The China Syndrome

No I am not talking about the possibility of a nuclear reactor melt down. I am instead talking about the US business rush to set up shop in China. Companies that don't set up in China are doomed for failure.

Why ?

Because labor in China costs 1/5th of that in the US. Even if Transportation of goods That leaves your original transportation costs plus 4/5ths your current labor cost before doing business in China costs as much as doing business in the US. However the cost of transportation at scale is ridiculously cheap. Think of the economy of bus renting. A bus rental for an individual is expensive. But with a butt in every seat paying an equal share it is often cheaper than a car. Well trains and ocean freight liners are probably the ultimate examples of economy of scale in transportation. So most times transportation cost increases are minimal when outsourcing manufacturing to China. The only real down side is increased lead time ( High initial numbers, massive loading operations and weeks of transit time) to market.

So the question really isn't why are companies outsourcing. The real question is why are their companies NOT trying to out source. At least in pure capitalistic terms it makes perfect sense to outsource in light of current world economic realities. However, there is a catch. That reality is tied to the current system of currency exchange. And that is what I refer to as the China Syndrome.

You see the current state of affairs for world wide economies is that of individual pools of autonomous economies connected by the system of currency exchange. The exchange is not tied to real purchasing power. By that I mean like what buys me an average meal. A logical exchange would mean that when I exchange enough money to buy me an average meal in the US it would be enough to buy me an average meal in the country I am visiting. However that is not the way it goes. For example take the UK. One pound is $1.75. A McDonald’s Big mac meal costs 5 pounds where in the US it costs 5 dollars. Yet my 5 dollars cannot purchase a Big mac meal in the UK. In fact its barely enough to order a large Fry. Why ? The prices represent very similar price points in their respective economies. They take very similar support structures to create the meal. Wages are similar. All that is different is the currency used. Yet when going from Pounds to Dollars you could buy almost two meals in the US where going from dollars to pounds you couldn't buy a single meal in the UK.

Hence the power of outsourcing to India and China where the difference in currency exchange are tremendous. India Labor cost for a company paying in dollars is 1/5th the cost in the US and often that 1/5th pays for someone with a higher degree of education than it would in the US. Why does the US not hire call center folks in the US ? Current baseline call center wages are around $10 and hour or less. Thats 20k or so a year. And it attracts the bottom of the labor pool. An indian college graduate with a technical degree (Computer Science) runs $300 a month. A MONTH. Or 3600 a year. Roughly 1/5th the cost of the US low level entry person. That 3600 buys them their pick of the top graduates. Of 100 interviewed for a position 10 will be hired and all will have similar qualifications.

This is not a case where a US company can compete by shaving some costs here and there. At current labor costs in the US a company providing a good or service which can be done somewhere with those labor costs simply cannot compete. Folks may pay a few percentage points more for an obviously superior domestic product. But they will not pay one penny more for products of equal (or worse.. LESS) quality. But they will NOT pay double or higher for a product that is equal or only marginally better. And that is the situation companies have found themselves in. And it is a function of exchange rate. Because without such absurd exchange rates then no company would willingly take on the added complexity of remote management of its labor and or manufacturing plants. It would be an added cost rather than an incidental expense needed to save money via the lower labor costs created by favorable exchange rates.

So what is the Economic China Syndrome? Simple. What happens if the Yaun or the Rupie gains significantly on the dollar? Hell what if they reach parity? What then? US cheap cost goods would vanish in a puff of smoke. Suddenly doing business 5000 miles away would look silly and foolish rather than savvy and necessary. And we would no longer be holding the cards. Of course to do so would be a suicide option for all concerned. IE Chinas life blood at the moment is exports and if the US (and other nations) could suddenly no longer afford to buy their goods they would be in a world of hurt. So as far as the current economic system goes there is an awful lot at stake in maintaining the status quo. But it can't last forever. China and India will never be content to remain the worlds cheap labor pool. Eventually they will want parity. Perhaps at that point we will see such operations move again, perhaps Pulling Africa out of its quagmire of corruption and disease. But sooner or later you have to run out of uncivilized nations with cheap labor. It just isn't a sustainable system. Sooner or later you run out of places for injuns and have room left only for chiefs. And you either re-define the game and go another round where chiefs start doing injun work for a super chief. Then Super Chiefs do... so forth and so on. If you want a concrete example of this. Remember that once upon a time in the US a High School Diploma was sufficient education to get none dead end good paying Jobs. This is no longer the case. Now it is a 2-4 year degree that you need... or even an advanced post graduate degree. Folks who once were chiefs (college grads) now do injun work (entry level grunt stuff).

This is the nature of the beast. The labor market is and always will be bottom heavy. There is no way around it. Everyone can't be 'above average'. It just doesn't work that way... and making things 5000 miles away based on an edge in currency exchange is not smart. Its stupid and its a house of cards that can come tumbling down in a damn hurry with a crazy day at the stock market just like on Black Tuesday which ushered in the depression. Only this time instead of a crushed US economy rippling through out the world. It will be a crushed world economy. It would be one thing if China and the US were on truly equal footing with a common currency and market forces had driven manufacturers to China for competitive reasons rather than the economic witchdoctor system of currency exchange. Then it would be the same thing as US automakers converging on Detroit rather than Phoenix. But this business with severe currency imbalance is a charade that can only hold up so long and I don't really want to be around when it all comes crashing down.