Co-blogger Steve Dickinson recently wrote an article for the China Economic Review, entitled, “Farewell to the China Price” [link no longer exists].  In it, he talked extensively on the price changes going on in China and on how those price changes have and will impact foreign businesses.

China’s wages are “abnormally” low and they have nowhere to go but up:
Even though China has a large GDP, this is simply due to the fact that it has a large population. On a per-capita basis, the country ranks 99th out of 183 nations. It is no surprise, therefore, that wages are low.
But salaries in China aren’t just low, they are abnormally low. Typically, a country’s minimum annual wage is 58% of its per capita GDP; in China it is 25% of per capita GDP, good enough for 158th place out of the aforementioned 183 nations.
The gap between the GDP and minimum wage rankings – 99 versus 158 – is perhaps the most telling statistic. For the majority of countries, there is a close correlation between the two rankings; the disparity in China’s case points to grossly inequitable income distribution.
This is borne out by the Gini coefficient numbers, a widely accepted measure of economic disparity. China’s coefficient is 0.47 on a range of 0 (perfectly equal) to 1.0 (perfectly inequal), putting it 83rd out of 134 countries measured.
According to Gini, China’s level of income inequality is higher than in almost every industrialized country in the world.
Though average wages are abnormally low for most, a small and elite subset in China does just fine:
• Wages of civil servants are abnormally high. The average salary of a civil servant in China is six times the minimum wage, compared to a global average of two times.
• Management level salaries in state-owned enterprises (SOEs) are abnormally high. The average SOE manager in China makes 98 times the minimum wage, compared with a global average of five times.
• Within the state sector itself, wage disparity is abnormally high. An SOE banker on average earns 3,000% more than his counterpart at a construction company, compared with a global average disparity of 70%.The pressure is compounded by costs of necessary items being abnormally high relative to wages.
• The UN recommends that it should be possible for an average worker to purchase a home with three to six years of annual income. In Beijing, it is estimated that the average worker would have to toil for 74 years just to buy a place in a suburban multi-story condo block, unfinished, unfurnished and without any amenities.
• The cost of electricity is a good index of the basic utility costs for urban residents. The average cost of 1,000 kilowatt-hours as a proportion of the average monthly wage in the US, South Korea and Japan is 2.67%, 3.19% and 8.19% respectively. In China, by comparison, it is 30.68%.
• The US Department of Agriculture estimates that the average Chinese family spends 28% of its total monthly income on food. While this compares favorably with other developing countries, the number is far higher than America’s 6.1%. Food prices remain the key driver of inflation in China, rising 10.3% year-on-year in January as the newly revised consumer price index rose 4.9%. The figure is well above the traditional central government target of 3%, and even above its revisedtarget of 4% for 2011. This makes wage growth an even more pressing social issue.
Steve sees China making foreign-owned enterprises and privately owned companies as the target for raising wages:
The obvious easy target is foreign-owned enterprises and privately owned export-orientedmanufacturers. Wages are already increasing in these sectors and it appears that the process has only just begun.
Governments in Guangzhou, Shanghai and Beijing are already experimenting with mandatory union collective wage bargaining, with the hopes of 80% coverage within three years.
Though the end result is of course unknown, Liu’s proposal for a doubling of worker wages within five years appears to be entirely reasonable. In fact, the increase could be much more significant in the foreign and export-oriented sector.
These changes will have big impacts on foreign firms, particularly those engaged in China manufacturing:
What does this mean for foreign firms? Much of the attractiveness of China as a location for manufacturing has relied almost entirely on abnormally low wages. Recent estimates indicate that on average labor accounts for about 50% of the cost of manufactured goods globally; in China this figure has been as low as 10% over the past 10 years. As wages increase, the attractiveness of China to low-end factory owners will fall.
For other businesses, the situation is less clear. Even taking into account impending wage inflation, it will be many years before Chinese salaries rise anywhere near the level of the developed world. And a wage increase commensurate with China’s overall economic development will not, on its own, make the country an unattractive place in which to do business.
On the other hand, it may well be possible that abnormally low wages have masked other, more fundamental issues related to manufacturing in China. For example, recent data suggests that the economy is remarkably inefficient and its workers unproductive. Once the artificial inducement of low wages is removed, it is entirely possible that these inefficiencies will cause some businesses to decide that operating in China makes no economic sense.
This kind of analysis needs to be done immediately, since there is little question as to the direction of wages over the next five years.
What do you think?

