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Manufacturers swinging away from China
Last updated 05:00 28/11/2013
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This is the one about the company listed in Australia, incorporated in Bermuda, headquartered in Hong Kong, manufacturing in China but now about to make footwear in the USA - one about the always-changing nature of globalisation and manufacturing.

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The Merchant House International story is a fine symbol of China's evolution as the Middle Kingdom continues to move up the value chain. It also says something about the nature of the United States these days and of manufacturing itself as it becomes ever more high-tech and less labour intensive. Manufacturing lobbyists here will take from it what they will.

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Footwear was one of the more obvious industries to move holus bolus to cheap labour nations - a trend MHI capitalised on with factories in China, establishing its footwear division in 1980 and exporting work shoes to the US for three decades.

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As the annual report details, the main MHI products are casual and industrial men's leather boots and shoes, diversifying into "American-style western boots" in 2003. The company has increased its annual manufacturing capacity in China to more than five million pairs of shoes. While the US is by far MHI's main market, its footwear turns up in other places as well. If you're into hard Yakka boots, you're wearing a Merchant House product.

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And now MHI is opening a footwear factory in Tennessee - "reshoring", as it's called. Chinese labour isn't so cheap any more, American labour is readily available and not as comparatively expensive as it used to be, there is generous state government "support" on offer and there are benefits in being closer to the end customer.

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Founder and chairperson Loretta Lee spelt out the changing realities in the annual report:

"Manufacturing in China is becoming increasingly difficult. We face continuing cost pressures on raw materials, labour and currency appreciation, whilst at the same time our customers will not accept price increases on their products.

"The Chinese Government is committed to raising the standard of living of their people and new minimum wage mandates went into effect on 1st May, 2013. Wages in Tianjin increased 14 per cent and in Guangzhou an additional 19 per cent. These increments are designed to stimulate domestic consumption and reduce the previous emphasis on an export-driven economy.

"At the same time, the government is encouraging labour-intensive manufacturers to move inland where land and labour costs are lower. This goes hand in hand with China's ‘urbanisation' objectives, where smaller townships are being pushed toward expansion and industrialisation to become regional cities.

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"Increasingly, China is no longer the low-cost producer in Asia. Production is moving south to Pakistan, Vietnam, Indonesia and Cambodia. This cycle has repeated itself for years beginning in Japan, then South Korea and now China. It means we need to continue to upgrade our products to survive and we have had some success in this regard. Our shoe orders now include a much greater percentage of branded goods as well as textiles."

The upgrade comes at a price. The company informed the ASX on November 14 that profit would be lower this half than previously expected.

And there's the cost of staffing, equipping and opening that new factory in Jefferson City, Tennessee. A Wall Street Journal story observed that with about 110 employees making 200,000 pairs of boots in its first year, the factory is small, but any footwear plant in the US now is notable as imports have more than 99 per cent of the market.

Lee told the Journal MHI wants to avoid US import duties and cut shipping costs and time by producing closer to its American customers. Even with the shipping and duty savings, US production costs will be 15 to 20 per cent higher than current Chinese output, but she hopes larger volumes and greater efficiencies can reduce the difference.

Besides, "using cheap labour" isn't a strategy that will work in the long run, she says, with sophisticated machinery from Germany minimising labour requirements. And there's US$1.5 million (NZ$1.83m) in various incentives from the Tennessee government, including tax breaks and subsidies for training workers.

The German equipment will be installed by the end of next month with worker training starting in January, with production targeted for March.

The usual bears regularly highlight China's rising labour costs and the trend to outsource low-value production to cheaper countries, but they tend to miss the point that that is what Beijing wants and requires. They also underestimate the ability of entrepreneurs like Lee to read the wind and adapt. The major reforms coming out of the Central Committee's third plenum promise to continue the long march towards a wealthier, more sophisticated country.

Besides, manufacturing in China certainly isn't in retreat. It's growing and evolving. Beyond the more basic, low-value activities that are moving elsewhere, China has developed the supply chains and skills that allow more sophisticated manufacturing than merely "cheap labour" nations can offer.

And the labour component continues to shrink in higher value-added manufacturing anyway. Certainly there's not much in a truly modern factory that can be categorised as "low skill" - automation is automation whether the robots are working in Jefferson City, Tianjin or even Melbourne. There's much more to a manufacturer's viability than the hourly cost of the cheapest available worker.

At the heavier end of industry, the United States is pinning big hopes its abundant cheap gas driving reshoring - gas so cheap in some places it's not worth piping. Debasing the currency by printing US$85 billion a month keeps the exchange rate favourable as well. It's the nature of successful businesses to adapt to whatever opportunities come along.

There are manufacturers failing in China, those that don't or can't adapt and move up the value chain, just as there are manufacturers failing in the US and here.

As the Reserve Bank keeps pointing out, our unreasonably high currency is a particular problem. It's causing casualties. It also forces us to be smarter and more efficient.

Merchant House isn't entirely alone in reversing American footwear manufacturing history. There's a former Timberland executive using crowdsourcing to try to raise the money to open a factory in New Hampshire with the goal of bringing half of his Chinese production back to the US by 2017. He's working on the basis of paying workers $US30,000 a year - still substantially more than $US4500 for a Chinese worker, but a lot less than the average Australian employee.

That sort of wage might sound like music to the ears of some Australian employers. They should remember that domestic consumption is marching in lockstep with income growth - shrink incomes and you'll also shrink consumption. That way recession lies.

For economies with stubbornly high unemployment, lower wages can be a market mechanism for clearing an oversupply of labour, but it's not a desirable longer-term goal for a rational society. It's not the basis of the future Beijing's cadres are aiming for, not the basis of what continues to make Australia one of the most desirable places on earth to live.

- Michael Pascoe is a BusinessDay contributing editor.

- © Fairfax NZ News
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