American Manufacturing Companies From China: Offshoring Factors And Cost Analysis

Factors Influencing Offshoring to China

Discuss About The American Manufacturing Companies From China.

Through offshoring, a business organisation can relocate its various business processes to other countries. The process is referred as operational one, where foreign countries have done manufacturing, accounting or other supporting activities (Unel 2018). Offshoring can be of two types, which are, production related and service related. In this context, some factors, which have evaluated this process of business, can be taken under consideration. Those factors are infrastructure, business size, cultural alignment, local skilled workers and standard of industry (Murphy and Siedschlag 2018). With the help of those factors, it can be easier to understand that why Asian courtiers have become a good offshoring partner compare to the South America and Africa.

The infrastructural facilities in both China and India have increased significantly over the last few years. These two countries have captured significant market share in world economy, which in turn has helped them to develop their economical condition. Both countries have developed transportation and communication system. The number of internet users has increased significantly on these two countries. In addition to this, telecommunication facilities along with transportations have also developed in China and India. The business sizes have also increased by large amount. Through their large market shares, China and India have captured significant market position in world economy (Fuller, Akinwande and Sodini 2017). This in turn can help other foreign companies to outsource their business as they can get positive and large business environments in those countries. Though India is a multicultural country, this diversification does not influence other foreign countries to offshore their business here. Moreover, people with middle and lower income groups can be found by large extend within these two countries. This has helped foreign countries to hire labour with a lower wage rate. However, those most important factors for choosing these two Asian countries are skilled workers and standard industrial sectors (Albertoni et al. 2017). Both countries have possessed huge number of population. Most of the service sector outsourcing can be seen in India because of the country’s skilled worker force. Moreover, manufacturing offshoring can be seen by large numbers in China due to their huge amount of physical workers. With large market share, these countries have also possessed standard industrial sectors. This has helped those countries to develop essential infrastructure and labour force according to the requirement.

Manufacturing offshore can be considered as irrational activities of companies from the economical perspectives. Companies chiefly offshore their parts of productions in other countries for saving cost. However, this concept is not always true. To conduct a business in other countries, a company needs to follow some administrative laws, which can further offset the savings (Zhai, Sun and Zhang 2016). In addition to this, parts of productions that are made in other countries, my not fulfil the product specifications. For this, the quality costs of this company may be higher. Moreover, transportation expenses and tariff may lead the manufacturing offshore towards a negative direction (Pearce II 2014). Higher tariff can increase the production costs in foreign markets compare to the domestic one. To produce products, proper training to foreign workers is essential. Hence, from here, it can be stated that the company cannot only enjoy benefits of offshoring, rather it needs to bear some external costs, which can be reduced by producing in its own country.

Cost Analysis of Offshoring to China

Within a production process, output can be increased by large proportion compare to the increase in inputs. In this situation, it can be said that the increasing return to scale has occurred within this production system (Pástor, Stambaugh and Taylor 2015). This can be explained with the help of suitable diagram.

Figure 1: Increasing returns to scale

Source: (created by author)

Figure 1 has represented the situation of increasing returns to sale. Here, two inputs of productions, capital and labour, have measured on the two axes. According to this figure, with 1 unit of labour along with 1 unit of capital, the producer can produce 10 units of output. However, the amount of output has increased by more than double, which is 25 units, when capital and labour are increased by double. Thus, the firm is operating under increasing returns to scale.

The firm has input choices and costs are completely depended on the prices of inputs in both domestic and foreign markets. Suppose income of capital is same for both foreign and domestic markets. On the othersider, labour is cheaper in foreign market compare to the domestic one. From this, it can be said that, the company can experience comparative advantages to produce a part of its output in foreign country with cheaper labour cost. Increasing returns implies decreasing average cost in long-run. By using some particular amount of inputs, the company can earn more amount of output. This situation is true for both foreign and domestic markets. However, due to lower prices of labour, the country can experience economies of scale in foreign market (Baumers et al. 2016). Economies of scale can be said as the advantages of costs that the organisation can enjoy during its scale of operations.

Figure 2: Economies of scale

Source: (created by author)

Figure 2 has represented the economies of scale. As the company has experienced this in foreign market, it can produce a part its product in foreign county.

The given production function is Q= K² L²

 MP_L= 2 K² L and MP_K= 2  L² K

Hence, the Marginal Rate of Technical Substitution = MP_L/ MP_K  = 2 K² L/2  L² K= K/L

Therefore, K/L = 20/40 = ½

• L = 2* K

Hence, to produce 100 unit of output in home country, the firm needs to bear $223

For foreign country:

K/L = 10/ 40 = ¼

• L= 4K

Hence, to produce 100 unit of output in foreign country, the firm needs to bear $255

Economies of Scale and Advantages of Producing at Home

As the cost of production in foreign country is higher compare to the domestic one, the firm can produce its entire output in home country only (Shen and Lin 2017).

