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100% wage hike on China's east coast makes England's North East more attractive

Many offshored British manufacturers are realising that they are better off in Britain than in China, according to a new Civitas report. In The Boomerang Economy, David Merlin-Jones examines the increasing number of UK companies, which expected to benefit from cut-price labour in China, deciding to bring production back to the UK.

High-end manufacturers are evolving and enjoying new competitive advantages that Britain offers, not in price but in quality and service. However, the report warns that this trend will falter unless the Government actively encourages whole supply chains to return home.

No longer made in China

Before the financial crisis, it was assumed that British manufacturing would emigrate to China and other emerging economies, while Britain would specialise in the financial services. David Merlin-Jones said:

The financial crisis revealed the risks of focusing Britain's competitive effort exclusively on the service sector. Now China is falling out of favour with UK manufacturers as labour costs have risen spectacularly fast. From 2005-10, Chinese wages grew by 19% per annum while British manufacturing wages actually shrank by 0.2% p.35. While they are still a fraction of British labour costs, Chinese wages are set to rise much more, particularly in the offshore manufacturing destination of choice, the Eastern seaboard. Wages are already 10% to 15% higher there than elsewhere in China.

By contrast, wages in the UK manufacturing heartlands are 10% to 15% lower than the national average p.37. By 2015, Chinese salaries will be a sixth of UK ones, up from only a twenty-fifth in just seven years. This is an opportunity for Britain to repatriate manufacturing production precisely when the service sector has failed spectacularly to deliver job growth.

In addition, labour costs constitute a shrinking proportion of production costs, around 22% in Britain in 2009. p. 39 This means that the wage savings of retaining production in China are estimated to be only 18% on the east coast by 2015. With other costs, such as shipping, rising, the potential for savings has been wiped out for many British offshorers. As a result, some are bringing production home.

Cheap goods no longer cheap enough

The report explains the key causes of China's rising costs of employment:

• Quality issues. Offshorers often find products to be of poor quality, even when Chinese workers are using the same equipment as British counterparts. Kevin Steers, the CEO of the British barbed wire manufacturer Betafence, shifted production of barbed wire to Tianjin in China. He found: 'the quality was poor and the service was terrible' and duly resumed production in Sheffield. p. 28 Many offshorers have received shipments of goods only to find they are unsellable. Rectifying this problem means waiting months for another shipment or, as some companies are doing, finding a UK supplier to make a one-off, expensive batch of the product.
  
• Labour shortages. Workers are harder to come by as migration to the East coast has slowed down. One manufacturing centre, Guangzhou had an estimated shortfall of 150,000 workers, forcing further wage increases to entice migrants. Tony Caldeira, of cushion manufacturer Caldeira UK found that his Chinese employees rebelled at the offer of a 30 per cent pay rise and demanded 50 per cent or threatened to leave. Job fairs are now a buyers' market with some potential employees able to negotiate 50% pay rises before even starting work. pp.42-3

• New Chinese labour regulations. Despite being known for providing backhanders to businesses to encourage them to set up shop, local governments have been imposing minimum wage hikes. In the last couple of years, 20 regions have experienced minimum wage hikes of over 20%. p. 35 The New Labor Contract Law also bans overtime beyond 36 hours on top of a working week of 40 hours. Many offshorers found they had to hire more staff as a consequence.

• Poorer exchange rates. The strengthening of the Renminbi and simultaneous weakening of sterling mean that, depending on how British firms pay for Chinese goods, they are paying higher prices for the same goods. This trend is only likely to continue.

Hidden costs of remote controlled production

Beyond labour costs, UK offshorers have encountered other problems with dealing in China. They include:

• Shipping costs. As the price of oil has risen sharply, so have the costs of sending offshored goods to the UK. In January 2000, the nominal spot price for European Brent crude oil was $25.51 a barrel and the cost of shipping tripled by 2008 when an oil spike occurred. This saw crude prices at a high of $132.72 a barrel and prices look set to reach similar levels again, leading to similarly expensive shipping costs. Even now, oil prices remain prohibitively high compared to 2000 at more than $80 a barrel. Delivery of goods is also unreliable, which has a damaging effect on supply chains for many firms. p. 56

• Low productivity. Offshoring is best for labour-intensive, high-volume goods but Chinese productivity is way below the UK's. While China's productivity grows rapidly, this is because there are still many 'low-hanging fruit' improvements to be made. Offshorers are unlikely to benefit from UK equivalent rates of productivity because this would mean costly capital investment, which undermines the original reason to offshore.
• Intellectual property theft. Many companies including JCB find that Chinese suppliers produce cheap counterfeit products to sell in the Asian markets. If they get hold of the paperwork and packaging too, they can be sold in huge numbers worldwide. JCB Chairman Antony Bamford has said: 'The machine designs of JCB products have been copied on many occasions by unscrupulous Far Eastern competitors'. p. 52

Government must commit to UK manufacturing

With offshorers increasingly alienated from maintaining Chinese production, there is ample opportunity to bring them home. Few emerging economies have the transport infrastructure that many manufacturers require to satisfy their customers. Those producing goods for the European and UK markets will find Britain to be an attractive location. However, relocating is expensive, and businesses will want a firm commitment that manufacturing is valued and viable in Britain for the long-term.

The report suggests four principal ways to support UK manufacturing production:

• Improve skills. The onshoring experience of America shows us that a shortage of the right skills is a bottleneck for onshoring. Too many potential workers do not have the ability without significant training to work with modern, computerised equipment.

• Active assistance. America has managed to secure the return of many onshorers through the liberal use of financial incentives. Electrolux recently received a total of $188 million through various funds and benefits to set up a new $190 million plant in Tennessee. p. 78

• Increase capital allowances. The reduction of the Annual Investment Allowances to £25,000 sharply reduces the incentive for companies to invest in the long-term capabilities of their British plants. Increasing this back to £100,000 or more would show greater commitment to UK production.

• Promote all manufacturers, not select sectors. The Government is too preoccupied with encouraging and funding particular high-tech sectors such as nanotechnology and pharmaceuticals, and even just promoting the retention of R&D work in the UK. This is a dangerous policy, and as various companies have shown, R&D often follows when production is moved abroad. The Government must support all points of the supply chain, including low-tech and intermediate manufacturers.

David Merlin-Jones concludes:

For more information contact:

David Merlin-Jones, Director of the Wealth of Nations Project, 020 7799 6677

Civitas 020 7799 6677

Notes for Editors

i. David Merlin-Jones is Director of the Wealth of Nations Project at Civitas and a Research Fellow in economics, energy and industrial policy.

ii. The Boomerang Economy: Why British offshored manufacturers are returning home and how to maximise this trend (RRP: £7.00) is available from the Civitas shop, by calling 020 7799 6677, and on Amazon Kindle. A PDF copy for journalists is available on request.

iii. Civitas is an independent social policy think tank. It has no links to any political party and its research programme receives no state funding.