Q+A-Is China finished as a low-wage manufacturer?

By Alan Wheatley, China Economics Editor

BEIJING, June 17 (BestGrowthStock) – A string of strikes over higher
pay demands at foreign-owned factories in southern China is
prompting investors to ask whether the country’s days as the
low-cost workshop of the world are numbered.

Here are some questions and answers about the implications
of the wage increases.

HOW FAST IS PAY GOING UP

— Some of the recent disputes have brought sizeable rises,
including a 66 percent increase for eligible workers at
electronics contract manufacturer Foxconn (2038.HK: ) and 20
percent or more for some Honda Motor (7267.T: ) employees.

— Various cities are raising their minimum wage by 20
percent. But multinational companies generally pay well above
this threshold in any case. Moreover, the increase is just
making up for a freeze in the minimum wage imposed in 2009 to
help exporters ride out the global economic crisis.

— Drawing on surveys and anecdotal evidence, Tao Wang,
UBS’s chief China economist, expects average wages across China
to rise this year by about 15-20 percent.

— That sounds like a lot, but the economy grew 16 percent a
year in nominal terms between 2004 and 2009 and 12 percent
annually for the five years before that. And wages were not far
behind.

“Wages have been rising in urban China at least 15 percent
per year, every year for the last decade,” Nicholas Lardy, a
China scholar at the Peterson Institute for International
Economics in Washington, told Reuters Insider television.
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Lardy clip on Insider, http://link.reuters.com/myr52m
BREAKINGVIEWS on China’s strikes [ID:nLDE65E0IM]
TAKE-A-LOOK -China labour in the spotlight [ID:nSGE65103V]
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CAN EMPLOYERS AFFORD MUCH HIGHER PAY?

— On the face of it, yes. Wages make up about 5 percent of
overall manufacturing costs. Thanks to rapid productivity
growth, unit labour costs in manufacturing have risen no more
than inflation, UBS estimates, thus causing neither a profit
squeeze nor an inflation spike.

— In support of the argument that firms have been able to
cope with steadily rising wages, average profit margins in
China’s industrial sector have been quite stable in the past
decade except for a swoon during the crisis year of 2008.

— But it is important not to see rising pay in isolation.
Other inputs, such as land, energy and water, are also getting
dearer. The government raised natural gas prices by 25 percent
on June 1. [nTOE64U07Q]. A labour law introduced in 2008
designed to strengthen workers’ rights has also added to costs.
And China is under pressure to let the yuan resume its rise.

HOW ARE COMPANIES RESPONDING?

— Low-value-added industries with slim margins such as
textiles, light manufacturing and electronics are moving to
cheaper locations in central and western China. This is smack in
line with the government’s development strategy.

— Some firms, Chinese as well as foreign-owned, are also
moving production to lower-cost neighbours such as Vietnam,
Bangladesh and India — just as Japan, South Korea, Taiwan and
others have shifted manufacturing down the years to China.

— As China’s price advantage is eroded, the incentive will
grow for international companies to move part of their
production out of Asia altogether, both to save on transport
costs and to be able to supply consumer markets more quickly.

— Anecdotal evidence suggests that Mexico, eastern Europe
and even north Africa are benefitting at the margin from this
trend. But for high-volume buyers, China’s vast manufacturing
capacity, first-rate infrastructure and clusters of suppliers
mean it is unlikely to have a serious rival for years to come.

WHAT’S THE SHORT-TERM IMPACT ON INFLATION AND PROFITS?

— Most economists reckon the near-term impact on inflation
will be muted because big pay increases are restricted to
southern China’s export strongholds.

— But corporate margins could be squeezed if wage growth
exceeds productivity gains this year. That is because the price
of Chinese exports is determined internationally and so few
manufacturers have the power to pass on higher costs.

— Next year could be a whole new ball game. Investment bank
CICC says labour market tightness today could give way to
serious unemployment as firms turn cautious about hiring and
China’s 4 trillion yuan ($585 billion) stimulus package is
completed.

— CICC estimates that government pump-priming created 25
million temporary jobs during 2009-2010. As they are shed, the
bank reckons total urban unemployment could reach a staggering
40 million in 2011.

WHAT’S THE MEDIUM-TERM OUTLOOK FOR JOBS AND WAGES?

— Even if supply and demand put a lid on wages again next
year, the spate of wage increases may be a harbinger of a
turning point in the Chinese economy.

— Demographers agree that China’s working-age population
will peak around 2015-2016. Surplus labour will therefore
shrink, even as farmers continue to leave the land for
better-paying urban jobs.

— That will generate structural upward pressure on wages,
reversing a steep fall in labour’s share of national income to
39.7 percent of GDP today from 53 percent in 1999. The figures
for the United States and Japan, by comparison, are 57 percent
and 51 percent, respectively, according to CICC.

— In short, Chinese workers will have more money to spend,
while the capital share of national income will shrink. This
will squeeze corporate profits, which have jumped to 31 percent
of GDP from 19 percent in 1999.

— Japan’s experience offers a guide to this likely
rebalancing. Japan’s ratio of labour income to GDP rose to 55
percent in 1983 from 39 percent in 1961, turning household
consumption into the major driver of economic growth, CICC said.

— The corollary of rising wages is rising inflation. After
Japan’s workforce started to shrink, its inflation averaged 5.6
percent from 1960-1972; in South Korea, the comparable figure
from 1982-1996 was 5.2 percent, said Wensheng Peng, chief China
economist at Barclays Capital in Hong Kong.

— Peng said Chinese monetary policy was likely to
accommodate the rising wages that population trends suggest are
inevitable. “If the monetary authorities tighten policy to hold
inflation at low levels, it may unnecessarily depress the rate
of economic growth,” he said.

Growth Stocks

(Editing by Ken Wills and Michael Shields)

Q+A-Is China finished as a low-wage manufacturer?