Co-blogger Steve Dickinson has been speaking of late at various embassies and chambers of commerce in Beijing regarding China’s Twelfth Five Year Plan. Steve will be speaking on this again at the Swedish Chamber in April. The following is the outline Steve has been using.

A major task for this year is the adoption of a 12th Five Year Plan by the National People’s Congress. This plan will be adopted during the March meetings of the National People’s Congress and the CPC. Guidance for the plan was adopted by the CPC last October in two critical documents: 

The Opinion of the CPC Central Committee on Establishing the 12th Five Year Plan (中共中央关于制定国民经济和社会发展第十二个五年规划的建议) (the Opinion) adopted on October 18, 2010

Explanation of the Opinion (央关于制定国民经济和社会发展第十二个五年规划的建议的说明) authored by Wen Jiabao and presented to the CPC Central Committee on October 15, 2010.

This preliminary review is based on those documents and on government and research institutes that have put out papers in response to those documents.

I. China’s Ten Major Challenges

The goal of the Chinese regulators is for China to become a moderately prosperous country by 2020. The current five year period will be critical in meeting that goal. China has recently reached a level where its per capita GDP equals $US4,000. Its goal is to achieve a $US10,000 per capita GDP by the year 2020. This is a critical transition. It is generally believed to be relatively easy for a country to achieve the $4,000 number. It is common, however, for countries to stall out in GDP growth and never achieve the $10,000 goal. 

The goal of the 12th Five Year plan is to prevent China’s growth from stalling. In the Opinion, the CPC identifies 10 factors that threaten the continued development of the Chinese economy:

  1. Resource constraints: energy and raw materials.
  2. Mismatch in investment and imbalance in consumption.
  3. Income disparity.
  4. Weakness in capacity for domestic innovation.
  5. Production structure is not rational: too much heavy industry, not enough service.
  6. Agriculture foundation is thin and weak.
  7. Urban/rural development is not coordinated.
  8. Employment system is imbalanced.
  9. Social contradictions are progressively more apparent.
  10. Obstacles to scientific development continue to exist and are difficult to remove.

II. The Theoretical Solution

Before discussing the concrete outline of the plan, the Party sets out the theoretical approach that will serve as the guide:

A. The Main Theme: Scientific Development

  • “During the period of the 12th Five Year Plan, economic development remains the key to resolution of all problems.” (Wen Jiabao, quoting from the Opinion)
  • Development must be “scientific,” practical (unconstrained by ideology), human centered, and sustainable.

B. The Main Line: “China must rapidly engage in a complete transformation of its form of economic development.”

It cannot be stressed sufficiently how radical is the proposed remedy. The idea is not to refine the current system, but to completely transform the current system in the brief period of five years. This is a bold goal.

The focus of transformation is as follows:

1. From export led consumption to domestic led consumption.

  • From excessive reliance on exports to balance between export, import and domestic consumption.
  • From reliance on foreign technology to reliance on domestic innovation.
  • From reliance on “old” energy and materials and industries to creation of a low-carbon /new-materials based economy.

III. Ten Point Outline of the 12th Five Year Plan

A. In order to address the 10 challenges, and in accordance with the theoretical approach, the CPC proposes that the 12th Five Year Plan focus on 10 major areas, as follows:

1. Expand domestic consumption while maintaining stable economic development.

  • Unleash domestic consumption This will be done through the measures at item seven below.
  • Coordinate consumption, investment and export to create a balanced economy.

2. Modernize agriculture to create the new socialist rural village. .

  • Modernize agriculture through mechanization and measures that allow larger farms.
  • Invest in agriculture infrastructure, especially in waterworks.
  • Create non-agricultural rural employment.
  • Improve legal and financial development mechanisms.
  • Improve agricultural service business in areas such as wholesaling, warehousing, processing, transportation and marketing.

3. Develop a modern, balanced industrial and trade structure.

  • Develop service trade. Services currently contribute to less than 40% of GDP. The goal is to raise this number to 70% or higher.
  • Develop modern energy and integrated logistics.
  • Develop marine resources.

4. Advance the integration between regions and encourage stable urbanization.

  • Combat regional disparities.
  • Eliminate the urban/rural distinction. Cities at the second tier and lower must accept rural migrants. The goal is to provide for industrial/service employment for agricultural laborers in areas close to their current residence. This will be done to avoid a mass migration of rural residents into the tier one cities.

