China is no longer “the cheap place to make things.”  Does that overstate the reality?  This is a debate, not a settled point.  But many signs point to the end of the era when non-Chinese companies moved manufacturing operations to China in order to supply the world.  Today’s international executives are more likely to see China as the source to supply China, and perhaps other parts of Asia, rather than the center of manufacturing or sourcing of their key goods.

Inflation in China today is eroding the outmoded model further.  If one combines the soaring price of materials with the substantial continuing rise in labor costs being felt by all Chinese enterprises, regardless of ownership, there is a powerful ongoing trend of double-digit annual cost increases.  This is squeezing particularly small and medium-sized businesses (SME’s).  According to a June 29 China Daily report, SME’s are feeling the triple whammy of escalating costs, inability to raise prices commensurately, and decreasing ability to borrow from lenders.  Chinese experts opine that SME’s have raised salaries by 20% or more since January 2011, and it has become more difficult to keep rural migrant workers from abandoning factories for their home provinces.  China’s consumer price index surged to 5.4% in March 2011, the first time in 3 years it has surpassed 5% (and nearly double the annual inflation rate experienced in June 2010).  Central government priorities have shifted from growth to fighting inflation as a top concern.  One method of attacking inflation has been to reduce lending, which in turn has made it difficult for SME’s to grow and endure difficult times with their customers.  The China Daily article cites several factory owners who may close their plants under these combined pressures.  5 of 20 members of a Shanghai entrepreneurs’ association are reported to have closed their factories and turned instead to the business of “guaranty companies,” meaning unregulated companies that lend money to others, with substantial interest rates and without the regulation banks face.

It is believed that SME’s contribute about 60% of China’s total industrial output, and employ an even greater percentage of urban workers.  Various macro statistical sources indicate an overall slowdown in industrial production.

China’s cost advantage has not disappeared, of course, and despite an appreciation in the RMB of about 9% in less than 2 years, Chinese goods retain a substantial competitive advantage over European and US producers.  Nonetheless, the inexorable impact of cost increases that are sustainably greater than what is experienced by western producers is a continuing shrinkage in that advantage.  One related double digit increase was seen in the number of Chinese millionaires.  Their ranks grew by 12% in 2010.