What factors can make U.S. based producers cost competitive vs. production offshore? Such questions typically raise another issue: can U.S. productivity offset Chinese wages? However, by examining the cost structure, we find that a great portion of the costs borne by U.S. industrial firms are incurred outside the realm of production in the form of salaries to administrative workers. In 2012 within U.S. manufacturing firms, for every hundred production workers, there were 53 salaried, administrative (and technical) employees. The administrative : production ratio as measured here in terms of people is also reflected in terms of cost. By 2012, for every dollar paid to production workers an equal sum was paid to the salaried employees. This equality of payments tells you immediately that the conventional method of slashing the costs of industrial products by lowering production worker wages is not the only option available. However, in most U.S. manufacturing firms the idea of reducing the salaries of administrative employees is almost unheard of. (Recall that U.S. corporate chiefs are on average being paid 531 times the labor employee average. Such differences are common among all US administrative employees in comparison to their production laborer counterparts. International administrative employees only make one to two times the amount of the production laborers they oversee.)
Apart from administrative costs and materials, the main body of expense in manufacturing production is controlled by the productivity of labor and the productivity of capital. The degree of mechanization of work has a controlling effect on the average output per production worker, (i.e. the productivity of labor). But for every work task, there is an alternative production method and new equipment that can be graded on the basis of intensity of mechanization, in essence, the size of the capital outlay per particular piece of equipment.
In the centuries-long history of manufacturing industry, managers and their engineers have responded to the rising wages of production workers by developing means of production by which the average output per production worker man-hour could be progressively increased. At any given time and for any given task, a manufacturer confronts an array of possible production equipment ranked in terms of the capital outlay required for each one: the higher the wages of production workers, the greater the capital outlay that can be justified in order to increase the output per production worker man-hour. This is called the alternative cost of labor to machinery.
In the United States in 2012, the average Hourly Compensation Cost of a production worker man-hour to management was $21.33. Therefore, any management seeking to minimize the cost of output per production worker was justified in making a larger capital investment per production worker man-hour in the U.S. as compared to the design of production methods where the Hourly Compensation Cost is much lower e.g. Mexico $2.38.
For example, the Pioneer Corporation of Japan has invested in new manufacturing facilities in China, and we learn that Pioneer is hiring workers by the hundreds to fill jobs on the line that pay about $95 a month, above average for the region. Assuming 170 hours per month (a 40 hour week), the China wage would be about $0.56 per hour. Compare that with the cost to management of a production worker man-hour in Japan. In 2012, it averaged $18.83 per hour, 33 times as much as the Chinese wage. Accordingly, it is no surprise at all that in China, paying workers to do rote tasks like hunching over tiny chip assemblies and affixing pinhead-size pieces is cheaper than installing the industrial robots that would reduce the workforce by 80%.
This is a clear demonstration of the role of alternative costs of labor to machinery, and their effect on production methods and productivity. The same considerations apply, of course, to American firms making investments in China as American firms are making the same calculation.
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