The "China Price" Continues to Rise

Stephen DeAngelis

June 22, 2010

Troubled Chinese labor relations have been a recent mainstay in the media. For anyone who has followed Chinese commerce, labor unrest shouldn’t come as a surprise. As the standard of living begins to rise, workers begin to concern themselves with better working conditions and better wages. The current global economic downturn has also played a role in generating unrest among Chinese workers. As the economy nosedived, Chinese factories laid off many workers who had no choice but return to the rural areas from which they originally migrated looking for work. When the Chinese economy started to recover, the workers didn’t come back, which caused an urgent shortage of labor [“No place like home for workers, by Tom Mitchell, Financial Times, 26 February 2010]. Mitchell reports:

“China officially returned to work … after the end of the lunar new year holiday, with factory managers more optimistic than ever that the worst of the global financial crisis is behind them. There is just one problem – the workers many factories were so quick to let go in late 2008 and early 2009 are not lining up outside their gates any more. ‘It’s kind of a scary situation, quite frankly,’ said Charles Hubbs, the American owner of Fortunique, a Guangzhou-based medical products manufacturer. ‘If we were to get swamped with orders, where would we get the workers? There are going to be some interesting times ahead.’ After 14 months of year-on-year declines, the value of China’s exports finally increased in December. According to the General Administration of Customs, China’s foreign trade figures for January recovered to 2008 levels. Then confirmation [in early February] that China had pipped Germany as the world’s largest exporter reinforced confidence that the country’s factories are back. The workers they rely on, however, are not back, despite ever greater inducements for them to return.”

Workers who were made redundant during the worst of the recession felt that they had been treated shoddily and unfairly. They weren’t eager to return to the conditions they left. Some companies realized that circumstances had changed and offered workers “complimentary food for the first month of employment, cooling herbal teas on hot days, free dorm rooms with en suite washrooms and hot water, and computer, library and leisure facilities.” Even those inducements, however, failed to attract any takers. One reason, Mitchell asserts, is because workers are now finding “better opportunities closer to home.” For companies that rely on migrant workers, that’s not good news. In a companion article, Mitchell reiterated the serious concern Chinese companies had about labor shortages [“China’s ‘workshop of the world’ suffers acute labour shortages,” by Tom Mitchell, Financial Times, 26 February 2010]. In this latter article, Mitchell reports that “export recovery [is being] held back by vacant jobs.” He continues:

“An export recovery in the world’s most populous country is running up against an unexpected constraint – manpower. … The problem is particularly acute in southern Guangdong province and its Pearl river delta manufacturing heartland near Hong Kong, the region known as ‘the workshop of the world’. Guangdong accounts for one-third of China’s exports and would rank as one of the world’s 10 largest exporters if it were a country in its own right. But the province’s ability to attract and retain migrant labor from China’s vast interior is slipping.”

More recently, two separate events have captured most of the headlines. The first was a strike at a plant that makes transmissions for Honda and the second was a spate of suicides at Foxconn, the world’s largest electronics contract manufacturer [“Chinese labour is licensed to stake its claim,” by David Pilling, Financial Times, 3 June 2010]. Pilling reports:

“Listen to the following statements about the strike at Honda’s transmission plant in Guangdong province, one that has brought the Japanese company’s car production throughout China to a juddering halt. The first goes like this: ‘The strike reflects the low wages the bosses are paying the workers … The system does not provide a legal base for collective bargaining.’ The second, like this: ‘In the three decades of opening-up, ordinary workers are among those who have received the smallest share of economic prosperity. The temporary stoppage of production lines in the four Honda factories … highlights the necessity of organized labor protection in Chinese factories.’ The first speaker is Han Dongfang, a former railway electrician who, in 1989, tried to unite workers and students during the Tiananmen Square protests. He was jailed for his troubles, contracted tuberculosis in prison and had a lung surgically removed. Now living in exile in Hong Kong, he works as a trade union activist, monitoring workers’ rights in mainland China. The provenance of the second – almost identical – statement is more surprising. It is an editorial in the Global Times, a tabloid founded by the People’s Daily. Chinese newspapers are not in the habit of writing about strikes, let alone endorsing them. Anything that smacks of an alternative pole of power or tarnishes China’s image as a hassle-free investment destination has generally been taboo. In any case, strikes are rare since independent labor unions are banned and ‘official trade unions’ rarely, if ever, organize industrial action. So why are a leading dissident from Tiananmen Square and a newspaper with close ties to the Communist party speaking with one voice on such a delicate issue? First, government authorities, through the media, are simply acknowledging reality. The years of an endless supply of cheap labour, on which the first three decades of China’s economic lift-off was built, are coming to an end.”