. If the firm choose to produce half amount of output in home country and half amount in foreign country, then, k= 4L

Substituting this value in production function, total cost can be determined as $237.6

Thus, the firm will not divide its production between home and foreign country.

Figure 3: Isoquant  line

Source: (created by author)

As the marginal rate of substitution between labour and capital is equal, the firm can substitute its capital input with labour one. That means, to sacrifices some amount of capital, the firm needs to substitute same level of labour (Benjamin et al. 2014). This is because, the wage rate is low comparing to the rental of capital. Hence, this substitution can help the firm to produce at its domestic market with cheaper costs. This can help the company to remain competitive in international market rather than offshoring.

NAFTA is a trade agreement between three countries, viz., U.S, Canada and Mexico. Those countries have eliminated all tariffs and trade barriers among them. According to the president of U.S, people of America are losing their jobs due to this agreement (Caliendo and Parro 2015). The chief reason is that, all companies are moving to Mexico for offshoring as they can receive cheaper labour in this country. Thus, the president wants to renegotiate it for bringing back job opportunities in America. For this, three trade policies have been taken under considerations. Firstly, the U.S exports huge parts of automobiles from Mexico. According to the new policy, the car, which is sold in either U.S, or Mexico or Canada, needs 62.5% parts from those three countries (O'Brien and O'Brien 2018). This policy can be referred as “rules of origin”. Secondly, to bring back workers from Mexico, another policy has been taken. According to this policy, manufacturing in Mexico is going to be expensive after increasing standard of labour along with environmental one. Some companies have set their business in Mexico because of the country’s lower restrictions regarding air and water regulations. However, increasing standard of environment can affect those companies inversely and consequently they may bring back their business activities in the U.S. Thirdly, the value-added-tax (VAT) of Mexico on all companies is 16% (Freund 2017). This rate is also same for American companies, who are operating within this country. However, according to the policy of the president, this rate needs to be abolishing, as it is unfair.

Those regulations have some unpredictable outcomes for future. Huge pressure on Mexico through this trade policy may help the U.S to bring back jobs. However, it is not confirmed that whether the U.S.A can create same amount of jobs in their domestic market or not. Moreover, by reducing offshoring car parts in other countries it can be difficult for the U.S car producers to compete in international market with higher car prices. On the other side, the policy to increase the labour standard in Mexico may help the country to increase its employment further.

References:

Albertoni, F., Elia, S., Massini, S. and Piscitello, L., 2017. The reshoring of business services: Reaction to failure or persistent strategy?. Journal of World Business, 52(3), pp.417-430.

Baumers, M., Dickens, P., Tuck, C. and Hague, R., 2016. The cost of additive manufacturing: machine productivity, economies of scale and technology-push. Technological forecasting and social change, 102, pp.193-201.

Benjamin, D.J., Heffetz, O., Kimball, M.S. and Rees-Jones, A., 2014. Can marginal rates of substitution be inferred from happiness data? Evidence from residency choices. American Economic Review, 104(11), pp.3498-3528.

Caliendo, L. and Parro, F., 2015. Estimates of the Trade and Welfare Effects of NAFTA. The Review of Economic Studies, 82(1), pp.1-44.

Freund, C., 2017. Trump's Confrontational Trade Policy. Intereconomics, 52(1), pp.63-64.

Fuller, D.B., Akinwande, A.I. and Sodini, C.G., 2017. The globalization of R&D's implications for technological capabilities in MNC home countries: Semiconductor design offshoring to China and India. Technological Forecasting and Social Change, 120, pp.14-23.

Murphy, G. and Siedschlag, I., 2018. Determinants of R&D offshoring: firm-level evidence from a small open economy. Economia Politica, pp.1-25.

O'Brien, M. and O'Brien, M. 2018. Donald Trump’s plan to bring jobs back to America comes with one giant asterisk. [online] Washington Post. Available at: https://www.washingtonpost.com/news/wonk/wp/2017/01/30/donald-trumps-big-plan-to-bring-jobs-back-to-america-has-one-giant-astericks/?utm_term=.157d1e21f108 [Accessed 25 Apr. 2018].

Pástor, ?., Stambaugh, R.F. and Taylor, L.A., 2015. Scale and skill in active management. Journal of Financial Economics, 116(1), pp.23-45.

Pearce II, J.A., 2014. Why domestic outsourcing is leading America's reemergence in global manufacturing. Business Horizons, 57(1), pp.27-36.

Shen, X. and Lin, B., 2017. Total Factor Energy Efficiency of China’s Industrial Sector: A Stochastic Frontier Analysis. Sustainability, 9(4), p.646.

Unel, B., 2018. Offshoring and unemployment in a credit-constrained economy. Journal of International Economics, 111, pp.21-33.

Zhai, W., Sun, S. and Zhang, G., 2016. Reshoring of American manufacturing companies from China. Operations Management Research, 9(3-4), pp.62-7