5. Promote energy saving and environmental protection.

Currently, for every 1% increase in GDP, China’s energy use increases by 1% or more. If this rate continues, China will need to increase its energy consumption by 2.5 times to achieve its 2020 economic goal. To put this into perspective, this would mean increasing the current consumption of coal from the current 3.6 billion tons per year to an astronomical 7.9 billion tons a year. No one in China thinks this can be done. One major way to reduce the amount of energy required for the Chinese economy is to implement energy saving practices throughout the economy. A second way to reduce is to shift from hydrocarbon based energy to alternative energy sources. The new plan advocates an all out program in this area.

6. Create an innovation driven society by encouraging education and training of the workforce.

The plan seeks to shift China from its role as the factory of the world to a new role as a technological innovator for the world. There are two components to this approach:

  • China will need to become a domestic innovator in all areas of current modern technology, with an emphasis on practical industrial applications.
  • Where China is not capable of domestic innovation, China will continue to import technology from advanced economies. However, China will seek to actively domesticate that technology through a program of “assimilate and re-invent.” The recent program for production in engines for high speed rail is offered as an example of the “assimilate and re-invent” approach.

7. Establish a comprehensive public social welfare system.

In order to meet the goal of unleashing domestic consumption, China has to move to a policy that puts more disposable income in the hands of its citizens. The plan proposed the following approach:

a. Labor and employment

China must provide jobs for a growing workforce. There are two key areas:

— It is estimated that over the next ten years, 200 million persons will be shifted from agricultural labor to urban industrial/service labor. Jobs for these persons consistent with their training must be provided.

— Currently, China’s colleges produce far more graduates than the economy can absorb. Entry level jobs for college and technical school graduates must be provided. Education must also be adjusted to accord with the realities of the job market.

b. Wages

Chinese wage are abnormally low. Most planners are pushing for tripling of the average wage for factory workers during this 5 year plan.

c. Provide comprehensive government benefit programs, especially retirement pensions.

d. Provide government funded medical services with comprehensive basic coverage by the end of 2011.

e. Maintain active population control.

It is interesting to note that two major issues are not effectively considered in the plan: the first is the cost of housing and the second is the cost of high school and college education. Though there has been some discussion of constructing low income housing, the measures proposed will do little or nothing to address the problem of affordable housing in China’s major cities.

8. Encourage cultural production in order to increase China’s “soft power”.

China will seek to make its case for the world to avoid misunderstanding China’s goals and its role within the world economy.

9. Increase the pace of reform of the economy.

  • Financial market reform, especially the RMB.
  • Energy price reform and price reform of other economic inputs (raw materials).

10. Continue with liberalization and “opening-up” to the outside, but on a new track.

  • Shift from export only to a balance between export and import.
  • Shift from inbound investment only to a balance between inbound and outbound investment. China will continue with its “going out” policy.
  • Actively participate in international economic governance.

UPDATE: The Wall Street Journal Real Time Blog, in its post, “National People’s Congress: Not Just a Rubber Stamp Session” and Christina Larson of Foreign Policy in her post, “What will be in China’s next Five Year Plan?” both cite to our post and then do an excellent job providing additional analysis of what we should be expecting from the Plan.

By:  Steve Dickinson

There are two related economic issues that are of primary importance to ordinary Chinese people. The first is the inflation in prices of basic necessities such as housing and food. The second is the lack of wage growth in the manufacturing and service sectors. Today’s China Daily (January 4, 2011) featured five separate articles dealing with these issues.

• The headline article of today’s China Daily reports that the PRC All China Federation of Trade Unions (ACFTU) is pushing for legislation that will establish the formal rules for mandatory collective wage bargaining in China. While China mandates that all businesses permit the formation of unions, there is no corresponding set of national laws or regulations concerning mandatory collective bargaining. However, a number of local governments have adopted local rules and “guidance” concerning mandatory wage agreements. The ACFTU assert that where collective bargaining has been used over the past 10 years under these local programs, worker’s wages are 15% higher on average than wages for workers in the same sector without collective bargaining. In a related article, the China Daily reports that the Beijing Municipal Federation of Trade Unions has adopted a three year plan to establish collective wage bargaining in 80 percent of the city’s unionized enterprises. Once Beijing takes the lead, other local governments are certain to follow, even without any national legislation on the issue.

What is the target of this collective bargaining effort? As you might expect, the target is privately owned Chinese companies and foreign owned companies. As the China Daily states:

The ACFTU will also guide enterprises, especially private and overseas-funded, to conduct collective negotiation . . . About 80 percent of enterprises in China are privately run or foreign funded, employing about 75 percent of the country’s total work force. . . By the end of last year, 79 percent of overseas-funded companies and 78.5 percent of private companies had set up trade unions.

