Where China Goes for Cheap Labor
By Graham Summers
December 17, 2007

In June 2007, China passed a labor contract law.

The law states that any employee who's been with a company more than 10 years qualifies for permanent employment. It's a small, albeit strange, step for workers' rights in China. And it's got large tech firms flustered.

Chinese labor costs have been rising for a while now due to inflation. And this new labor law is going to accelerate that trend. "China is definitely not the cheapest place to produce any more," Peter Tan, president of Flextronics in Asia, told the Economist earlier this year.

For companies like Hon Hai Precision, a Taiwanese electronics manufacturer with plants in China, labor costs are expected to rise as much as 15% because of the policy shift.

As unbelievable as it sounds, companies have actually begun to outsource from China. And many of the tech firms are looking at Vietnam. The biggest and most famous is Intel, which announced in 2006 that it would invest $1 billion in Vietnam. In one year, Intel committed more to Vietnam than it had in a decade in China.

Likewise, Hon Hai announced plans to invest $5 billion in manufacturing plants there in the next five years. Compal Electronics, the world's second-largest laptop maker, is building a $500 million PC plant. And AsusTek, a China-based maker of computer parts, is planning on moving some of its production lines.

Vietnam's government is offering plenty of special benefits to these guys. Businesses that set up in the Hoa Lac High Tech Park, a pro-business tech zone in Northern Vietnam, don't pay taxes for the first four years following profitability. And they'll only pay half of the normal 28% tax rate – so 14% – for nine years after that.

In 2006, Vietnam received $12 billion in foreign direct investment. This year, it should hit $16 billion.

Don't get me wrong. I'm not saying Vietnam will ever fully compete with China when it comes to manufacturing. The country's much too small – 85 million people vs. China's 1.3 billion – and doesn't have the infrastructure to become a heavyweight just yet.

However, Vietnam is benefiting greatly from China's increased labor costs, rising office rents, and industrial land shortage. Malaysia and Indonesia are other Asian countries that have attracted international firms.

Vietnam's stock market, the Ho Chi Minh Exchange, has been one of the top performing indexes in the world. It's up 400% in the last five years.

But investing in this market is extremely difficult. And frankly, I wouldn't suggest putting your money there now. In 2006, the average price-to-earnings ratio for Vietnam's top 20 firms was already 73. Vietnam officials claim this number is inflated by new firms coming online and pre-existing firms bringing more shares to market (both moves that dilute earnings). However, even the local estimate of 30-40 times earnings is too high for me to be comfortable putting money there.

To me, the real potential lies in real estate. As international firms and investors pile into Vietnam, Malaysia, and Indonesia, real estate prices in select areas will boom. This happened in Singapore and Dubai already: both places in which the government offered incentives to international firms to set up shop.

I'm planning on visiting Vietnam next year, and I'm going to poke around for some out of the way real estate plays. If you're in the area or have contacts there, drop me a line here.

Good trading,

Graham