Higher pay and the relocation of factories are undermining China's three-decade export model that concentrated production, cheap labor, infrastructure and supply chains in one place, allowing savings that made it the world's supplier of low-end goods. As manufacturing costs rise, price increases will be passed on to the world, said Tao Dong, head of Asia economics excluding Japan at Credit Suisse Group AG in Hong Kong.

“The days of China as the anchor of global disinflation have ended,” said Tao. “When global demand picks up, global inflation may arrive sooner rather than later. This will affect everything, from the Italian housewife to Federal Reserve monetary policy.”

China's pool of 15- to 39-year-olds, which supplies the bulk of workers for industry, construction and services, fell to 525 million last year, from 557 million five years earlier, according to data compiled by Bloomberg News from the U.S. Census Bureau's international population database. The number employed in industry rose to 147 million from 117 million in the five years through September.

The labor squeeze means wage costs inland are fast catching up with the industrial belt in the south and east. Average factory pay in Henan, about 800 kilometers (500 miles) from the coast, rose 110 percent in the past five years and gained 84 percent in Chongqing, 1,700 kilometers up the Yangtze River. In the same period, salaries rose 78 percent in Shanghai on the east coast and 77 percent in Shenzhen's province of Guangdong.

“The wage differential between inland and coastal regions is down by more than half since 2006,” said Jitendra Waral, a Bloomberg Industries analyst in Hong Kong.

Pay pressures are set to intensify with the supply of young workers forecast to shrink by 20 million to 505 million by 2015 and a further 22 million by 2020.

In Wuhan, the capital of Hubei province, Japanese automakers Nissan Motor Co. and Honda Motor Co. pay a basic wage of $333 a month, compared to $352 in Guangzhou and $317 in Shenzhen, according to an April 2012 report by the Japan External Trade Organization.

'Tipping Point'

The gap between manufacturing costs in the U.S. and China has almost halved in the past eight years and will fall to 16 percent this year, according to Hackett Group Inc., a Miami-based consulting company. That's a “tipping point” that will prompt some companies to shift factories back to the U.S. or to destinations nearer consumers, says Hackett, which lists customers including Pfizer Inc., Microsoft Corp. and Boeing Co. on its website.

Nations including Vietnam, Cambodia and Bangladesh already are reaping gains. Vietnam's foreign investment increased more than threefold to $7.4 billion in 2011 from five years earlier, according to the United Nations Conference on Trade and Development. In Cambodia it surged 85 percent to $892 million and in Bangladesh 43 percent to $1.1 billion.

Hong Kong-based bra maker Top Form International Ltd. shuttered its factory in Shenzhen last year and is expanding production in Phnom Penh, Cambodia's capital.

We are “trimming down our expensive capacity in China,” Chairman Fung Wai Yiu wrote in the company's 2012 annual report.

The average monthly pay for a factory worker in Guangzhou was $352, compared with $111 in Hanoi, $82 in Phnom Penh and $78 in Dhaka, the Japan External Trade Organization's survey said.

Other producers, such as automaker Great Wall Motor Co. in Baoding, are investing in automation to reduce headcount.

“The hard fact is that unless China moves up the value chain the future contribution of exports to economic growth will decline,” the World Bank said in “China 2030,” a report released last year in cooperation with the Development Research Center of the State Council.

Foxconn was one of the first of China's big exporters to build plants inland where the bulk of the nation's migrant workforce comes from. More than 90 percent of the 250,000 workers in its 5.5 square-kilometer Henan plant are from the province's population of 94 million.

“Every company I talk to has been taken by surprise by the tightening of the labor market,” said Auret van Heerden, president and chief executive officer of the Washington-based Fair Labor Association. “Foxconn chose to shift to very populous provinces where they thought there would be a deep pool of labor. What they're finding is that the younger generation simply doesn't want to work in factories.”

Zhuge Leilei, 24, signed on with Foxconn in Zhengzhou two years ago and was sent to the company's Shenzhen plant for four months to train as a team leader.

“The pressure is huge,” Zhuge said in January. “Once I get my year-end bonus, I'm going to quit.”

The new factories have denuded many rural communities of young workers. In five central provinces, more than 90 percent of men in villages and about 76 percent of women between the ages of 20 and 40 now work elsewhere, according to a poll of 2,020 rural households conducted by Beijing Forestry University, the Chinese Academy of Sciences and Stanford University.

“Young, mobile labor is gone,” said Scott Rozelle, head of the Rural Education Action Project at Stanford in California. “Moving inland helps, but only a little. It is mainly for tax purposes and cheap land, not cheap labor.”

Search Reward

On field trips since 2008, Rozelle offered about 300 students and interns a 100-yuan reward for every person they could find between the ages of 20 and 40 who worked on a farm.

