China has become the world’s top manufacturing country by output, according to a study released last week by IHS Global Insight, a US-based economics consultancy (h/t Financial Times Article). Last year, China accounted for 19.8% of world manufacturing output, a fraction ahead of the United States’ 19.4%.

According to the Deborah Wince-Smith, chief executive of the Council on Competitiveness, a Washington-based business group, China’s ascendancy “shows the need for the U.S. to compete in the future not on the basis of commodity manufacturing, but on innovation and new kinds of services that are driven by production industries”.

As I pointed out in my post Made in the USA isn’t Dead, Just Different, Smith’s comments highlight the trend already taking place: US manufacturing is graduating on to higher value/higher skilled products such as aircraft, defense related equipment, space equipment, car parts, energy products, etc.

In fact, in 2007, for every $1 of value produced in China’s factories, American factories generate $2.50. Mark Killion, head of IHS’s world industry services, notes that the IHS report’s latest data indicates that manufacturing is far from bleak in the US, a fact that the media and policy makers often overlook:

The US has a huge productivity advantage in that it produced only slightly less than China’s manufacturing output in 2010 but with 11.5 million workers compared to the 100 million workers employed in the same sector in China.

The advantages of sourcing manufacturers in China versus sourcing manufacturers in the United States are quite distinct. A great many low-cost consumer products will continue to be made overseas, be it in China or other developing economies, as the low-skill/low-cost labor advantage is irrefutable. However, higher-value goods and industries requiring supply chains offering speed and flexibility will continue to find advantages here with U.S. factories.

What do blankets with arm holes, robotic hamsters, and magnifying glasses have in common?  Imports of all of these products are WAY up for this holiday season.  Apparently, in America, it's important for people to stay cozy while maintaining mobility with their TV remote.  God Bless the Snuggie.  Kids want to play with intelligent robot hamsters.  Take a look at Zhu Zhu Pets.  And Sherlock Holmes International (a Sherlock Holmes Fan Club…I'm not kidding: website) may be planning a secret international conference for all of it's members because (it's elementary my dear Watson) magnifying glass importations are up almost 300% this season!

Holiday season imports are going full steam, and Panjiva's latest offering, Trade Trends, displays trade data for a given product over the last few years up until the most recent month.  One can also see which countries are shipping more of a given product and which are shipping less.  Talk about transparency!  It's a great way to get an idea of trade flow and which countries might be producing more of certain kinds of products over time (perhaps indicating a country's forming competitive advantage?), seasonality of products, and which products retailers are expecting to do well in the near future.  Check out the data below to see this holiday season's hits and misses:

Not so cool this Year:

Sorry Miley.  You may want to buy a Snuggie and stay at home this year.  You're not old enough to party yet anyways…

Reason for Optimism: Panjiva's trade data reports a 7% increase in July 2009 over June 2009 in the number of global manufacturers shipping to the United States. 

However, before we hail the end of the decline, it should be noted that in July 2008, we experienced a similar uptick of 6% in global trade to the United States.  Thus–a suspicion of a seasonal impact is warranted. 

To compliment this in larger global economic terms, Paul Kedrosky's Infectious Greed has posted a familiar graph of the Four Bear Markets, in which the economic declines and recoveries of the major market fallouts of the last 100 yeras are depicted.  Kedrosky notes that the typical pattern after the "We're back!" bounce is a relative flattening out (except for the Great Depression) of economic growth. 

I tend to think this is not bad news.  We may not be rocketing back to the bull market of 2006, but flat means steady and stable.  Steady and stable means a return of investor and consumer confidence that conditions will be safe again, or at least more predictable, to…invest and consume.   Manufacturers can begin to create operating plans and hire on workers with relative confidence that they won't have to slash slash slash again in the immediate future.  They may even invest in new manufacturing equipment at good prices.  Investors can begin putting money into further product innovation and growth.  Retailers can begin taking chances on new product lines as excess inventory is finally depleted or liquidated.  Consumers can begin to spend their dollars on some of the latest innovations that will undoubtedly come out of this economic shake-up. 

It's not an oxymoron.  As a great article in Forbes.com, which originated from a post by Dan Harris at Chinalawblog, explains, it's the way Douglas Smith, founder and owner of SmithCNC-USA, is working to save the US manufacturing sector.  SmithCNC-USA is a North Lawrence, Ohio firm that helps midwestern manufacturers get components and raw materials abroad.  Companies starring the neccessity of self-preservation in the face are finding that the path to staying alive is by sourcing and working with factories in other countries to create a business structured for competition in the global economy. 

