Why China Is "The World's Factory"

The Chinese economy thrives as a manufacturing powerhouse and the nation's products seem to be everywhere. The majority of tags, labels, and stickers on a variety of goods proclaim they are “Made in China.” Because of this, it's understandable Western consumers might wonder, “Why is everything made in China?”

Some may think the ubiquity of Chinese products is due to the abundance of cheap Chinese labor that brings down the production costs, but there is much more to it than that. In addition to its low labor costs, China has become known as "the world's factory" because of its strong business ecosystem, lack of regulatory compliance, low taxes and duties, and competitive currency practices. Here we review each of these key factors.

Lower Wages

China is home to approximately 1.41 billion people, making it the most populous country in the world. The law of supply and demand tells us that since the supply of workers is greater than the demand for low-wage workers, wages stay low. Moreover, the majority of Chinese were rural and lower-middle-class or poor until the late 20th century when internal migration turned the country's rural-urban distribution upside-down. These immigrants to industrial cities are often willing to work many shifts for low wages.

China doesn’t follow (not strictly at least) laws related to child labor or minimum wages, which are more widely observed in the West. However, this situation seems to be changing and more provinces report they have increased their minimum wages in response to increases in the cost of living.

In 2021, Guangdong, China's largest economic providence, increased its minimum wage by almost 10% to up to 2,360 yuan per month. As of 2022, Shanghai has the highest hourly minimum wage among 31 provinces (2,590 RMB per month), while Beijing has the highest hourly minimum wage (25.3 RMB per hour).

The huge labor pool in China helps to produce in bulk, accommodate any seasonal industry requirement, and even cater to sudden rises in the demand schedule.

Business Ecosystem

Industrial production does not take place in isolation, but rather relies on networks of suppliers, component manufacturers, distributors, government agencies, and customers who are all involved in the process of production through competition and cooperation. The business ecosystem in China has evolved quite a lot in the last 30 years.

For example, Shenzhen, a city bordering Hong Kong in the southeast, has evolved as a hub for the electronics industry. It has cultivated an ecosystem to support the manufacturing supply chain, including component manufacturers, low-cost workers, a technical workforce, assembly suppliers, and customers.

American companies like Apple Inc. (AAPL) take advantage of China's supply chain efficiencies to keep costs low and margins high. Foxconn Technology Group (a Taiwan-based manufacturer of electronics) has multiple suppliers and manufacturers of components that are at nearby locations. For many companies, it's economically unfeasible to take the components to the U.S. to assemble the final product.

Lower Compliance

Manufacturers in the West are expected to comply with certain basic guidelines with regards to child labor, involuntary labor, health and safety norms, wage laws, and protection of the environment. Chinese factories are known for not following most of these laws and guidelines.

Historically, Chinese factories have employed child labor, have had long shift hours, and have not provided the workers with compensation insurance. Some factories even have policies where the workers are paid once a year, a strategy to keep them from quitting before the year is out.

Faced with mounting criticism, the Chinese government has claimed to institute reforms that protect workers' rights and provide for fairer compensation. However, compliance with the rules in many industries is low and change has been slow. Additionally, environmental protection laws are routinely ignored, enabling Chinese factories to cut down on waste management costs.

Taxes and Duties

The export tax rebate policy was initiated in 1985 by China as a way to boost the competitiveness of its exports by abolishing double taxation on exported goods. Exported goods were subject to zero percent value-added tax (VAT), meaning they enjoyed a VAT exemption or rebate policy. Additionally, consumer products from China were exempted from any import taxes. These lower tax rates helped to keep the cost of production low, enabling the country to attract investors and companies looking to produce low-cost goods.

China and U.S. Tariffs

In July 2018, the U.S. announced China-specific tariffs, targeting 818 imported Chinese products valued at $34 billion. This was the first of many rounds of tariffs imposed by both countries, resulting in $550 billion of U.S. tariffs applied to Chinese goods and $185 billion of Chinese tariffs applied to U.S. goods as of February 2020.

Upon President Joe Biden taking office, China's Foreign Minister Wang Yi called for the end of multiple tariffs. Throughout the Biden presidency, there have been ongoing discussion of easing tariffs. As the United States continued to battle rising inflation throughout 2022, both President Biden and U.S. Secretary of the Treasury Janet Yellen stated easing tariffs with China could have positive implications on domestic inflation concerns.

Currency

China has been accused of artificially depressing the value of the yuan to provide an edge for its exports against similar goods produced by U.S. competitors. China keeps a check on the appreciation of the yuan by buying dollars and selling yuan. The yuan was estimated to be undervalued by 30% against the dollar in late 2005.

In 2017, the yuan appreciated 8% against the dollar, a move that experts say came about after former President Trump threatened to label China a currency manipulator. However, this trend reversed and the yuan weakened against the dollar beginning in June 2018 when the U.S. imposed tariffs on Chinese goods.

On Aug. 8, 2019, China's central bank lowered the yuan to 7.0205 per dollar, the weakest level since April 2008. Throughout the COVID-19 pandemic, the yuan continued to lose value to the U.S. Dollar. The average exchange rate throughout 2021 was 6.4529 CNY to USD with the exchange rate hitting 6.36 at the end of 2021.

The Bottom Line

Pundits have wondered if China will lose its spot as "the world's factory” as other emerging economies offering cheap labor dull China's competitive edge. However, the availability of cheap labor is just one of many factors that have kept the "Made in China" label on so many products purchased by consumers around the world. It will take more than low labor costs for emerging economies to set up a business ecosystem that can compete with China's. For some time to come, China will be "the world factory” with its low production costs, huge labor pool, vast talent base, and business ecosystem.