Gone are the Days of Unlimited Chinese Labor

Includes: CAF, FXY, PGJ
by: Roman Dutkewych

I have come across some email comments from someone who does quite a bit of direct import from China for a major U.S. retailer, and thought it would make for a very interesting discussion to share with the Seeking Alpha community. Some of the information from these emails is already well known, but I thought that the way the content is directed at U.S. buyers makes for a very interesting read. There is quite a bit of information to gleam from these comments. The point is here is not to make a directional call on China, but rather to bring up some potential impacts of China’s growth and new labor policies might have on the U.S. consumer and retail sector in general starting in the later part of 2008.

The two themes that stick out here are further inflationary pressures, and a potential squeeze on factories and suppliers. I am not sure that many will argue against the notion that the Fed has put inflation concerns on the back burner in favor of economic stimulus. This policy, coupled with a weak U.S. Dollar and higher commodity prices (food & energy), is a certain recipe for higher inflation. Now, add in the potential that the cheap labor that the U.S. consumer has enjoyed from China for a very long time might also be near an end. These higher costs will be passed on, and should see consumer prices continue to increase across other areas.

The second point is that the changes in Chinese labor laws, rapid growth in their economy, and inflation have forced many foreign companies to leave the mainland (Korea), as well as putting big strains on existing locally owned factories. Some retailers, likely smaller operations, may see delays and or other disruptions in inventories this year as a result.

In any event, here are the comments.

1. Many factories in the Southern part of China will be closing before Chinese New Year and not reopening. The new labor law instituted by the Chinese government is too much for many of the marginal factories to absorb. The government requires the factory to let all workers go and then rehire them. Each worker is to receive monetary compensation for every year worked in that factory. This is putting a tremendous cash crunch on all factories. Also, the new labor law limits the number of hours a worker can work over-time. However, the factory workers made a good deal of extra money working over-time and now this income is lost to them. These workers are now demanding more pay in regular salary to make up for the loss of this over-time. Gone are the days of unlimited labor. As more and more factories are forced to move North, the factories in the South which house Northern labor will be losing this labor force to those new Northern factories. Hence supply and demand. Southern factory owners will have to pay more for their work force, leading them to hire less people to do the same amount of work. Work that traditionally took 45-60 days, will now take 90 days. Along with labor, the increase in oil, transportation and the weak U.S. dollar, American companies will have to pay more for goods made in China.So my friends, the picture is not great. We all can expect increases, and this is just a polite way of letting you know that as much as we have tried to absorb some of these increases, we can not continue to do so. We had modest increases during January Toy Fair in the hope that things would settle down. As a company, we felt it wasn’t fair to pass on expenses that hadn’t materialized during the show. Now that they have come to the surface fast and furious, we are caught in a bind. No one likes to go back after the fact and have to deal with re-quoting. We felt it unfair that our factories hit us after the show. The reality is prices are up and in the end the consumer will have to understand that the same items today will cost more in the future.

2. In the last year, there have been major changes in both the China and US business market. These have had a large impact on all businesses operating in China, whether they be owned by Hong Kong companies, foreign companies or by the mainland Chinese. For your information, we have attached a few recent Hong Kong newspaper articles reporting how businesses in China have been hard hit by the new labour laws, increasing minimum wages, increasing taxes, inflation, rising raw material prices, shortage of migrant workers, appreciation of the RMB and economic slowdown of the US. The recent snow storms that crippled the electricity and transport in parts of China made the situation worse but on its own, it would not have had a lasting impact. But for businesses already struggling under the changes of the past year, the damage from the storms could be the final straw that will force them to close down. It is estimated that tightening of government policies and unfavourable economic factors may lead to the closure of thousands of factories in mainland China. While the mass folding/exodus of Korean companies has been widely reported on, a bigger but less visible problem may be the overnight disappearance of many locally owned factories. Their mainland Chinese owners, already having a hard time with inflation, may not survive the sudden introduction of such drastic changes to the labour laws and these new laws are being tightly enforced all across China.In the face of all these economically unfavourable factors, our customers can rest assured we are financially strong and sound. As our factory is located in the southern part of Shenzhen China, we were not affected by the recent snowstorms. However, even without the snow storms, the electricity supply in China has been unstable for many years due to an overloaded network that cannot keep pace with the growing population and modernization. To combat this problem and to ensure that our production is not affected by power shortage, we have our own power generator that is capable of supplying our entire factory and staff residences. Although the new policies and economic factors have definitely impacted our cost of production, we have always closely monitored our costs and are constantly fine-tuning our production for optimal efficiency. Our adherence to government guidelines in the past will enable us to quickly adapt to the new policies.We recommend that you make sure your suppliers are financially strong. If your supplier goes out of business, your down time to make a new plastic injection mould with another experienced supplier would be about 60 days. Not only will you have to pay for new moulds, but there is also the cost and time involved to re-sample and re-approve. Moulds can easily cost Usd 2,000 - 5,000 each and could be much more depending on the size and complexity. With the increase in all raw material and labour prices, your new moulds will cost even more. Also, find out if your suppliers have insurance for your moulds. These are your assets and should be well protected.China and Hong Kong are undergoing major economic changes. As China grows, changes and rising costs are inevitable. There is much that is beyond our control. We will strive to keep our customers informed and alert to the changes that will affect them as early as possible. We wish all of you the best during these turbulent times and we wish to reassure you that we are one supplier you do not have to worry about. With diligence and foresight we are prepared to adapt and we will do our utmost to keep our costs as low as possible while maintaining the good quality of our products. We hope you will understand and work together with us.