One factor that has attracted North American and European companies to China has been freedom from unionized worker organizations. Over the past several years, unionization has increased. However, foreign companies have not reacted strongly due to the impression that unions are relatively weak in China. With the rise of a push towards mandatory collective bargaining, this situation will change. The inevitable result: a dramatic increase in wages in the manufacturing and service sectors for the next decade.

• One phrase that is has become common in China is “worker draught”. This refers to a lack of laborers that has become a major issue in three areas: the Pearl River Delta (Guangzhou), the Yangzi River Delta (Shanghai) and Shandong Province. However, the issue is not lack of available workers. This is shown by today’s China Daily article reporting that over 10,000 recent college graduates attended a recent job fair held in Tianjin where only 2,000 job posts were being offered. The reality is this. At the top end of the scale there is a severe shortage of jobs, not workers, for entry level positions for college graduates in China. This is particularly true for graduates in any discipline other than engineering. At the bottom end of the scale, there is no shortage of workers for low skill labor jobs in the manufacturing, manufacturing and service sectors. The issue in those sectors is that workers are no longer willing to work for the low wages typical in China for those industry sectors. Companies have found that when they raise their wages and improve working conditions, they find no problem in finding semi-skilled laborers all over China. I know this from the many conversations I have had with our clients on this issue.

The amount of wage increase required to fully staff a factory in China has been substantial. Reports we have received indicate that many of the traditional outsourcing based manufacturers have been required to double their wages to attract workers. Then when they do that, their already employed workers expect pay raises not just equal to the new hires, but to a level that reflects their greater seniority. Foreign owned manufacturing and service sector companies that have reported to us that they started raising wages several years ago also indicate that they have had no problem finding and retaining workers. This will certainly be the trend for the future.

• Two articles in the China Daily today illustrate why wages must rise. In the first, the China Daily reports that housing prices in Shanghai are roughly the same as in Hong Kong. However, the average wage in Hong Kong is ten times higher than the average wage in Shanghai. This means the average person is simply shut out of the housing market. In a second story, the Daily interviewed a worker in a factory that assembles notebook computers. The worker stated that he will never purchase one of the computers he assembles because the retail price is equal to four months of his salary. The only real solution to these wage-price disparities is higher wages. In that same article, Zhang Yansheng, director of the Research Institute of Foreign Economic Relations at the NDRC is quoted as saying:

China is now under pressure due to rising costs of labor, land, resources, energy and other factors of production, undermining the low-cost advantage of “Made-in-China” products. In about five to 10 years such low-cost advantages will be over for China.

The price/wage issue will not go away in China. It must become a central focus for all foreign companies who invest in China or who purchase product and services from China. The China Price will soon be resigned to the dustbin of history.

I tend to put very little stock in economist’s predictions and I tend to put even less stock in economist’s predictions on China (and even less still on non-economists prognosticating on China’s economy as though their doing business there all of a sudden makes them an economist). Though I find the predictions to be of only very limited value, I do often find the assumptions on which the predictions are based to be intriguing and sometimes even worthwhile.

That is how I feel about a recently released Morgan Stanley report, summarized in this Beyond Brics post, entitled, “China ‘Megatrends’: How to Get Exposure to China’s Growth.” The post is ostensibly about the stocks in which you should be investing to take advantage of China’s growth, but it also delves in to what Morgan Stanley has to say about the China trends that will be shaping China’s economic future:

The trends set to reshape China over the next decade are demographics, urbanisation, infrastructure, social security network, education, and consumer financing. But this is not new. There are, for example, plenty of companies clamouring to tap China’s growing consumer market, but that doesn’t make them likely to succeed.

i agree there is nothing new here, but that is because these trends are so apparent and, to a very large extent, so uncontroversial.  

But the part of the Morgan Stanley report I found most intriguing was its almost over the top predictions on what will happen by way of wages, consumption and foreign investment in China over the next ten years:

Morgan Stanley’s optimism about the mega-trends is based on the assumption that three factors will change the economy over the next decade: that real wages will quadruple, consumption in total numbers will triple, and foreign investment will double.

The funniest thing is that I think Morgan Stanley might end up being right.  

What do you think? 

Caixin online has a great graphic setting out the minimum wage in various China provinces and cities (h/t Taikongren’s Advice). I think this graphic’s greatest use is as a rough starting point for comparing salaries among cites and regions than as a legal tool. I say this because among the cities and regions on this graphic of which I am familiar, you will need to pay more than the minimum wage if you are interested in keeping your employees.