladeshi workers, who make clothes for major Western brands such as Wal-Mart and H & M, have been demanding wages of at least 5,000 Taka (US$70) a month, while it is currently 1,660 Taka, less than US$ 25. The increase demanded is about 300%, and factory owners have said they couldn’t pay more than 3,000 Taka a month.

Meanwhile, as protests by Bangladeshi textile workers get more violent and supply chains are crippled, Chinese factories owned by multinationals too have been blighted with a series of strikes. There have been a spate of recent suicides (linked to low pay and work conditions) at Taiwan-owned electronics manufacturer Foxconn, followed by strikes in a number of auto-parts factories, which has led to granting of a rapid rises in wages. With no explicit government intervention (except for some raising of minimum wage rates in certain urban agglomerations), and facing debilitating strikes and factory-floor suicides, the foreign firms have granted wage increases in the range of 25-30%. These wage hikes would see their monthly wages rising from US$ 200 previously (working 6 or 7 days a week), to close to US$ 300 now. Much of the labour issues involved migrant workers from rural, inland areas who have moved to the manufacturing hubs in China’s coastal areas, where costs of living are higher.

So, all this has stirred up a hot new debate as to what the implications are for the longevity of low-cost manufacturing in the Chinese economy.

The End of China’s Labour Surplus?

Economics has an interesting yet highly stylised model which attempts to show how the structure of an economy, which initially enjoys surplus labour, changes over time as that advantage diminishes. It is the so-called Lewis Turning Point, which indicates that after reaching the turning point in development, the economy’s labour surplus disappears, the labour market tightens and real wages rise rapidly. This in turn forces various structural changes to take place in the economy from that point on.

However, in China, the turning point may occur at different times in different regions owing to the vast size of the country and the resultant diversity in each region’s labour markets. The diminishing labour surplus would most likely in the industry-heavy coastal areas, and take more time to occur in the rural inland.

Demography is also playing a role in this effect. An unfortunate consequence of the success of China’s one-child policy is that although the country’s absolute supply of labour will continue to grow for a few years more, the numbers of young people entering the labour force will shrink by 30% over the next decade. This would in turn, improve the bargaining position of labour in general. Moreover, unlike their parents, the young migrants born in the 1980s and 1990s who were striking last week have higher expectations and want better living conditions and a better quality of life. Cheap labour is no longer being assumed as an ‘inexhaustible resource’, and already a labour crunch in the coastal urban areas is underway.

In essence, what is happening is that China’s growth model, which largely reliant on the abundance of rural workers migrating from the countryside and willing to work for very little pay, under poor conditions, is seeing the beginning of the end.

As Wage Costs Rise, will Foreign Firms Pack-up and Leave?

The recent suicides and strikes have triggered worries of more widespread labour disputes leading to accession to more wage hike demands, resulting in a profit margin squeeze in China’s export sector as well as a big jump in inflation or even a wage-inflation spiral.

In much of the conventional wisdom of FDI, it was assumed that demands for higher wages would simply mean that firms would pack-up and leave to the next source of cheap labour, and therefore this renders such workers ‘powerless’. However, this is increasingly being debated. , Workers in China’s components assembly firms or Bangladesh’s garment factories have fairly strong bargaining power to organise and drive up wages as they are a vital link in the international supply chains of multinational firms. Additionally, these foreign firms are unlikely to move out of China due to the many other advantages that the nation offers them, and this is the important lesson to be extracted here. China as an FDI host, initially competed purely on cheap labour cost advantages, but since then has quickly evolved to become a veritable biz hub for the world’s top production enterprises by streamlining procedures, improving education and productivity to provide a steady flow of skilled workers, and by investing in science and technology to ensure firms are continuously moving up the value chain. China also invests heavily in its connective infrastructure, making its highways, ports, airports as well as Special Economic Zones extremely attractive for businesses to locate in China. So, even as the labour cost advantage diminishes over time following issues like the recent unrest, China’s competitive advantage is likely to be very well preserved for years to come. This is the lesson for Sri Lanka.

China’s position as ‘the world’s factory floor’ and its success story of export-driven economic growth are being challenged by the rising wages and labour shortages in coastal urban areas.

For a few years now though, China’s low-wage era has being drawing to a close. Chinese workers’ wages which are generally around 800 Yuan per month are higher than in countries like India, Malaysia, Vietnam, and Bangladesh. Data shows that the minimum wage for unskilled labour in Vietnam is between 400 and 500 Yuan (US$59-74) per month, and is lower than even in Bangladesh. It is quite likely that wages in China’s manufacturing industries will rise even further in the next several years.

Does industrial transfer then seem inevitable? Yes, and no. According to a survey by the Federation of Hong Kong Industries, “37.3% of 80,000 Hong Kong companies based in the Pearl River Delta are planning to transfer part or all of their production capacities out of the region, and 63% of surveyed companies are prepared to move away from Guangdong province”. Soaring costs such as the rising wages have forced them to turn to areas with lower costs, they said.

