Economies shift in response to changes in financial power, and these changes will always affect our world. News reports about the strikes and labor problems in several Chinese manufacturing plants highlight the challenge the Chinese government faces in maintaining an economy based on cheap labor and exports. Although such an economy is not sustainable in the long run, it has served China during its industrial development phase. However, China’s manufacturing base has been evolving since the government completely revised its labor laws. These changes, along with the currency appreciation of the yuan and stricter enforcement of environmental legislation, have caused China to signal it is no longer interested in low-value production. Although the recent strikes and labor unrest have certainly contributed to this change, they aren’t the sole cause of it. China is increasing its manufacturing momentum to draw alongside and possibly overtake some of its global competitors. The fallout from this is just beginning.

Outsourcing’s about-face

Toy companies, such as K'NEX Brands LP and Wham-O Inc., find it’s no longer cost effective to source their products in China and are returning their production to the United States. Compal Electronics, the world’s second largest contract notebook-computer maker, is planning to move half of its total production to Vietnam by 2013. Similar to how the shoe and textile industries left the New England states during the 1950s and 1960s for lower-cost locations, many China-based manufacturers are moving to less expensive venues in western China or declining to do business there outright, as toy manufacturers have done.

“The laws in China are shifting for many political reasons, and it’s no longer legal for people to work unlimited overtime,” says David Metzemaekers, director of operations for Scott Electronics. “Chinese workers are now starting to leave low-paying jobs, and this is creating increased overheads and training problems for companies based there. The landed cost is being more accurately tracked, and we found that when a China-based operation has to copy exact material specifications, Mexico can beat it. In some instances, when comparing landed cost, the United States is better as well. We are now making a number of assemblies that are shipped to China.”

Metzemaekers also points out that electrical machine and equipment components in China have increased by 61 percent between January and April 2010, as compared to the same period last year. Although this is good news, particularly for electronic exports from Massachusetts, which account for 38 percent of the United States’ total exports to China, this will have a negative effect on many U.S. manufactures that have depended on a stagnant purchasing price for Chinese parts to keep the price of their own product offerings down. There will be considerable reengineering or price increases to compensate for this.

A boon to U.S. producers

GE, the godfather of outsourcing, has reacted to all of this by promoting the need for a vibrant U.S. manufacturing base and returning production to the United States. This change is not just for production but for technology as well. John Rice, vice chairman and CEO of GE’s technology infrastructure, recently announced that the company is opening a software center right outside Detroit that will employ 1,100 people. “Most of the jobs at this point are software engineers,” concedes Rice, “but it’s the kind of stuff that eight to 10 years ago would have automatically gone to India.” Obviously, shifting economics have halted the U.S. trend to outsource virtually all production. Three manufacturing groups—the National Tooling and Machining Association, the Precision Metalforming Association, and the Association for Metal Forming Technology—have now hosted a supplier fair to demonstrate, thanks to the changing economics, the competitiveness of domestic suppliers.

Today’s economics were best described in a recent Wall Street Journal article announcing Caterpillar’s plans to consolidate and triple its domestic excavator production by moving its worldwide production to a single U.S.-based plant. The article stated that “after a decade of rapid globalization, economists say companies are seeing disadvantages of off-shore production, including shipping costs, complicated logistics, and quality issues. Political unrest and theft of intellectual property pose additional risks.”

All of this happened prior to the Chinese government’s announcement about its plan to eliminate its currency's peg to the dollar. Although this might be a hopeful signal that we will be seeing a more balanced world economy, it will probably not create significant changes in the short term. Any increases in the yuan’s value might mean higher prices, but it will also enhance China’s purchasing power for raw materials abroad. We could see more manufacturing returning to the United States as these new economic realities require that we once again produce more than we consume.

However, the manufacturing sector must realize that waiting for China’s manufacturing capability to falter will do nothing to shape the future of their respective firms.  We have all been here before: Most of the organizations that sat on the sidelines waiting for Japan’s manufacturers to go away are for the most part no longer with us. Manufacturers would be wise to position their firms to effectively compete and deal with the new economics.