Chinese Development Follows a Well-Worn Path

Thu, May 9, 2013 - 1:03pm

And that May Be Good News for China and Her Neighbors

“The rapidly growing economy produced a high demand for labor, especially among young workers such as the rural migrants. The possibilities for sales outstripped the ability to produce (given the relatively labor-intensive techniques of the time), bringing about a labor shortage. This produced relatively high wages, even for those without a high school education.”

That quotation sounds like a perfect description of the contemporary situation in China. But it’s not; it’s a comment by Ikuo Kabashima, political economist and governor of Japan’s Kumamoto Prefecture—discussing Japan’s post-war rise as the “world’s workshop.”

China’s economic success is driving higher wages and a shift from an export-driven manufacturing economy to one more balanced by the consumer and service sectors, and by innovation and high value-added production. We shouldn’t be surprised by this process; it’s the same one that Japan and South Korea followed before China. Just as the mantle of the “world’s workshop” passed to China after Deng’s reforms, China’s economic success is already pushing manufacturing to other developing nations in Asia and beyond. Those countries may not yet have the synergy of infrastructure and production ecosystems that China has—but eventually they will, and the current migration of low-cost manufacturing will help them build it.

The Service Sector Climbs in the Chinese Economy


Source: Wall Street Journal

Rising Labor Costs Put Pressure on Manufacturers

Manufacturers are paying higher costs in China, for many reasons: land prices are rising; environmental legislation is becoming more stringent; the Yuan has appreciated in value, etc. However, the largest component in the rise is the cost of labor. Overall, the past decade has seen phenomenal wage increases in China. Since China joined the World Trade Organization in 2001, manufacturing-sector wages have risen 200 percent. Blue-collar wages in Guangdong rose 12 percent a year in the past decade; in Shanghai, 14 percent. But with huge productivity gains already under its belt, China has been unable to keep productivity rising at the same pace. Thus, its unit labor costs, or ULC—the ratio of compensation to real output—have been rising.

Labor Costs on the Rise: Annual percentage wage growth outpacing annual percentage increases in labor productivity


Source: Financial Times

As the flow of migrant labor from China’s interior provinces slows, and the demographic consequences of the one-child policy continue to play out, this trend will likely continue. A new generation of Chinese who are far more affluent than their parents will be seeking jobs in the services sector—rather than in low-cost manufacturing. This is not the end of China’s economic prowess by a long shot, nor is it a disaster. It is a natural stage in the economy’s development.

Changing Face of Chinese Manufacturing

The divergence between productivity growth and labor cost growth means that other economies, where labor costs are lower and there is more low-hanging productivity fruit to be picked, will look increasingly attractive to manufacturers looking to trim costs. This is especially true for low value-added sectors such as apparel, where margins are small and the impact of savings is significant.

Following in the footsteps of its Asian predecessors, Japan and South Korea, China will overarchingly be seeking to shift the balance of its production towards innovation and higher value-added manufacturing, and labor-intensive manufacturing will migrate to the next economies down the ladder. The likely giants of this movement will be companies such as Huawei and Baidu—whose corporate headquarters already resemble something more like Silicon Valley than an American’s typical picture of a Chinese industrial park. Notably, many executives of such up-and-coming Chinese firms were educated in the U.S. and cut their teeth in American tech culture (so-called “sea turtles” who returned home after an education and work experience abroad). Firms have also been canny in using a lot of American managerial talent to shape their cultures.

Looking For the Next Workshop

What are the economies to which manufacturing is migrating? Bangladesh is on everyone’s mind after the recent catastrophic collapse of a multi-factory structure in Dhaka. Bangladesh had been a darling of the garment industry, but the Rana Plaza disaster pointed out a stark truth that many already knew—Bangladesh lacks the infrastructure necessary to support the intense growth in manufacturing development that it has been experiencing. The French Chamber of Commerce hosted a sourcing conference in Hong Kong in late 2012, at which participants discussing Bangladesh pointed out the delays caused by inadequate power and transport infrastructure: “There are predictions that Bangladesh’s exports will double or triple in 10 years. We look at [the roads and the infrastructure] and say, ‘How?’”

These questions illustrate the quandary that presents itself to manufacturers looking for alternatives to China with lower labor costs. China has massive infrastructure advantages, such as a well-developed transport system, deep-water ports, and perhaps most importantly, a complex and highly developed manufacturing ecosystem in which component manufacturers are within easy reach of one another, easing supply chain woes.

The likely beneficiaries of this nascent shift, may not be nations on the low end of the development and manufacturing spectrum. As much as Bangladesh, or even Nigeria, would like to stake a claim to being the next workshop of the world, they don’t have the physical, corporate, or cultural infrastructure to accomplish it. Rather, it will be nations with adequate infrastructure and an accommodative regulatory environment in which it’s easy to do business. Names that come up frequently are Vietnam, Thailand, and Indonesia. Vietnam in particular earns accolades for its relatively developed infrastructure. Taiwanese company Wintek will be investing nearly a billion dollars in Vietnamese plants to manufacture displays and touch screens, according to the Wall Street Journal.

Manufacturers will still choose to stay in China, take advantage of its supply chains, and cope with labor costs by automation and shifts in workforce management. Other manufacturers will make the move—and their destination countries will, in turn, be able to parlay the increase in foreign direct investment (FDI) into improvements in infrastructure and increased standard of living. While FDI fell by 3.7 percent in China in 2012, it rose 63 percent in Thailand and 27 percent in Indonesia during the first nine months of the year. According to HSBC, Southeast Asian nations now account for 7.6 percent of global FDI, nipping at the heels of China’s 8.1 percent.

China and Her Neighbors Will Reap Rewards

What we’re seeing in China’s rising costs is not a sudden change, but the continuation of a long-term process that we should recognize because we’ve seen it play out in other Asian economies before. Nations such as Thailand, Malaysia, and Indonesia will welcome their turn in the spotlight, as foreign investment boosts their development and raises their living standards. And Beijing will also welcome this shift. Incomes will rise, dirty manufacturing will find its way elsewhere, and some of its pressing social tensions may begin to be calmed -- if it can navigate this change as sagely as it did the transition of a generation ago.

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