Economy, Talking Point

Stuff’s about to get pricier

Li & Fung says era of cheap Chinese manufacturing is over. Is it bad news?

Stuff’s about to get pricier

The boss of this factory will need to pay more to get more workers like her...

“The biggest topic on the minds of everyone in this business is that higher prices are really here to stay,” Li & Fung president Bruce Rockowitz warned attendees at last week’s company results presentation.

Li & Fung started out trading porcelain and silk in 1906. But in more recent times it has proven one of the biggest winners in the gargantuan growth of China sourcing. With ‘the China price’ sweeping all before it, so Li & Fung has become one of the biggest suppliers of clothes, toys and furniture to retailers worldwide.

Hence Rockowitz’s analogy: Facebook connects people but Li & Fung connects factories and retailers, with a business model based on placing client orders among its 15,000 suppliers, and then shipping them the finished items.

So, when its top executives warn of new era of higher prices, it is worth paying attention.

Blame wage increases?

Clearly, there are other factors too, like higher commodity prices. But most of the headlines recently (including a few of our own, admittedly) have concentrated on the impact of higher salaries for Chinese workers. Li & Fung executives did something similar, in talking about the price pressures in their own business.

The current news cycle kicked off in mid-summer last year, following a series of strikes and subsequent wage hikes. Two companies – Foxconn and Honda – bore the brunt of press attention, and both appeared to buckle to worker demands, offering salary increases exceeding 20%.

It wasn’t just a case of high-profile employers forced into greater generosity. China’s 31 provinces boosted their minimum wage levels by 24% last year, according to Yin Weimin, the country’s minister for human resources and social security. Six provinces have already topped up the threshold again this year, and the central government is targeting an increase in minimum pay of 13% a year through to the end of 2015, Yin says.

The sense is that this is not a cyclical thing. Li & Fung talks about changes in the wage environment meaning an end to 30 years of low prices for manufactured goods.

Still, only a year or so before reports of the wage spiral began, the narrative was somewhat different, with news of 23 million migrant workers laid off as a result of the global economic crisis. Most then trudged back to their home provinces and many of those who stayed in work had their pay frozen. This has led to suggestions that the flurry of recent rises is more a case of wages playing catch-up.

Recent research from HSBC is also more circumspect in reviewing whether wage inflation is really breaking new ground.

Announcing minimum wage increases is not the same as delivering them, suggests Qu Hongbin, HSBC’s chief economist for Greater China, particularly when close to 70% of the workforce is employed in small or medium-sized private firms (where mandatory minimums are not always going to be rigorously applied). Local governments have so many targets to meet that enforcing the wage rules may not top their priorities, either.

Further, Qu believes that much of the talk of wage inflation torpedoing Chinese cost competitiveness is overplayed. Yes, wages have increased, especially in the manufacturing sector (there’s less sign of similar increases in service industries, HSBC notes). But fixating on factory wages in absolute terms misses the bigger picture on the price of Chinese goods. Industrial output in the last 18 months has grown faster than wages, meaning that the unit of labour cost required to produce each unit of output has actually fallen.

In laymen terms: productivity is improving faster than wages are rising.

But bigger picture: what about labour shortages?

One of the key themes to the wage inflation story is that China is running out of workers. Where once there were millions seeking factory jobs, now recruitment is said to be more of a challenge. Towns and factories are waging PR campaigns to attract newcomers (see WiC96) but even so, more migrants than ever are opting not to return to the assembly line after holiday (see WiC50) festivities.

One response for the bigger employers is to move inland in search of lower-cost workers. Again it’s Foxconn in the news, with two mega plants under construction in Henan and Sichuan. Another is to leave China altogether and last month Bloomberg presented figures from the Japan External Trade Organisation to argue that China’s wages now occupy the “middle range” of Asian labour costs.

Average monthly pay for the most recent data (now more than a year old) shows Shenzhen ($235) and Shenyang ($197) still far below Seoul’s $1,220 or Taipei’s $888. But the two Chinese cities were also well above the $100 earned in Ho Chi Minh City or the $47 in Dhaka.

Correspondingly, Li & Fung says China is now responsible for only 25% of its clothing sourcing, as Bangladesh and Vietnam rapidly gain share.

So, an irreversible trend?