So, yes, but mainly among low-end, small-scale processing industries which may go shopping for cheaper labour pools, but the higher-end industries are likely to remain. For leading industries like Foxconn and Honda the labour cost advantage was useful – it was a necessary but not sufficient condition. These industries enjoy the advantages of local industry agglomeration, including features like the existence of a strong market, good logistics, efficient procedures, biz-friendly tax policies, and suitable living conditions. Given China’s comprehensive advantage in these factors, foreign companies exporting from China are likely to want to remain rather than move to other countries. Furthermore, China has begun investing heavily in skills upgrading and productivity improvement in order to continue being an attractive location for export-oriented industries, even if wages continue to rise in the coming decades.

Moreover, companies like Honda are doing what American firms did a decade or so ago facing similar conditions – they installed more automation into their factories in order to reduce the manual worker component.

For many of the sophisticated electronics industries which have located in China, labour is just a small slice of the pie. Much of the cost is in the design and marketing capabilities, and the complicated distribution system, including retail outlets. So they are likely to retain their basic production operations in China.


Does this Open the Door Wider for Other Countries?

The recent developments in China certainly do edge the door a little more open for other FDI-attracting countries. Products requiring less sophistication and are labour-intensive (footwear, plastics, textiles, etc) would be prime candidates for relocation to Vietnam, Bangladesh and Indonesia. Whereas, in the case of more complex products like consumer electronics, home-ware and toys electronics, firms may move the less-skilled manufacturing components to the interior provinces of China where wages are still lower, while keeping the higher-skill operations in the established industrial hubs in the coastal provinces.

On the question as to which countries could benefit from any industrial transfer? India comes to mind. It is the only other country with a big enough cheap labour force. But the main disincentive is India’s weak infrastructure, and less spread of infrastructure-ready zones, thus not allowing to effectively compete in really low-cost manufacturing. India fares better in skill-intensive manufactures like software, pharmaceuticals, engineered products where margins are higher.

So, as one Economist, Pietra Rivoli, Professor of International Business at Georgetown University, put it* – “In the mid-term, if China ceases to be the world’s low-cost workshop, we may all be in for a dose of inflation”. She added, “the effects of rising labour costs will vary by industry, perhaps with lower-valued goods like garments being forced to move to Western China or even to Vietnam and Bangladesh. But high-end electronics like smart- phones are likely to remain, because they command high profit margins and because China has built a sophisticated infrastructure and quality-control system”.

Lessons for Sri Lanka’s manufacturing sector

Sri Lanka can draw some valuable lessons from the ongoing issues in Bangladesh and China, two of our key rival manufacturing centres.

Many Sri Lankan firms have already discovered that they are often unable to compete with Bangladesh on price, firstly, owing to the cheap labour costs in Bangladesh (a typical ceramic plant in Bangladesh pays the equivalent of US$ 40 compared to US$ 100-120 in Sri Lanka), as well as lower energy costs due to the availability of cheap and abundant natural gas. So competing with countries like Bangladesh on cost is fairly difficult. This is the case with China too. Sri Lanka cannot rely anymore on competitive advantages based on cheap input costs, particularly labour. Sri Lanka has lost, and continues to lose, its labour cost advantage for manufactures at the lower end of the value chain (plastic toys, for example), as countries like Bangladesh and China dominate in those. Also, even if there is any industrial shift stemming from a sustained China wage hike, it is unlikely that Sri Lanka will be the next most attractive location for the low-end manufactures – Vietnam and Bangladesh are stronger contenders.

So, the key to growing Sri Lanka’s manufacturing potential lies in moving up the value chain and positioning Sri Lanka as a “cost-effective, high quality, innovative, ethical, and green manufacturing centre”. Many manufacturing firms in Sri Lanka are truly becoming best-in-class. Firms like Brandix and MAS are pioneering innovation in apparels, including using nano-technology. In order to survive, they are leveraging on their green credentials, as well as on enhanced design capabilities, excellent customer-orientation, and quality assurance. In fact, not just in industry, but in the service sector too, Sri Lankan IT firms have shown that even though they cannot compete with India on cost, through innovation and quality they have managed to capture lucrative niches at higher ends of the value chain. Some indigenous IT software developers deliver e-commerce and m-commerce solutions to global telecoms firms and financial institutions.

In this new post-war growth phase, in which the government is keen to attract high-end FDI, not the low-cost, footloose type, Sri Lanka needs to show why it a good place to locate – “we may have slightly higher-priced labour compared to Bangladesh and China, but you get a host of other advantages”. As highlighted earlier, this is what China is beginning to do. It knows that the cheap labour cost advantage will not last for ever. The key to the longevity of its ‘manufacturing hub’ status is continuous improvement in the other factors that contribute to industrial development. We often, continue to believe that China continues to compete purely on the low cost advantage, but this is swiftly changing. China is retooling its arsenal, and evolving with the times. Sri Lanka must follow suit. We need to: 1) Develop new competencies through skills upgrading and productivity improvement; 2) Move up the value chain through innovation, R&D and branding, and as has already begun, and 3) Improve our location attractiveness (connective infrastructure, purpose-built industrial zones, energy supply and costs) and reduce bureaucratic impediments to FDI and industrial development.

 

(*Pietra Rivoli is also the author of “The Travels of a T-Shirt in the Global Economy”)