[A-List] Rising Chinese wages and Competitiveness

["Henry C.K. Liu" <hliu@xxxxxxxxxxxxxx>]

Bwijing Review Feb 16, 2006

Cheap Labor

A low-cost work force has helped to drive China’s economic growth for
some time. But as salaries rise, can the momentum be sustained?

By FENG JIANHUA



“The price advantage of the Chinese labor force will disappear in five
to eight years,” said Hua Ruxing, professor at the School of Economics
and Management of Tsinghua University, in a recent speech. His comments
were widely quoted by the media as confirmation of the view that China
is losing its labor cost competitiveness.

In fact, this view originated from a report released by a foreign
research institution in late 2005. An analysis by Germany’s Nuremberg
Research Center predicted that China’s labor cost advantage could only
last three to five years.

An important reason the Chinese economy has maintained its rapid growth
is the abundance of inexpensive laborers who have basic work skills.
This factor has been cited by some local governments to attract foreign
investment. Hence, many people worry about the development of the
Chinese economy once such an advantage disappears.

This idea has been taken up by some economists as well, who agree wages
are an important component of labor costs. Li Jian’ge, Deputy Director
of the Development Research Center of the State Council, noted at an
international seminar that an improvement in workers’ salaries should be
in line with an enterprise’s ability to bear such an increase. If salary
levels are raised too much, investors will transfer their investments to
neighboring low-wage countries such as Viet Nam, costing Chinese workers
their jobs, he warned.

Although Li’s remarks have been accused by opponents of trying to
achieve high economic growth by sacrificing workers’ benefits, some
argue his concern is necessary and reasonable in certain respects.

Guangdong Millennium Group Ltd. is a manufacturer for U.S.-based Nike
Inc. For many years, most of the Nike footwear sold in the Chinese
market were produced by Millennium. However, since the beginning of this
year, Nike has transferred many of its orders to Viet Nam. It has also
begun to expand its four production lines there and invested more than
$16 million to build a new plant. It is reported the sportswear giant
plans to make Viet Nam its largest overseas production base by the end
of 2007.

A major reason that Nike is withdrawing its production base from China
is that the cost of labor in Viet Nam is much lower than in China,
according to sources familiar with the situation.

For many years, a cheap labor force has been the main reason that
Chinese products have enjoyed a competitive advantage in the
international market. However, in recent years, Chinese labor costs have
shown a steady increase, especially in coastal provinces and big cities.

Foreign corporations that have invested in China feel the impact of
those rising costs directly. Statistics from Japan’s Unix Electronics
Co. Ltd. show, when the company invested in a factory in Shenzhen in
1992, the average salary of its workers was about 8,000 yen ($67) a
month, but that has risen to 18,000 yen ($150) this year. Despite the
increase, fewer candidates apply for vacancies in the factory than
several years ago.

It is not just the cost of average laborers that is the issue. The
salaries of high-caliber managers have also risen continuously.
According to a German machinery equipment company, before 2000, the
monthly salary of an experienced manager was about 5,000 yuan ($616),
but that has risen beyond 15,000 yuan ($1,847) this year, excluding the
year-end bonus that is equivalent to 40 percent of annual salary.

A disappearing advantage?

A report in Financial Times Deutschland said that from 1998 to 2004, the
annual growth in the average salary in China was between 8 percent and
12 percent, higher than in Malaysia, Thailand, Viet Nam, Indonesia and
the Philippines, indicating that the cost advantage of Chinese workers
may be fading.

Yet, Tang Kuang, professor at the School of Labor Relations and Human
Resources of Renmin University of China, said there is a
misunderstanding in the view that rising labor costs will decrease a
country’s attractiveness to foreign investment.

Tang said that if an enterprise’s labor costs increase at a rate faster
than workers’ productivity, its competitiveness will decrease;
otherwise, its competitiveness will increase. He noted that in the
1970s, while labor costs in the United States rose sharply, the economy
still grew strongly because productivity rose at a faster pace. During
the same period, the Italian economy slowed down, as labor costs climbed
more rapidly than productivity.

Still, for those labor-intensive enterprises where labor costs make up a
large proportion of total expenses, increases in this field will
influence investment decisions. Nike’s investment in Viet Nam is one
such example. However, when a multinational company decides to make an
investment, it will consider all factors, including labor costs, labor
productivity, infrastructure, the quality of human resources and R&D
capacities. The cost of labor is not the only decisive factor.

A market analyst from the German Chamber of Commerce pointed out that
German enterprises have accommodated to China’s policies and regulations
so that they will not think about transferring their factories to other
countries for the time being. Besides, China’s huge market potential is
a big attraction to those German companies.

