China Issues
Monday, May 16, 2005

There’s been a lot of discussion about China lately. For one thing, we are going to see more and more manufacturing move out of the United States. It does not make any sense to put a factory in the US when you can manufacture so much cheaper in China. It is my guess that product design and logistical control will also move out of the United States.

Manufacturing in China versus the US or México
A couple of years ago I was at the Flextronics plan in Guadalajara, Mexico. They gave me a detailed tour of the plant. We spent about four hours walking around.

Flextronics is a company that we categorize as a "CM." “CM” stands for “contract manufacturer." For example, they make a very large percentage of all of the cell phones that are manufactured in the world. They do not put their name on the products they manufacture. Instead they make cell phones for brands such as Kyocera, Sony Ericsson, or Motorola. With most consumer electronic items, hardly any recognizable brand manufactures their own stuff anymore. For example, HP does not make their printers or personal computers. Instead, they outsource the manufacture and assembly. It is much cheaper to outsource them than build them internally. The brand owner can be much more flexible if they contract for the fabrication of their products. Flextronics can do the design, source the materials, assemble the product, and then manage the distribution. They are doing this for a lot of companies that used to manufacture in the United States.

At any rate, let's get back to the story about Flextronics in Guadalajara, Mexico. As I was walking around this beautiful 170-acre manufacturing campus, it felt to me like there is something missing. I could not figure out what was different about the Guadalajara campus versus other American electronics and industrial parks. This industrial power was similar in many ways to those that are all around Silicon Valley, California. This property had several brand-new buildings and a beautiful soccer field centrally located in the middle of the campus. What it did not have -and took me a long time to figure out -was parking lots. It did not have any parking lots because the workers were transported to the plant on company-owned buses. They could not afford to own cars because their wages were not high enough. So, the company brings them to work every day on buses. As I walked to the cafeteria, I noticed that many of the workers were having breakfast. They were eating company-provided burritos for breakfast. So as part of the pay/benefits package, the workers received a trip to work and home, and also one hot meal.

The Flextronics folks took me over to the Xbox line. The Xbox is a game machine designed by Microsoft. Microsoft, like most other companies, does not make their own equipment or games. Instead they contract out the manufacturing of the Xbox to Flextronics. As they walked me down the Xbox assembly line, the plant manager said, "Unfortunately, these are leaving here. They are moving the manufacturing of the Xbox to China."

I asked the plant manager why the Xbox was no longer going to be manufactured in Mexico. He said that it was much too expensive to make them in Mexico because the labor costs at the Guadalajara plant were substantially higher than the plant the Xbox was moving to in Shenzhen, China. The Guadalajara plant manager also told me that at the Flextronics plant in China there were no buses to transport the workers to the plant. Instead, the workers live in dormitories owned and operated by the company.

If the cost of manufacturing the Xbox is too high at a plant in Mexico where the workers wages are not high enough for them to afford their own cars, it is unlikely that there would be any place in the United States where it could be manufactured economically. There is no way that American factories can compete effectively with low-cost technologically competitive Chinese factories. It is not just the unskilled labor in a Chinese plant that is low cost. Skilled labor is also much cheaper. Engineers that design the flow of product through the plants, or even design the product itself, are much less expensive than an engineer in Guadalajara, San Jose or Reno.

Is China going to be the Most Powerful Country in the World?
Does this mean that China is going to put the US out of business? Probably not. They're a lot are reasons why China, which is clearly ascending in power, may not dominate the 21st century as many experts believe it will. There is an excellent essay in Gary Becker and Richard Posner’s blog that speaks to this issue. You can find this article at the following URL.

Gary Becker wrote a column every week for the last 10 years or so in Business Week before quitting to write the blog mentioned above. He is a Nobel prize-winning economist at the University of Chicago. It is Becker's thesis that the phenomenal growth of China's economy will not last. He compares it to Japan's economy which looked incredibly strong in the late 80s and early 90s. Since then, Japan's economy has been basically stagnant.

Sociological Problem - Boys and Girls
Additionally, I think there are some interesting sociological issues in China. For one thing, they have now had the "one-child policy" in place for two generations. Because it is better in the Chinese culture to have a son than a daughter, there are now many more boys than there are girls. Some Chinese women have had abortions when they found out the child they were carrying was a daughter, and Chinese orphanages are filled with little girls abandoned by their parents. A couple of friends are flying to China to adopt couple of little girls this fall.

This mismatch between boys and girls cannot be good in the long run. For one thing, these boys are now probably the only grandchild of two different sets of grandparents. As China's economy continues to improve and China becomes a richer nation van it once was, the parents and grandparents will be more able to spoil these little boys. So, you'll have little boys who turn into big boys that have been catered to most of their whole life by their parents and grandparents. These kids have no siblings or cousins. When you think about a whole country full of these spoiled boys and remember that there are not enough girls to go around for them, you can see the roots of fairly serious sociological problem. Whenever you've got a bunch of men and not enough girls around, you typically have trouble. Think about prison. It could be ahead so we in the future the boys will start organizing in groups and march around looking for trouble - and chicks. If it is a powerful country that lacks women, it seems likely that the men that live there will go beyond their borders to find some. At least, I think I probably would. Based on the behavior that I see around the house, it is my belief that the next generation of Rogers would likely act the same way.

The Numbers
The sheer numbers related to the Chinese economy are staggering. The Chinese population is more than six times the size of the US population. There around 2 billion Chinese people. There are approximately 280 million people living in the United States. We don't know for sure how accurate that estimate of the Chinese population is, because there are a lot of folks living out in the hinterlands that are difficult to count. At any rate, we know that it is a much bigger country than the United States. And he eventually, the market for products could be a lot bigger as well.

In the fall of 2003 there was an NBA exhibition game between the Houston Rockets and Sacramento Kings. This was an exhibition game and not many people and the US were paying much attention to it. It was a game in which Yao Ming played for the Rockets. As most of you know, Yao is the starting center for the Houston Rockets. The Chinese TV audience for this NBA exhibition game was 300 million people. Now, there are a lot of people in China that still don't have access to a television. But even though they're a lot at Chinese folks that cannot get to a TV, the television audience for this NBA exhibition game was larger than the entire population of the United States. More people in China were watching a meaningless game between Houston and Sacramento than live in the entire US.

Earlier today (May 16, 2005) and I heard the sad story of United Airlines defaulting on four different underfunded employee pension plans. This default will impact approximately 120,000 current and former United Airline employees. The responsibility for these pensions now falls on the federal government in the form of the Pension Benefit Guaranty Corporation. If many firms follow United Airline's lead, the Pension Benefit Guaranty Corporation will not be able to find all of the defaulted pensions.

Because of outsourcing manufacturing to China and shedding expense of American workers, there are likely to be more pension defaults. The two most horrifying specters on the horizon are General Motors and Ford potentially defaulting on their pension responsibilities. Older workers and retirees are a couple of important reasons why GM and Ford are not as competitive as they used to be. If those two companies default the US economy will take a big hit. The severity of this problem is more immediate and then the potential insolvency in the Social Security system. The magnitude may not be as great as the sole security problem in the long run, but coupled with the Social Security problem we could see a fair amount of trouble fairly shortly. Some of the companies that are selling products in the United States may totally disappear due to foreign competition. If that happens their pension funds may also disappear. If the courts allow a lot of firms to follow the lead of United Airlines we are going to see a draining of the Pension Benefit Guaranty Corporation resources.

Dr. Dale Rogers biography