China’s factory floor is moving—but not to India or Mexico

A factory in China’s Hubei region, one of several central and western provinces where exports are soaring. (Photo: AFP)
A factory in China’s Hubei region, one of several central and western provinces where exports are soaring. (Photo: AFP)

Summary

Companies seeking alternatives to China are finding the country’s vast interior still holds big advantages.

SINGAPORE—In the contest to knock China off its perch as the world’s factory floor, countries such as Mexico, India and Vietnam face a formidable rival: China’s vast interior.

Low-cost manufacturing is expanding away from China’s bustling coast as companies hunt for cheaper land and labor in central and western provinces. The migration has accelerated in recent years as U.S. tariffs push up costs for factories, and China’s coastal megacities focus on high-tech electronics, electric vehicles and other advanced industries.

The result has been an export boom for China’s inland provinces that dwarfs the acceleration in overseas sales enjoyed by would-be rivals to China’s manufacturing crown.

As inland China develops further, it is helping China deepen its dominance in swaths of global manufacturing, even as Western nations grow wary of China as a supplier for critical industries such as semiconductors and renewable energy.

China still faces major challenges in holding on to its top-dog status. Worsening demographics mean its manufacturing workforce is shrinking, and foreign investment in China is drying up.

The U.S. and its allies are dangling subsidies and other incentives to persuade businesses to embrace alternatives to China, though a sizable shift in companies’ sourcing is likely years away, economists say.

“China is going to be a major player in global manufacturing for the foreseeable future," said Gordon Hanson, an economist and professor of urban policy at Harvard University’s Kennedy School, who explored the possibility of more manufacturing moving to inland China in a 2020 paper.

“China just has too much capacity for the world not to need to rely on it for a good while."

Since the start of 2018, exports from 15 of China’s central and western provinces have rocketed 94% as factory production expanded beyond the Pearl and Yangtze River deltas that are the engine rooms of China’s industrial economy.

In the 12 months through August, those provinces exported a combined $630 billion—more than India’s $425 billion, Mexico’s $590 billion, and Vietnam’s $346 billion over the same period, according to official figures compiled by data provider CEIC.

Exports from China’s interior have been growing faster than those countries’ exports, too, despite the surge in interest in alternative locations for manufacturing other than China.

Since the beginning of 2018, exports from India have risen 41%, exports from Mexico have risen 43%, and exports from Vietnam have increased 56%. All three countries have benefited from the reshuffling of global supply chains in the wake of the U.S.-China trade war and the Covid-19 pandemic. In 2018, Mexico was exporting more than China’s interior but was overtaken in 2020.

China’s coastal provinces, which encompass manufacturing hubs such as Guangzhou and Shenzhen in the south, Ningbo and Shanghai in the east and Qingdao and Tianjin in the northeast, remain the powerhouse of global manufacturing. Together, those regions exported $2.7 trillion of goods in the 12 months through August, around half the total exports of the U.S., European Union and Japan combined.

A hunt for lower costs

Behind the shift inland is a search for labor. In the 1990s and 2000s, millions of Chinese left the countryside to work in the factories sprouting in the coastal cities.

Today, that trend is all but played out, and wages in coastal areas have risen sharply as companies jostle for staff.

Average annual private-sector wages in Guangdong more than doubled in the 10 years through 2021, according to China’s National Bureau of Statistics. Better-educated younger workers in coastal cities are skipping tough factory work for jobs in services.

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Ray Zhou, head of supply chains at Commerse, a fashion brand based in New York and China, said his company began shifting production to inland China from the coast in the second half of 2022.

Now, about half of the machine sewing work is done by factories based in China’s interior, including Guangxi and Hunan provinces. While producing garments inland means longer shipping times to the U.S., overall labor costs are about 30% cheaper than in Guangzhou, he said.

Most workers hired by the factories that supply Commerse are in their 30s and 40s. “Young people would rather deliver takeout than be sewing clothes at factories," Zhou said.

Other forces pushing companies into the interior include a search for cheaper factory space and tighter rules in coastal cities to reduce pollution or rezone industrial areas for residential development.