More likely it’s the Lewisian Turning Point, say economists. They’re talking about Arthur Lewis, who won a Nobel Prize for a 1954 paper that suggested developing countries can grow their industrial sectors for years without wages going up much, as long as they have plenty of surplus agricultural labour to add to the workforce.

But when rural supply peters out, industrial wages soon begin to rise sharply. Academics first started talking in earnest about China’s pending Lewisian moment about five years ago. Plenty more are now joining the debate.

So are we there yet? Some question whether China’s rural worker surplus is fully depleted, including Kam Wing Chan at the University of Washington. Last year, Kam estimated a rural working-age population of close to 490 million. He assumes a low labour force participation rate of 75%, subtracts about 150 million workers needed to sustain China’s agriculture at current technology levels, and then another 80 million working in non-farm jobs in townships. Even if stimulus campaign spending has created another 30 million jobs, Kam argues, that still leaves a rural surplus of well over 100 million workers.

It depends where you look…

Certainly, it seems to be a more mixed picture than the bolder headlines allow. Mixed enough, in fact, for human resources minister Yin to offer two rather different sound bites on the labour market in the space of a few days.

At last month’s NPC Yin told the media throng that China’s shortage of workers had become a “structural problem” and was spreading from the manufacturing zones in the eastern coastal areas to central and western China.

But a week later at the China Development Forum, Yin was more focused on the need to create jobs: “There is a workforce surplus of about eight million people in rural areas and 24 million urban people waiting to be employed.”

Yin’s eight million rural surplus is some way from Kam’s own much larger calculation, of course. But even at this low figure, the People’s Daily expresses concern. “China’s job market is oversupplied,” it warns. The employment situation is “very serious”.

So which is it – feast or famine? There is no authoritative assessment that WiC has seen. But clearly, there is not the endless flow of workers once remarked upon as China’s great competitive advantage. And where supply is showing greatest strain, says Zhang Zheng, an academic at Peking University’s Guanghua School of Management, is among those best suited to the fast-paced, repetitive work of factory assembly lines.

This “golden age group” of 35 year-olds-and-below is now just about “used up”, Zhang told China Business News this week.

It’s here where news of strikes and wage concessions has been most prominent. And it’s also here where some of the biggest problems loom ahead, as the one-child policy begins to bite into the dwindling pyramid of China’s working population. There are warnings that the supply of twenty-somethings could fall by 30% over the next 10 years.

Aside from fewer potential workers, there is also less willingness among migrants to accept low-pay factory employment, especially as living costs rise in the cities faster than wages, and more options become available at home. “It’s not accurate to say China’s young labour in the countryside is exhausted,” Wu Guobao at the Chinese Academy of Social Sciences told CBN. “A large number of young people choose to stay at home.”

The boss of this factory will need to pay more to get more workers like her...

The boss of this factory will need to pay more to get more workers like her...

True: higher wages are a policy objective for the Chinese leadership. Pay has not kept pace with increases in GDP in recent years. Companies, rather than their employees, have been the ones cashing in on the blockbuster growth.

President Hu and Prime Minister Wen have tried to redress some of this, and they also want to see more economic development in the Chinese interior, to close some of the wealth gap with the coastal zones.

Similarly, international investors now scan the news for signs of burgeoning Chinese consumer demand. The idea is that this will become a new engine for global growth, and also allow for a realignment in the international economy that will see China export less and consume a great deal more. Clearly, that is more likely to happen if millions of Chinese are being paid more, and have more cash in their pockets.

Li & Fung anticipates something similar, and is undertaking a strategic shift to become less dependent on the China-outbound trade. Clients in the US and Europe currently make up 90% of its customer base, says Rockowitz. But he expects many more Asian clients to emerge over the next three years, as the company builds out much more of a two-way supply pipeline. As part of those efforts, the company has been investing heavily in its China-based distribution capability which now covers 150 cities.

But the more negative scenario for the rest of us? The end of an era of cut-price consumer goods, with toasters, televisions and tablet PCs all starting to cost more. Pessimists warn that Chinese wage increases are bound to feed through into higher prices for exports. And at precisely the wrong moment: coupled to the increased Chinese appetite for commodities, this will stir top line inflation in Western economies, at a time when growth prospects are far from inspiring.

Perhaps it is the end of an era, after all.

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