As I noted in a previous blog post, Made in the USA isn't Dead, Just Different, companies are not simply shifting everything away, but instead adopting a more global supply chain, wherein they retain higher value-added tasks and jobs here, and contract out low skill, low-value work to more cost competitive sources.  Other companies are outsourcing tasks for cost purposes, but retaining local production for quick response purposes to hedge against difficulties in forecasting demand. 

Like SmithCNC-USA, our clients often grow the design, engineering, sales & marketing, and administrative departments in their businesses and add jobs to these areas, by outsourcing operational duties like sourcing, some engineering tasks, manufacturing, packaging, and logistics to companies like us and our network of suppliers. 

The Forbes.com article describes Smith and some of the results his clients have enjoyed:

These companies, who might have otherwise stagnated or folded, have been able to expand and hire in existing and new areas because of their overseas manufacturing partners. 

The impacts of global supply chains are not always rosy.  The dynamics are often more complex, and involve both positive and negative consequences, with an inordinate focus by pundits on the latter.  US companies surviving, and often flourishing, in the face of competition inevitably coming from all parts of the world, is positive.

Like me, you may have experienced surprise when you've purchased a common consumer product, found the Country of Origin label and read "Made in the USA"?  "Wow–look at that, made in the USA!" 

A great article put our by the AP on MSNBC.com, Made in the U.S.A. isn't dead, just different, helps to put the shifts in the U.S. manufacturing sector into perspective.  The common perception that virtually nothing is Made in the U.S.A anymore is inaccurate.  As the article points out, the question revolves more around what is no longer made in the U.S., and what is: 

Leading manufacturer?  Of what?

The article illuminates an issue that is too often simplified and/or approached from a perspective that highlights our shedding of low-skilled manufacturing jobs and inefficient industries.  This is no doubt challenging to many. 

At the same time, America is advancing up the value chain and doing more with less.   US manufacturing is not only doing more with less, but also making supply chains more responsive and efficient.  Another advantage of US manufacturing which companies are becoming aware of is its utility in the reduction of risk.  The rise in lean and JIT manufacturing in the US allows companies to become more responsive to short-term demand fluctuations to hedge inventory risk (Inventory is a bad bad word right now), and speed go-to-market product cycles. 

We're losing.  We're gaining.  We're changing. 

Looking back over the developments of 2008 in China's manufacturing base, they are quite astounding.  The signs of change began before 2008–probably the most notable being the Central Govt.'s elimination of VAT tax rebates in the summer of '07.  Consider this the long, first ascent of the rollercoaster.   Hope you have your seatbelt on.

We
began the '08 with rapidly increasing costs across the board in most
sectors: new labor laws, repealed VAT rebates in effect, increasing commodity
prices, unprecedented growth in shipping, rising energy and material
prices–a slew of factors raising the cost, and the perception of cost,
of manufacturing products in China.  It is estimated that 10,000+
factories in southern China alone shut down due to an inability to
compete amidst the changing conditions.  There were powerful winter storms blocking tens of millions of workers timely return home during the Chinese New Year Holiday.  Many workers returned late, and many more never returned at all.  Also, the mounting preparations and excitement over the Olympics also caused a lot of frenzy in manufacturing and logistics circles.  This affected the Shanghai and Beijing regions far more than the southern regions.

Now, with the mounting slump
in demand becoming apparent in the second half of 2008, material and
commodity costs have dropped, VAT rebates have been reinstated for a
number of product categories, and capacity in shipping has quickly
opened up.

I recently heard the claim (haven't been able to verify yet) that Dongguan, a
region in Southern China long known as a manufacturing hub of the area,
has had it's population (previously ~12 million people) cut in half
over the last year.  Comprised largely of migrant workers from regions
further west in China, approximately 6 million of these workers have
returned home and not come back.  If the claim is true, which I believe there is at least a lot of truth to it, it's quite remarkable!  I think it's hard for Westerners to fully grasp
the kind of challenges a shift like this can present to local governments,
economies, etc.  Imagine if half the population of Los Angeles, New
York, London, or Paris, simply up and left in a matter of a year! 

The challenge of retaining skilled workers in China is well known, but some are now questioning whether retaining unskilled workers in some key manufacturing areas like Guangdong, is going to heat up.

World demand for Chinese exports drop–and many of the short-term effects we've seen aren't hard to predict.  See my post here.  But they will no doubt have longer term effects–and there is a lot of talk, but no consensus, on what exactly they might be.  Elliot Ng, of CNReviews.com, has written a good summation of the challenges China's economy now faces amidst the world financial crises.  In the article, Elliot's Hong Kong Uncle summed up things rather concisely:

Uncle’s simple but powerful framework:  China is supported by a three-legged stool, but two legs are now broken

China’s economic growth is supported by three primary legs:

The first and second legs are now broken.  Ng goes on to write:

China's growth model necessitated their domestic consumer market pick up the  burden of the export sector–basically meaning that the hope was Chinese manufacturers would be serving their own consumers as much or more than foreigners.  But for a number of reasons (maintaining an undervalued currency, very high savings rates, and maybe just not enough time), China hasn't reached this point.

