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In China, the Cost of Doing Business Rises

Recent wage hikes combined with rising prices mean China isn't as cheap an option as it once was.

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Workers inspect motherboards on a factory line at the Foxconn plant in Shenzen.

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Looking to China for cheap production? Not so fast.

Recently workers of Foxconn (the makers of Apple's iPhone) and Honda received raises of about 30 percent, a move expected to trigger a wave of salary hikes at factories across China. The rising costs are expected to affect prices for a host of consumer products from smartphones to t-shirts, with labor-intensive sectors such as textiles and toys likely to be the most affected. Profits could begin to erode as early as the second and third quarter of this year.

"If labor accounts for about a third of a company's total costs, a salary increase will greatly affect its profits," analyst Andrew Wong of Hong Kong's Quam Securities told Hong Kong's The Standard newspaper.

The increase in salaries at Foxconn follows a public uproar in the wake of 10 suicides at the electronics manufacturer's plant. Honda's rising payroll came in response to striking workers at a key car parts plant.

"For a long time, China has been the anchor of global disinflation," Credit Suisse economist Dong Tao told the New York Times. "But this may be the beginning of the end of an era."

For decades, the conventional wisdom about production in China held that its massive population would supply an endless stream of workers. So many people would need work that pay could stay low. But as early as 2003, worker shortages began – not because there's an overall dearth of labor, but because young workers are unwilling to accept the low wages of the 1990s. Factories advertise heavily for young workers – because they are perceived to be well-equipped to take the grueling 11-hour workdays, the weekend shifts, and the often-tedious life in factory-owned dormitories – and Chinese employment offices consider it a success if someone over 40 can find any job in less than a year. (For a 2007 New York Times report on this trend, click here. Registration required.)

Besides the recent upward pressure on wages, production costs in China have been rising thanks to government regulations on taxes and retirement insurance, as well as more expensive raw materials. Another challenge is an increase on the price of gas and diesel fuel, which rose 4.1 percent and 4.5 percent respectively in April 2010. Those figures are up 28.7 percent and 29.5 percent, respectively, from the end of 2008, according to the Hong Kong Trade Development Council's report on "Mounting Price Pressure on China Exports."

Vietnam, Cambodia, and other countries where labor costs are lower could prove to be an increasingly attractive alternative to China, but economist Pansy Yau thinks most companies will stay in China and accept the price consequences.

"China's well-established industrial clusters, highly efficient and skilled labor force and infrastructure systems are able to offset the disadvantage of rising costs," said Yau, the trade development council's chief economist.

That likely means higher prices for consumers and small businesses the world over. Says Credit Suisse's Tao of companies' response to rising prices: 'They're going to have to find a way to pass this on to the end user."

Last updated: Jun 8, 2010

Inc. contributing editor COURTNEY RUBIN was for five years a London-based staff writer for People magazine. Rubin, a former senior writer for Washingtonian magazine, has written for the New York Times magazine, Time, Marie Claire, and other publications. She is the author of The Weight-Loss Diaries.




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