Niche industries sometimes cluster in one place. A town in Anhui specializes in brushes, while one in Henan makes measuring tapes. In Guizhou, a mountainous province that also exports Kweichow Moutai, a fiery spirit, dozens of firms make high-quality guitars.

Inland China’s upsides

In many ways, the shift in China mirrors the migration of industrial activity in the U.S. after World War II, when new highways and the advent of the shipping container enabled factories to move out of big cities in search of lower taxes and cheaper workers.

Development of China’s interior has been on Chinese leaders’ minds since the 1960s, when Mao Zedong grew fearful of invasion by the Soviet Union from the north and the U.S. from south, where it was fighting in Vietnam. Authorities pushed to move basic industries such as power generation and steel and arms manufacturing into China’s interior to protect them in the event of war.

Beijing concluded in the 1980s that the effort was mostly a waste of resources. But Covell Meyskens, a historian of China and associate professor at the Naval Postgraduate School in California, said it laid foundations that nurtured industry later, such as the building of roads, schools and electricity grids.

China’s central planners have for decades emphasized the importance of creating an integrated national economy, said Meyskens. The interior “isn’t just treated as a rust belt you can completely abandon."

Even today, the industries flourishing inland tend to be labor or resource-intensive or relatively low-value-added manufacturing, leaving China’s coastal regions to concentrate on more advanced manufacturing.

In Hubei, a central province with around 58 million residents, exports of heavy industry products such as chemicals, metals and vehicles more than doubled between 2018 and 2022, while exports from labor-intensive sectors such as clothes, furniture and toys rose 90%, according to Chinese customs data.

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The landlocked province, which includes the city of Wuhan and the Three Gorges Dam, has many attractions for companies seeking a new base: Access to the coast and world beyond via roads, rail and rivers; universities focused on technology, science and business; and average private-sector wages that are 77% of the level in Guangdong.

Garrett Motion, a maker of turbochargers, said in June it expanded production capacity at a plant in Wuhan by 50%. German auto parts maker Webasto has said it plans to establish a global research center in the city.

Why China’s grip is firm

The U.S. and other Western countries have grown uneasy about their dependency on China for manufactured goods, especially now that China isn’t just providing cheap furniture and toys but is competing with Western manufacturers in sales of smartphones, machinery and, increasingly, autos.

Washington and other capitals are offering subsidies to lure more manufacturing back home. They are also restricting China’s access to Western technologies, such as semiconductors, that could have military applications.

Many companies scarred by the pandemic and spooked by tensions between Beijing and the U.S.-led West arere fashioning supply chains to make them less reliant on China.

But economists say loosening China’s grip on global manufacturing will be tough.

China’s share of global goods exports was 14% in 2022, down slightly from 2021, and compared with 8.3% for the U.S. in second place and 6.6% for Germany, in third. A recent report by Rhodium Group, a New York-based research outfit, said moving factories out of China to other countries may have little impact on China’s manufacturing clout, since those factories will remain dependent on Chinese suppliers for materials and components.

“It would not be surprising to see China’s overall share of global exports, manufacturing and supply chains continue to rise, even as diversification away from China accelerates," the authors said.

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One advantage for China is its scale. As Japan, South Korea and other countries in East Asia industrialized during the 20th century, they quit manufacturing products such as textiles or furniture to concentrate limited factory capacity on higher-end products, such as cars and consumer electronics.

China, by contrast, has maintained a stranglehold in manufacturing all sorts of goods, a testament to its factories’ ability to keep down overall costs even as average wages of Chinese workers have risen.

“It’s not really going anywhere. It is producing everything from semiconductors to your shoes and your garments," said Louise Loo, lead economist for China at Oxford Economics.

Chinese factories also benefit from cheap loans from domestic banks and a deep bench of suppliers of almost every conceivable component and raw material. Logistics costs in China are a fraction of the cost in India, for example, which can’t match Chinese port and road infrastructure.

All that means up-and-coming manufacturing nations such as Vietnam, India and Bangladesh face sizable challenges in competing with China, economists say.

“My concern is very much about the newcomers," said Stefan Angrick, senior economist at Moody’s Analytics in Tokyo. “How do you compete with that?"

Stella Yifan Xie in Hong Kong contributed to this article.

Write to Jason Douglas at jason.douglas@wsj.com

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