“Caixin Online: Sweet spot for China's blue-collar revolution”

Caixin Online: Sweet spot for China's blue-collar revolution

Posted: 28 Jun 2010 04:55 PM PDT

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By Andy Xie

BEIJING (Caixin Online) -- Export manufacturers based in China have long been terrified of big buyers from the West. China has a lot more factories than the West has buyers for its products, so exporters have generally assumed that their powerful clients would never accept higher prices.

But business costs have been rising in China, manufacturers are well-connected to markets and infrastructure, and buyers are realizing that their supply options are not unlimited. As a result, Western buyers these days should be a lot more terrified than their Chinese suppliers.

A recent spate of worker strikes at factories in China partly reflects a search for a new balance at the labor end of the manufacturing landscape, especially among young, blue-collar workers. On top of that, export manufacturers have been talking about labor shortages for the past year or two. But "labor shortage" is an oxymoron: Any product in shortage is simply not priced right.

These conditions point to a need for adjusting the price of labor in China. Western buyers should take note. Although individual factories may lack pricing power, China has national pricing power. Every factory in a given sector has a uniform wage level. And China is the factory of the world.

Exporters recently affected by strikes and labor shortages shouldn't worry too much. They have room to increase wages, and yet wage pressures are not unlimited. I think annual wages need to rise between 15% and 20% every year to re-establish an equilibrium. Improved productivity can pay for more than half of these wage increases, while the other half can be passed in the form of higher customer prices. And as wages rise, it will make sense for factories to retrain and hire middle-aged workers idled in recent years as manufacturers focused on hiring low-cost young people.

Some may argue that production can shift to other countries from China to appease buyers. Yes, some factories should and will move to other countries. This is how globalization works. When costs in one country rise significantly, production should shift to countries with lower wages. In this way, prosperity spreads all around. It would be wrong for China to pursue policies that prevent this process.

On the other hand, don't look for a massive shift in production away from China anytime soon. No other country has the production scale, cost advantages and infrastructure to replace China.

Shifting a portion of a company's production base to Bangladesh, Indonesia or Vietnam would raise costs and erode price advantages. Infrastructure could be built up in these countries to prevent bottlenecks and boost competitiveness. But infrastructure building takes a long time. Moreover, since factories should be close to suppliers and buyers, moving to another country could increase a company's logistics costs substantially.

Besides, Western buyers should be able to pass on higher costs of Chinese labor and production to their retail customers. Only about 10% of the cost of each Chinese factory is attributable to labor. A retail price in the West is three to four times China's export price. Hence, China's labor cost is about 8% to 9% of a retail price in a Western store. If China's labor costs double, retail prices need rise only 8% to 9%. And if this increase is phased in over three years, prices would climb 3%, which is an acceptable inflation rate.

I think China now has a sweet spot for increasing wages without losing significant market share in global trade. The window is probably 10 years. During this period, China's exports will rise mainly on higher prices and perhaps volume. China's annual exports could climb 7% to 10%, and more than double in a decade, to more than $3 trillion.

Tipping point

When a labor pool surplus vanishes and a shortage emerges, labor becomes a limited resource. A business that wants to hire more workers must lure them from other opportunities by, for example, offering higher wages.

In development economics, the tipping point from early- to late-stage equilibrium is called the "Lewis turning point." And what's been billed as a recent labor shortage in China suggests the nation's economy has reached this point. But it is not black and white.

College graduates still find it hard to get a job, and when they do, they have to wrestle with low starting wages. This seems to suggest that the supply in the college graduate labor market is still unlimited. Indeed, at this point, the wage premium for college graduates is too small to justify the cost of a college education. In the jargon of economics, college education in China has negative value added.

Neither is the blue-collar market uniform. Employment opportunities for middle-aged workers are poor, and a significant share has been idle a long time. A re-entry for these workers could significantly shift the supply-demand balance.

The Lewis turning point is a process. One part of China's labor market -- the young, blue-collar sector -- has been exhausted. Export factories whose business model relies on this sector are now suffering acute labor shortages. Yet young workers are valuable: Their maintenance costs are low in terms of healthcare needs, willingness to relocate and limited expectations for housing.

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Monday, June 28, 2010