Now, the government is forced to make up for the lack in spending through economic stimulus packages.  Whether this will be enough, no one knows.  Many bloggers and economists are speculating on the impacts of all of this on the next year or two: possible increased social unrest, a tougher stance by Beijing on social unrest, currency revaluation, export subsidies, and the list goes on.

I prefer to error on the side of "no one really has any clue what's going to happen", and to not make hasty judgments.  Some are predicting China will be just fine this year.  One thing is certain, if you're manufacturing in China, change is in the air.  I know–that's not rocket science.  The rollercoaster ride may have just begun, but this doesn't mean you can't find opportunities to thrive in this environment.  If you have time to tend to more than your challenges here, pay
attention to your sources, pricing, shipping, and govt. policy in China.   New prices, better sources, more attention, faster shipping…  All worth looking into.

Yesterday morning, I watched U.S. Treasury Secretary Henry Paulson give a short speech and field some unforgiving questions from the audience before heading straight to the airport and on to China to continue the U.S.- China Strategic Economic Dialogue.  His prepared remarks were more or less standard with Washington's public position on the current challenges and issues facing the U.S. and China today.  I was particularly interested by the amount of attention Sec. Paulson devoted to environmental issues and initiatives.  While Sec. Paulson does have a personal interest in the environment and conservation, and perhaps he would rather highlight the ecological environment compared to the financial environment at this time, I believe it's an interesting sign of the times, that a Secretary of the Treasury is emphasizing environmental topics.   As you can see from the picture, he looks pretty happy about it.

As Sec. Paulson pointed out in his speech, with economic prosperity, comes environmental degradation–unless we do something about it.  The financial crises, trade and currency, will no doubt be the main topics of attention during Sec. Paulson's visit to China, but an action plan for air quality, and discussion of launching an initiative to establish eco-city partnerships among their cities, will also be on the agenda.

At a high level, with respect to the environment, China gets it.  With the new U.S. administration coming in, it seems we may be "getting it" real fast. 

In both countries, on a local level, it may be beginning to trickle in:

Greensburg, KS: This midwest, U.S. town, was leveled by an F5 tornado in early 2007.  As you can see from the picture, the town was destroyed.  Today?  The town has implemented a green rebuilding project that mandates all city buildings larger than 4,000 sq. ft. to be built to LEED-Platinum level and have an energy
performance level at least 42% better than current building codes.  Talk about seizing an opportunity. 

Dongtan, China: Many have heard of China's work in building one of, if not the most, pioneering green city in the world, from scratch.  The first of four "eco-cities" slated for construction by the Chinese govt., the city will open in 2010 and offer residents zero-greenhouse-emission transit and complete self-sufficiency in water
and energy. 

These are two small examples of local town/city implementions reflecting higher-level goals.  But as Sec. Paulson stated, the importance of the U.S.- China economic relationship, if not already, will likely become the most consequential for the world economy very shortly, and it's implications will reach every corner of the world.

There is a lot of turmoil out there and a lot of opinions on short-term and long-term developments.  But going green has gone from fringe issue, to popular lofty goal and topic for government, media and corporations, to perhaps one of the safest long term bets at this point in two of the most important countries in the world.

It's simple economics really…as demand drops worldwide, so too, do prices for a number of materials, products, and trade dependent services.  Purchasing.com reports that steel beam prices, polyuerethane, and ABS, materials used in large volumes in the slowing construction and automotive industries, are now falling in price. 

Shipping rates have also decreased quite a bit in the last few months.  Supply Chain Digest cites some reports claiming that 20' container rates from Asia to Europe have plunged from $2800 to just $700.  From Asia to the US, rates have fallen to $1500 per container.  Interestingly, the London-based consulting firm, Drewry Shipping Consultants Ltd., expects container volumes from Asia to the US to shrink by approximately 5% in 2009, after years in double-digit annual gains.  What seems to be a modest projected decrease in container volumes is actually quite a shift for the shipping industry, which had been ramping up capacity on expectations that double-digit volume increases would continue into the future.

It's unclear how long price reductions will hold.  Many producers are now cutting supply, but cuts have not kept pace with the fall in demand.  When equilibrium is reached, the decrease in prices will likely hold and then begin to pick up again as the global economy begins to emerge from the downturn. 

