China's soaring wage bill

Jun 11, 2010
By Simon Wilson
MoneyWeek

A wave of strikes and wage rises signals a shift in labour relations in China. So what does this mean both for China and the global economy? Simon Wilson reports.

What's happened?
Honda has been hit by a series of strikes at factories making parts for its production lines in southern China. These have paralysed production and forced the firm to raise wage levels by between 24% and 33%. The strikes, and a number of copycat actions at smaller manufacturers, come in the aftermath of a wave of international publicity over the spate of suicides by workers at the enormous Foxconn factory complex in Shenzhen. Like Honda, electronics giant Foxconn has responded by dramatically boosting pay levels. As well as a 30% wage increase from 1 July, workers who pass a three-month evaluation period will also get another 66% pay rise from October. That will more than double basic wages to Rmb2,000 ($290) a month. The Taiwanese-owned group is the world's largest electronics contract manufacturer - clients include Apple, Dell and Sony - and is China's biggest employer, with a headcount of 800,000.

What is behind this shift?
The pool of available Chinese labour is shrinking. That's down to the long-term one-child policy, combined with years of rapid economic expansion. When the pool of surplus (mainly agricultural) labour dries up - at what economists call the Lewis turning-point - power shifts from employers to workers. The latter can demand higher wages without fear of being undercut by new entrants. In China's case, the situation is complicated by the rapid growth of the services sector, which provides strong competition as source of potential employment for low-skilled workers. And it is made more complex by the fact that the new generation of workers are better educated and have higher aspirations than their parents - leading to greater frustration at the miseries of factory life.

Aren't higher wages bad for businesses?
No doubt for some. Exporters, for example, are unable to push up productivity as fast as their labour costs. Rising wages pose a special threat to small, low-end manufacturers of items such as shoes, clothes and toys - profit margins might already be as slim as 2%. Some firms, often owned by Hong Kong or Taiwanese investors, are already starting to move factories to even lower-cost labour markets, such as Vietnam, Cambodia and Indonesia. Others are moving inland. But for more sophisticated manufacturers, the impact will be limited. For example, the likes of Foxconn and Honda can boost low wages (by Western standards) overnight. And many economists see rising wages as a very good thing for China as a whole.

How so?
Most fundamentally, because China's factory workers haven't been sharing in the proceeds of growth. Such transparent unfairness radically threatens China's future economic growth and social stability. Last month an official from the state-controlled union admitted workers' wages as a share of GDP fell from 56.5% of GDP in 1983 to 36.7% in 2005. Other official data show that between 2001 (when China joined the World Trade Organisation) and 2008, total exports surged by 436%, but manufacturing wages rose by only 148%. As a share of the overall value of manufactured exports, wages fell from 3.65% in 1990 to 1.4% in 2000 and just 0.81% in 2008. That's a lot of ground to make up.

Will higher wages boost inflation?
Quite likely. After all, one reason why China managed to achieve double-digit growth over the past decade with minimal price inflation was because wages rose more slowly than productivity. Wage inflation brings with it some major macro-economic issues for China's already over-heating economy, including the prospect of higher interest rates. But higher wages are a necessary condition for Beijing's long-term economic goal of rebalancing the economy and delivering sustainable growth by boosting domestic consumption and cutting China's reliance on exports and foreign investment. As workers earn more, they will (it is hoped) spend more in China, fostering a virtuous cycle.

What about outside China?
Companies such as Foxconn will try to pass on some of their wage cost increases to customers. So the prices of manufactured goods (iPods and Playstations, in the case of Foxconn) may increase a little globally. But overall, rising wages in China look like very good news. A boost to domestic consumption means China will be importing more goods from the rest of the world, leading to a slow but steady erosion of its oversized trade surplus. Sure, relatively low wages will remain one of China's competitive advantages, and China will remain a growth engine. According to Ting Lu of Merrill Lynch, China's potential growth rate will slow to about 9% a year from 11% due to wage increases. But if inflation spikes can be managed, China - and the world - have much to gain.

Are these wage rises exceptional?
They are big, but they represent the continuation of a gradual process of upping wages for blue-collar workers. Beijing recognises that wages need to rise as part of China's strategy of fostering higher-value manufacturing. Several regions and cities have introduced large increases in the minimum wage in recent months. For example, in Beijing the authorities have just increased the legal monthly minimum by 20%, from ¥800 to ¥960, effective from 1 July. For hourly workers, the rate will rise from ¥9.6 to ¥11. The upgrade should increase pay for 100,000 workers in the capital.