“I have never paid out one cent,” he said. “In northern Sichuan, Guizhou or Gansu, there are zero people between 20 and 40 on farms. My students have looked long and hard.”

Thirty kilometers from Foxconn's Zhengzhou factory is the village of Mengzhuang, surrounded by orchards of jujubes, or Chinese red dates. On the dusty main street, Hao Yong crouches in his one-room store over a metal stove to keep warm, surrounded by boxes of jujubes he hopes to sell to passersby.

“All the young people have gone,” said Hao, 30, who says he was turned down by Foxconn because of a disability.

Foxconn increased its China workforce by 50 percent in two years to 1.2 million. The company has suffered suicides, riots and strikes in the past three years. Employees, who work up to 12 hours a day, complain of difficult demands from managers.

As many as 4,000 workers walked off the job at Zhengzhou in October, according to advocacy group China Labor Watch. A dispute occurred when employees became frustrated trying to prevent scratches on iPhone casings, according to two people familiar with the matter.

“Workers are becoming increasingly demanding,” said Li Qiang, executive director of the New York-based labor group. “They want to spend, they don't want to work long hours.”

After pressure from Apple and the media, Foxconn more than doubled wages in 2010 for some workers in China and employed counselors. The company is giving workers greater representation in unions. Its dormitory complex in Zhengzhou looks like a private residential development, with shops and a karaoke lounge.

“If you want to exist for a long, long time, you must create a system providing not only jobs but also lifestyle,” said Liu Kun, a company spokesman, in an interview in Zhengzhou.

Factories shifting inland also face other challenges. Moving away from subcontractors and parts makers stretches supply chains and often increases transportation costs.

Jeans maker Yi Ding Hong Clothing Co. shifted production to Huaxian in Henan in 2009 from Guangzhou, lured by tax incentives and cheaper land, said founder and chairman Kang Xunda. Two years later, Kang moved back to the coast.

“It cost us millions,” he said. “There were virtually no savings on wages and the logistics was a nightmare.”

Kang said he could find 30 suppliers on the coast for each one in Henan.

“In Guangzhou, delivery promised in three days will be delivered in three days,” he said in a telephone interview. “In Henan, delivery promised in a week can take a month.”

Companies that do move inland often worsen the labor shortage on the coast because many of the staff they hire are former migrant workers.

Henan resident Wang Xiaohong used to work at an electronics factory in Hangzhou, south of Shanghai, before taking a job last year at Foxconn in Zhengzhou. After deductions for food and board, Wang earns the same starting wage as she did in her previous job, about 1,500 yuan a month.

Homemade Noodles

“It's nice to be a bit closer to home,” said Wang, 23, from Dengfeng, a nearby wheat-growing county. “I can go home often and have my mother's homemade braised noodles.”

China still has advantages for manufacturers other than cheap labor, including the scale of its domestic economy, superior infrastructure, proximity to component suppliers and established logistics networks, said Beijing-based Fred Hu, founder of private equity firm Primavera Capital and former Greater China chairman at Goldman Sachs Group Inc.

The share of exports produced inland rose to 8.7 percent in April last year, from 5.5 percent in December 2010, Goldman Sachs said in a Dec. 11 research note. Last year, exports from central and western China rose 22 percent and 38 percent, respectively, compared to a 5 percent gain on the east coast.

After a leadership change this month, new Chinese Premier Li Keqiang promised on March 17 to open the economy more to market forces to achieve 7.5 percent annual growth through 2020.

Expansion may slow to 6.2 percent annually by 2030, or less if employment gains weaken or investment drops as a share of gross domestic product, Jane Haltmaier, an economist at the U.S. Federal Reserve in Washington, wrote in a research paper posted this week on the central bank's website.

International Monetary Fund researchers Mitali Das and Papa N'Diaye say China's cheap labor may last longer than five years. The nation has a pool of 150 million unemployed or underemployed workers that probably won't be exhausted until between 2020 and 2025, they wrote in a paper released in January.

Still, they say forecasts may understate prospects of a labor shortage because the pool of workers below 40 years old will shrink faster than the overall workforce.

Older workers “don't want to work in factories and factory owners don't want to hire them,” said Stanford's Rozelle.

As farms in central China give way to factories, Tao at Credit Suisse estimates China will face a shortfall of almost 18 million workers by 2020. The shift of labor-intensive industry will only delay the loss of China's comparative advantage, said Cai Fang, head of the Institute of Population and Labor Economics at the Chinese Academy of Social Sciences in Beijing.

“The surplus labor pool is diminishing,” said Cai, a member of the National People's Congress. “Central and western regions cannot afford more factories of Foxconn's size.”

Bloomberg News

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