Thus, falling prices can be a short-term bright spot in an otherwise doom-and-gloomy economic time.  There are worries that the short-term challenges could inflict long-term damage on some industries.  Steve Dickinson, of ChinaLawBlog, posted an informative piece on the risks the credit freeze poses to the ship building industry.  In tough economic times, waves of consolidation in any industry are not uncommon, as weaker players either go under or are acquired by larger companies.  Just look at what happened in the US finance industry this year.  A good friend of mine, who is a financial advisor at Morgan Stanley, watched two of his major competitors disappear within a matter of weeks. 

The reduction in prices, as well as the economic challenges facing us, will likely not hold.  But, for the time being, enjoy the bright spots and negotiate appropriately. 

So what if you’re not the NBA in the Chinese market?  (Not that NBA jerseys are flying off the shelves in China anyways)

In southern China earlier this week, I had several conversations with locals about the domestic consumer market.  I also thought that several readers of ChinaLawBlog’s post on this topic made solid comments worth reading.  The general consensus seemed to be that China’s domestic consumer market is still nascent. 

Before we look to NBA viewership stats and firms selling services through marketing reports, a strong weathervane of the domestic market might indeed be Chinese companies themselves.

A logical key indicator, to me, in determining whether China’s domestic markets are indeed on the rise, would be that their domestic companies and manufacturers would be more eager to sell locally rather than export to foreign markets.  This doesn’t seem to be the case for a few very fundamental reasons.

• Often, receiving payment from Chinese buyers is much riskier than foreign buyers. Many Chinese companies prefer to sell to foreign buyers because they have a strong likelihood of payment.  They may have to work on tough terms, but in the end, cash is king.  Late cash and/or some cash, is better than no cash.
• Quality standards.  The overall purchasing power of Chinese consumers remains comparatively low to developed countries.  To sell into this market entails manufacturing poorer quality product to be profitable.  A well-run factory will not use the same production line to create product for export markets as well as domestic markets.  You will see a great many companies that make product for both markets.  But quality from these firms is to be watched.  It’s unlikely that you’ll see an export-oriented firm falling all over itself to lower quality and sell into the Chinese market.  I have yet to run into an export-oriented manufacturer that will send all of the quality control staff home at lunch on Thursdays and Fridays so they can get some lower quality product out into the local market.

For these two basic reasons (not including serious challenges of distribution), in my humble opinion, the Chinese market has not arrived and will certainly take quite some time to mature.  Yes, there is an upper class in coastal cities that is growing in affluence.  This, however, is still very small.

A concise and well-written article, Reality Check, by James Fallows (h/t Chinahearsay) at The Atlantic, brings great clarity to the situation.  His anecdotal observations create an image that, to me, is far closer to reality, than so many of the China-sized hype articles out there.  I highly recommend the read.  I’ve personally emailed this article to friends because it’s important (to me) that America has an accurate perspective of China. 

Is the Chinese domestic market arriving?  That depends…are you the National Basketball Association?  Or, are you another reader of China-sized hype?

ChinaLawBlog recently covered an email/article by Shaun Rein of the China Market Research Group out of Shanghai.  The email discussed many points covered in a Business Week article entitled China’s
Rising Retail Market: Chinese youth intend to spend "considerably more"
in 2008 than they did in 2007. Multinationals had better start thinking
young,"

The email summary began with:

While retail sales are plummeting in the US, sales in China are
continuing to boom, driven by optimistic shoppers largely shielded from
the global economic malaise. China as a market to sell into rather than
a place to source cheap products from has become a major engine for
growth for even the largest companies worldwide.

In another recent report by Booz, Allen, Hamilton and the AmCham Shanghai (h/t AllRoads), the #1 reason US companies would stay in China despite rising costs is access to the domestic market.

What gets these companies salivating over the consumer market in China?  Consider the example of a regular season NBA basketball game.

The most
televised TV sports event, a regular season NBA basketball game between
two average NBA teams, which happened to have two native Chinese
basketball players (Yao Ming of the Houston Rockets and Milwaukee’s Yi
Jianlian), drew an estimated 250 million viewers.  This figure that puts
any SuperBowl to shame.  That’s right, a regular season NBA basketball game trumps the Superbowl because of two Chinese guys.  That is significant.  In advertising, three digit numbers in front of the word "million" causes excitement.

If you’re the NBA, you’re happy.  If you’re selling to a very small group of affluent Chinese kids in a handful of coastal cities, you’re interested in reading the China Market Research Group’s report.

But, unfortunately, NBA + 250 million viewers, does not equal 1.3 billion customers.  Not even by a long shot…

Part II is coming…