Recently, South Korea’s Institute of Global Economy surveyed 58 Korean
entrepreneurs in China, finding that only 33 percent said they invested
in China in order to obtain cheap labor, while 52 percent of the
respondents admitted that their investment projects were aimed at the
huge local market.

A researcher at the Samsung Economic Research Institute agreed that
China’s labor productivity is showing continuous improvement. Despite
growing labor costs, he said, China’s comprehensive advantages,
especially the huge market potential, have a strong attraction to
international investors. The researcher believes that while such
countries as Viet Nam and India are highlighting their cheap labor
forces in order to attract foreign investment, they cannot overtake
China’s status in and effect on the international economy in near future.

Japan is a country that has massive investment in other countries, and
thus it pays great attention to labor costs in Asian countries. Data
from a Japanese Government’s white paper on international trade show
that while labor costs account for 4 percent of total production costs
on average in Asia, the proportion is only 3.5 percent in China. This
indicates that while labor costs in China are increasing rapidly, they
are still not only lower than those in Japan and such newly rising
economies as South Korea and Singapore, but also the average level for
all of Asia.

Adapting to change

Though low labor costs can be an advantage in export trade, economists
emphasize they are not an entirely positive factor. On the contrary,
they may contribute to a vicious circle: Workers cannot get the salaries
they deserve so they lose many opportunities to be trained and further
educated and this can lead to low productivity and a decrease in
international competitiveness.

Thus, while developed countries continuously strengthen industries
offering high salaries and gradually become production centers for
capital-intensive products with high added value, China’s adherence to
low-salary strategy could only attract low-added-value industries.

Take textile disputes between China and the United States and the EU in
the last couple of years as an example. Chinese textiles were blamed for
disrupting the market because many people in these countries thought
that China gained an unfair advantage because of its low production
costs. In fact, Chinese producers have earned meagerly through
processing the raw materials, while nearly 90 percent of the profits go
to multinational corporations that own brands and marketing channels.

Concerned departments in China have paid close attention to this
situation. A study report released by the Institute of Salary under the
Ministry of Labor and Social Security last November says that with the
rapid growth of exports of Chinese products, trade frictions between
China and such developed economies as the United States and the EU have
become increasingly severe so that “the space for China to compete with
other countries by using low prices and low labor costs becomes smaller
and smaller.” Besides, exporting mainly labor-intensive products is not
helpful in improving workers’ welfare, so the low-salary strategy must
be changed.

The report indicates that the current ratio of labor costs to total
production costs of Chinese manufacturing industries has reached an
all-time low, being 2.2 percent of those of the United States, 2.1
percent of Japan’s and 2.8 percent of Germany’s. Even compared to the
Czech Republic and Poland, which are lower-cost producers in Europe,
China’s cost is only 15-20 percent of theirs.

The report also points out that for a long time, the so-called labor
cost advantage in China was based on sacrificing reasonable salaries,
working and living conditions and the social security of workers.

From 1998 to 2004, China’s labor costs, consisting of salaries, social
security and welfare benefits, and other related expenditures, increased
6.4 percent each year on average while per-capita gross domestic product
grew an average of 11.4 percent annually.

In early 2005, the monthly salary for a farmer-turned-worker in the
Pearl River Delta was about 600 yuan ($72), only increasing 68 yuan ($8)
in 12 years. Among all workers of this group in the area, 46 percent
have to work 12 to 14 hours every day and 47 percent have no weekends off.

There is little doubt that low labor costs can create competitiveness
for a time, but such competitiveness is always awkward and may even
become a barrier to the development of society because, over the long
term, low labor costs can lead to a distortion of the labor market.

Given an open international market, capital is seeking an innovative
labor force and a market environment that is beneficial to the
development of such a labor force, not simply cheap labor. Some data
show that four fifths of international investments flow to developed
countries. For example, China brought in more than $340 billion in
foreign investment in the 20 years after launching its reform and
opening-up policy in the late 1970s, while the United States attracted
$313.2 billion in investment in 1999 alone.

Hence, some economists argue that there is no need for China to feel
anxious about the rising labor costs. The key is how to appropriately
deal with the change. If succeeded, they said, the extensive price
advantage of the labor force could be changed into an intensive
technological advantage to guarantee the smooth development of the economy.

In this respect, Japan’s experience is very valuable. In the early
1960s, Japan began to change its development strategy and moved onto the
high-wage and high-productivity path. Higher labor costs drove Japanese
enterprises to adopt advanced technology and improve their productivity.
Subsequently, Japan’s economy went through rapid development, where the
use of industrial robots is the highest in the world.