In previous posts, I wrote that emerging market countries would be wise to study the history of labor relations in the industrialized West so that they could avoid the worst pitfalls (e.g., exploitation, violence, corruption, and uncompetitive practices). Even though such advice may seem to be falling on deaf ears, lessons may have been learned. Chinese workers are beginning to express their frustration as they realize the empowered position they occupy. Pilling explains why workers are better positioned:

“[It] is partly demographic. Because of China’s one-child policy, the supply of workers under 40 has dwindled by as much as a fifth. Fewer workers mean more bargaining power. Honda staff are demanding no less than a 50 per cent rise. Foxconn, a China-based Taiwanese contract manufacturer plagued by a recent spate of worker suicides, has just granted a 30 per cent wage increase. Unlike the first wave of migrants who came to the cities in the 1980s and 1990s, the current batch has more options and higher aspirations. Many are not content to save money for a few years before returning home. They want to settle in the booming cities. That means they need higher wages. If they can’t get them, there are opportunities at home. Under cost pressure, some factories have shifted inland, away from the factory towns on the east coast and the Pearl River Delta, and closer to the provinces from which most migrants come. The second reason for the cautious sanction of industrial action is that the Communist party has a stake in better working conditions. Providing cheap Chinese labor to multinationals from Japan, the US and Europe was a means, not an end. Deng Xiaoping said it was glorious to get rich, not to make foreign-invested capital rich.”

Pilling notes that the Chinese press has given ample coverage to the Honda and Foxconn cases and that the coverage has been “heavy with analysis of the widening income gap.” He continues:

“This changed atmosphere has obvious implications for foreign investors grown accustomed to a low-wage, strike-free, hire-and-fire environment. Yet few are likely to pull out. That is because China has ceased to be merely a low-cost production center. For many companies, it is also becoming an important market and an integral part of their global supply chain. Walmart sources $30bn worth of goods from China each year. Japanese car manufacturers, such as Honda, have brought with them a network of components makers, and built ties with Chinese parts suppliers. What goes for cars goes for iPads, mobile phones, digital cameras and color photocopiers. Such a clustering effect makes it almost impossible for manufacturers to pick up sticks and start afresh elsewhere. For all these reasons, Beijing may continue to offer cautious support to an emboldened workforce, though it will keep a watchful eye on wage inflation. But on no account will it tolerate any hint of organized labor evolving into a political force. … When a Chinese labor activist wants to take the politics out of collective bargaining and official China is cheering on strikers, change is clearly afoot.”

Another Financial Times’ article rhetorically asks, “What are we to make of the labor unrest in China? Do the strike against Honda’s joint venture parts maker and the spate of suicides at Foxconn, the contract manufacturer, mark the end of the cheap labor era?” [“Chinese workers are now in revolt,” 4 June 2010]. Its answer:

“Probably not. But China is changing. Here, to underline this fact, is the opening of a recent story in China Daily: ‘The proportion of China’s gross domestic product that goes toward wages has been shrinking for 22 consecutive years, a senior trade union official said on Wednesday.’ The killer fact was that the share of wages and salaries in GDP dropped to a mere 37 per cent in 2005, from 57 per cent in 1983, and remained static since then. The story also reported the official’s warning that ‘low pay, long working hours and poor working conditions for millions of workers are triggering conflicts and mass incidents, which pose a grave challenge to social stability’. The remarkably low share of wages and salaries in GDP makes China the most ‘capitalist’ large economy in history. Until this is reversed, the much-desired shift to a consumption-driven economy cannot occur. China’s demand will continue to depend, instead, on soaring investment. But the resulting high capital intensity is also a reason for the declining share of wages in GDP. Equally significant is official discussion of the case for higher minimum wages. The strike at the Honda plant could hardly have happened without official acquiescence. Yet what does this imply for the future? The freedom to strike is, in western eyes, a fundamental right. The case for ensuring minimum standards in the treatment of workers is strong. But it is crucial to remember that those with jobs in large factories in successful coastal regions are among the more privileged Chinese. The big challenge is to spread higher incomes across the whole country. To achieve this, there has to be fundamental reform. This must include: shifting labor-intensive industry from coastal regions, supporting rapid growth of labor-intensive services, repricing underpriced capital, giving households a bigger share of the return on capital, via higher interest rates, creating stronger social safety nets and increasing direct spending on health and education services. Over time, a better balanced economy, with higher wages and standards of living, will emerge. Throughout, policy makers cannot forget the overriding aim of generating more and better employment opportunities for the population as a whole, not just for a minority.”

A companion article notes that the changing labor environment has both up and down sides [“Pay deals raise questions over China’s workforce,” by Tom Mitchell and Kathrin Hille, Financial Times, 4 June 2010]. Mitchell and Hille report:

“For Chinese workers, the double-digit pay rises granted … by two multinational manufacturers were bittersweet victories. Striking employees at a Honda components plant in southern Guangdong province settled for a 24 per cent increase in monthly pay to Rmb1,900 ($280, €228, £190), having initially asked for 50 per cent. Foxconn, the world’s largest contract electronics manufacturer, raised wages 30 per cent after suicides in one of its large southern China factory complexes. … For employers, however, this week’s wage concessions could signal the start of a period of consistent and large salary increases. … That, in turn, is raising questions about whether exporters will have to transform their modus operandi, which for years was predicated on a seemingly endless supply of cheap labor.”

In other words, the “China Price” is rising. Such a rise was inevitable. I first discussed the rising China Price in September 2008 when oil prices were skyrocketing along with transportation costs [see The Rising “China Price”]. Most analysts knew that the price of labor wouldn’t be far behind; but because of the recession timing of labor pressures was uncertain. It looks like that time has arrived. Although companies may lament the end of cheap labor, they also realize that increased wages are likely to open up new markets as wage earners find themselves with discretionary funds. Mitchell and Hille explain that enlightened companies see other benefits as well. They continue:

“Manufacturers [have] … argued that better wages would reap other rewards, including higher worker retention rates and increased efficiency. Combined with first-rate infrastructure and dense ‘clusters’ of components suppliers, which tended to group round big assemblers such as Foxconn, China would remain a formidable manufacturing power. ‘Labor costs are just one small factor in a big calculation,’ a manager at Pegatron, an affiliate of computer company Asustek, said. ‘[Higher wages] won’t destroy these clusters.’ ‘[China’s] competitiveness as a production base is not due to price alone,’ Pansy Yau, deputy chief economist at the Hong Kong Trade Development Council, said. ‘Well established industrial clusters, a highly efficient and skilled labor force and infrastructure systems are able to offset the disadvantage of rising costs.’ Guangdong-based manufacturers also have the option of moving to cheaper locations in China’s interior.”

The shell game of moving factories from location to another within China can’t last very long. The more connected the country becomes the more difficult it will be for companies to treat workers in similar plants differently [“Labor unrest in China reflects changing demographics, more awareness of rights,” by Keith B. Richburg, Washington Post, 7 June 2010]. Richburg reports:

“A seemingly endless supply of cheap labor is drying up, and workers are no longer willing to endure sweatshop-like conditions. China’s export-driven growth has long been linked to its abundance of workers — mostly migrants from the impoverished countryside who jumped at the chance to escape a hardscrabble rural life to toil long hours in factories for meager wages. If they were unhappy, they rarely expressed it through action, and if they did, they were quickly fired and replaced from among the hundreds of others waiting outside the factory gates. Now all of that has started to change. … young workers don’t have to travel far from home like their parents did to find work. They are more aware of their rights. And having grown up in a more prosperous China, they are demanding a fairer share. ‘The first generation of migrant workers made a lot of money compared with their poor life before,’ said Cai He, dean of sociology at Sun Yat-sen University. ‘But right now the majority of migrant workers are in their 20s. They were born in the 1980s. Most of them have no farming experience’ and ‘are more sensitive to the disparity between the wealth of the city and their own poverty.’ Cai added: ‘The younger people received a better education. They surf the Internet, use mobile phones and watch TV. Their awareness of their rights is much stronger than the older migrant workers.’ These young workers are asserting those rights in the form of work stoppages, slowdowns and demands for higher wages and shorter hours.”

All of this activity is making manufacturers outside of China take notice because the rising China price makes them more competitive in the global marketplace [“As China’s Wages Rise, Export Prices Could Follow,” by David Barboza, New York Times, 7 June 2010]. Barboza reports:

“The cost of doing business in China is going up. Coastal factories are increasing hourly payments to workers. Local governments are raising minimum wage standards. And if China allows its currency, the renminbi, to appreciate against the United States dollar later this year, as many economists are predicting, the relative cost of manufacturing in China will almost certainly rise. The salaries of factory workers in China are still low compared to those in the United States and Europe: the hourly wage in southern China is only about 75 cents an hour. But economists say wage increases here will eventually ripple through the global economy, driving up the prices of goods as diverse as T-shirts, sneakers, computer servers and smartphones. ‘For a long time, China has been the anchor of global disinflation,’ said Dong Tao, an economist at Credit Suisse, referring to how the two-decade-long shift to manufacturing in China helped many global companies lower costs and prices. ‘But this may be the beginning of the end of an era.’ … Analysts say the changes result from the growing clout of workers in China’s economy, and are also a response to the soaring food and housing prices that have eroded the spending power of workers from rural provinces. … But there are other reasons. Analysts say Beijing is supporting wage increases as a way to stimulate domestic consumption and make the country less dependent on low-priced exports. The government hopes the move will force some export-oriented companies to invest in more innovative or higher-value goods. But Chinese policy makers also favor higher wages because they could help ease a widening income gap between the rich and the poor. Big manufacturers are moving to raise salaries because they are desperate to attract new workers at a time when many coastal factory cities are struggling with labor shortages.”

Although consumer prices are likely to rise as a result of the rising China Price, some manufacturing jobs may return to areas that lost jobs to China because of its cheap labor. Although that is not likely to occur in the short-term, both rising labor and transportation costs could make local manufacturing more attractive in industrialized countries over the long-term. Barboza continues:

“Economists say a necessary restructuring is under way [in China], one that should allow the nation’s huge ‘floating population’ of migrant workers to better share in the benefits of growth and stimulate domestic consumption. … Rising labor costs here are not the end of cheap production in China, analysts say, but they are likely to help change the country’s manufacturing mix. ‘China isn’t going to lose its manufacturing base because it’s got a huge domestic market,’ said Mary Gallagher, director of the Center for Chinese Studies at the University of Michigan. ‘But it will move them toward higher-end goods. And that matches the Chinese government’s ambition. They don’t just want to be the workshop of the world. They want to produce high-tech goods.'”

If Chinese companies can’t meet future demand, then other countries will have to step in to fill store shelves. There are plenty of eager manufacturers waiting for that opportunity. What is happening in China will eventually repeat itself in other countries where cheap labor has attracted manufacturers. If China can feel its way safely through what is likely to be a turbulent period, it can provide a good example for others. There is one last policy change coming out of China that is raising the “China Price,” the government’s decision to let the yuan appreciate against the dollar [“Western retailers: yuan move not all bad,” by Brad Dorfman, Reuters, 21 June 2010]. As Dorfman puts it, “Western retailers may pay more for goods they import from China as the yuan appreciates, but the thought of millions of Chinese consumers who will be able to shop at their stores is helping to ease the pain.” The global economy needs China to have a stable, growing economy. Poorly managed labor relations could tip an unsteady boat and the falling bodies would send ripples throughout the global economy.