The Guest Blog

Rein: Can Indonesia Benefit From Rising Labor Costs in China?

Shaun Rein, CNBC Contributor|Founder HKSCKPVIamp; Managing Director, China Market Research Group

I noticed a buzz about the economy, when I was in Indonesia last week, which was very different from the first time I visited the country in the late 1990s. A commercial banker at a large international bank told me, “My garment and shoe manufacturing clients are all moving away from China and relocating to Indonesia and even Cambodia.”

His bank was increasing operations in these markets to handle the change in business patterns. He continued, “China is no longer cheap, especially with the renminbi appreciating 7 percent in the last year, so everyone is looking for cheaper production.”

The government has been actively trying to end the nation’s cheap labor force era by increasing wages and social security benefits and accelerate a consumption and services oriented economy rather than preserve low wages.

Twenty one of China’s 31 provinces this year have increased the minimum wage by an average 21.7 percent. The government has also set a nation-wide target to increase salaries by 13 percent annually.

These hikes are on top of minimum wage boosts in provinces like Sichuan that raised minimum wages by 44 percent in 2010. Cities like Shanghai have also been increasing social security benefits for native residents and migrant workers so that tens of millions get better access to medical care. The new regulations add about 30 percent to compensation costs per migrant worker.

China’s leadership recognizes it must end the nation’s reliance on exports by promoting domestic consumption by raising salaries. If it does not do that, the nation could hit the middle-income trap, which countries like Mexico have when their per capita GDP hit $6,000 a year. China’s per capita GDP will hit that figure in the next five years and the government needs to narrow the rich-poor gap by then.

The efforts made by the government, are however, helping increase consumption. My firm estimates domestic consumption now accounts for 42 percent of the economy, up from 30 percent a decade ago.

The difficulty facing China is not that the government does not realize it needs to put an end to cheap labor but that it will overshoot. By forcing labor costs to go up too quickly too fast, it could land up making China unaffordable for low-margin businesses. There is a risk rising labor costs will force too many companies into bankruptcy if the global economy does not heal quickly. Already thousands of factories have shut down.

Inflation is also playing its role in increasing hiring costs. Employees, fearing continued food inflation, which topped 15 percent in the last year, are negotiating huge salary increases.

Companies in turn are starting to transfer higher labor and commodity costs to end consumers. The result is a never-ending cycle of inflation which hit 6.1 percent in September.

Companies and nations that understand the shift in China’s economy and political mindset will win. Rising incomes and better social security safeguards are creating a new class of consumers that provide opportunity for brands that sell into China.

Intel estimates sales there will eclipse those in America in 2012.  China has already become Dell’s and Apple’s second largest market globally.

Higher labor costs in China, while necessary to boost consumption, can also create an opportunity for countries like Indonesia, which can offer cheap and efficient labor for mass manufacturing. If Indonesia can maintain stability and train better its 240 million population, it could emerge as the next China.

Shaun Rein is the founder and managing director of the China Market Research Group () a strategic market intelligence firm, and is based in Shanghai.

He is the author ofpublished by John Wiley & Sons in the U.S. He does not own shares in any company mentioned. Follow him on Twitter at @shaunrein.