The China Syndrome

As global financial disparities start to wind down, China is likely to end up a winner because emerging-market economies have a definite advantage rooted in the way the global economy functions. Writing in the McKinsey Quarterly, Lowell Bryan, a director with McKinsey & Company, notes that “Saber-rattling Western trade negotiators frequently focus their attention on the ‘unnaturally’ depressed exchange rate of countries such as China, and this is a component of the structural advantage to which I refer.  But its roots run far deeper – all the way down to the fundamental issue that labor can’t be freely traded on a single global market, while capital and commodities can.  Any company sourcing its production or service operations in a lower-wage emerging market-country therefore can save enormously on labor costs.”

China’s recent decision to relax the informal peg of its currency, the yuan, to the U.S. dollar proves that the world must come to grips with a set of economic relationships that are currently unsustainable.  According to Lowell, “Their unwinding will have serious long-term implications for those executives’ strategic priorities, including where they locate operations and what customers they serve in which markets.  Equally important is the need for preparedness in case the unwinding process is sudden and abrupt.  While we surely seem to be headed toward a new global equilibrium, the transition to that future may not be smooth and gradual.”

The cost of labor in China and India is less than one-third of what it is in developed nations.  Additionally, Chinese and Indian productivity are at extremely high levels and tend to be in highly specialized fields – high-tech assembly in China and software development in India.  To take advantage of the cost savings, many multinational firms are locating production facilities in emerging markets.