Changes in China Afoot
By Jim Haughey -- Movers & Shakers, 6/22/2006
Three evolving trends in the world economy will change the character of the electronics market in 2006-07 while electronics sales continue to expand faster than the overall economy. World economic growth will average above the sustainable long-term growth pace of about 4 percent although the growth pace will progressively slow from well above average early in 2006 to about average at the end of 2007. Four years of strong economic growth during 2004-07 will strain production capacity. On the supply side, this will raise production costs, especially in China, speeding up the dispersal of production to the next round of cheap production countries. On the demand side, this will raise the share of electronics sales to the capital goods market relative to consumer electronics and will also raise the share of electronics final demand in developing countries.
In the key electronics-consuming markets, economic growth is forecast to ebb during 2006-07 from 3.5 percent to 3.0 percent in the United States, from 2.5 percent to 2.0 percent in Japan and from 9.0 percent to 8.0 percent in China. But growth will accelerate from 2.0 percent to 2.5 percent in Europe. GDP growth began 2006 very strong, especially in the United States, as most businesses were building inventory back to normal levels. However, when inventory stocking is completed the growth pace will slow. And this slowing will be aggravated by the slowdown in housing construction in the U.S.
Rising production costs-—which always accompany strained capacity—have been evident in China for about a year, appeared in the United States last fall, were seen in Japan early in 2006 and are likely to appear in Germany by summer. So far, non-electronics manufacturers have experienced the largest increases for materials and labor and logistics. Inflation resulting from capacity shortages will fully reach electronics manufacturers later this year when the slow post-holiday production period ends in late spring. Component and semiconductor prices will hold firm as they did last fall. Credit costs are also increasing worldwide but only by about 50 to 70 basis points this year and will be less significant in total production costs than material and labor cost increases.
Already, rapidly rising Chinese costs are beginning to divert production to the new cheapest countries, including Vietnam, Bangladesh and Indonesia. This is more pronounced in textiles and household goods, where factory operating margins are smaller than in electronics. However, semiconductor sales to the Asia/Pacific region weakened considerably early in 2006, partly due to more assembly work outside of China. Geographically, the supply chain will get more complex.
Wage, benefit and labor recruiting costs are largely responsible for the relatively rapid rise in Chinese production costs. How can a country with many tens of millions of unemployed and underemployed workers be short of labor?
New government tax policies have reduced the incentive for rural-to-urban migration. The surplus of workers with experience operating machinery has been nearly exhausted by many years of rapid factory expansion. A huge rise in college enrollment has removed millions of young workers from the labor pool. And the "one child" policy put in effect several decades ago has now begun to reduce the number of new entry level workers each year. Chinese factories now have to search for new workers instead of simply hiring those who appear at their door.
Jim Haughey is director of economics for Reed Business Information.
