China's Role as 'World's Factory' Coming to an End

China’s economy is at a significant crossroads as it enters 2011, with wages rising rapidly and the labor force, particularly of migrant laborers, starting to shrink. The shift is causing many to predict the end of the country’s status as the world’s shop floor.

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China’s role as “sweat shop to the world” is coming to an end, according to Ashley Davies, the senior economist for Asian emerging markets at Commerzbank. “They’ve come to the end of a certain model of development,” he said. “They need to move up the value spectrum.”

Dong Tao, the chief Asian economist at Credit Suisse, agrees. “This is the beginning of the end of an era – China as the world’s factory,” he and his team wrote in a report on China’s labor market released on Jan. 5. “This is the beginning of the end of an era – China as the anchor of global disinflation. It may take a decade for China to see its export competitiveness erode, but we have seen the beginning of this happening.”

What came to the fore in 2010 is that China has too much demand for the products made by low-skilled workers, who are in increasingly short supply and increasingly vocal in their demand for higher wages.

A series of disruptions at overseas-owned factories last year shone the spotlight on the issue. Japanese carmakers Honda and Toyota were hit by labor disruptions. Taiwanese electronics companyFoxconn International Holdings hiked wages by about 30% and then 66% after a string of suicides at its factories in southern China that worker-protection groups blamed on young employees working long hours for poor pay.

"This is the beginning of the end of an era – China as the world’s factory." -Chief Asian Economist, Credit Suisse, Dong Tao

Those kinds of large increases look set to continue for some time. Wages for migrant workers rose by 30% to 40% last year, and will likely continue to rise 20% to 30% every year for the next three to five years, Credit Suisse forecasts.

Official statistics show that the average wage in China for 2009, the most recent data available, was 32,736 yuan, the equivalent of US$4,950. Manufacturing wages were a little lower, at US$3,896 per year. Farmers could expect to make US$2,184.

China is set to be a “labor surplus” country until roughly 2014. But raging demand for service-sector employees as well as the reluctance of some workers to leave the countryside will gradually stretch China’s job market, particularly at the low end.

The wage increases are necessary after a decade in which China’s economic growth outstripped worker pay. Factory owners, not employees, have been the primary beneficiaries of China’s rapid growth, economists say.

According to the U.S. Bureau of Labor Statistics, the average hourly wage is US$1.36 in China, more than 20 times lower the US$32 per hour average in the United States.

Wei Yao, China economist with Société Générale, noted that China’s wage growth has lagged its economic progress for years. There is still a large supply of underused labor in China. But that picture is beginning to change, with some major demographic shifts due in the first half of this decade.

Wage Growth vs Economic Growth

“The working age population is going to peak somewhere around 2015, which meaning the labor supply is going to gradually decline,” Yao said. “That is going to put more pressure on wages.”

Wage growth has been running at 8% to 9% per year, whereas gross domestic product has run above 10% in recent years — consensus forecasts suggest China’s economy will grow at 9.2% this year. But the situation may soon be reversed, marking China’s maturation away from the world’s factory to a valued-added economy with an emerging middle class.

“Wage growth shows a reallocation of the wealth, allocating wealth from investors to the laborers,” Yao said. “It’s something that couldn’t be avoided as the demographic shift goes on.”

Municipalities have been raising the minimum wage across China. Beijing led the way on January 1, by raising the minimum wage in the capital by 20% to 1,160 yuan per month, its second such increase in six months. That makes it the highest minimum rate in the country. But it is a move that will likely be followed in other cities.

Last year, many provinces raised their minimum wage by between 10% to 30%. “We expect similar size of increase in the minimum wage this year as well,” Yao said.

According to research by Credit Suisse, wages have actually fallen from 53.2% of gross domestic product between 1992 and 1999 to 49.7% between 2000 and 2008. The United States, by contrast, saw wages cross the 60% threshold in the 1920s, and it has remained above that market, at 63.9% of GDP last decade.

“There is a good chance that we can see the share of wage to national income increase by a few percentage points from now to 2015,” the report states. Conservatively, it should grow to 55% of GDP by the middle of this decade – and the bank’s “base case” is that it will rise to an amount equivalent to 62% of the economy.

Higher wages will increase consumer demand, something Beijing is keen to encourage. It will also help combat asset bubbles and the increasingly high price of housing, which policymakers and prospective home buyers say is becoming unaffordable for the middle class.

The gains are greatest for the lowest kind of worker, though. There is still a glut of people with universities degrees, who may find that the incomes they command aren’t far beyond what workers are able to command in factories.

With the broad economy in China growing at 16% to 17%, when you combine economic growth with inflation, wages will have to grow more rapidly for goods, rents and housing to become more affordable. But that seems to be happening.

The income gains are good for companies such as car makers that have a relatively low labor component in their goods, but benefit from stronger demand. They will eat into the profits of companies operating in China, but will relieve some of the social tensions fromrising foodand housing costs that are beginning to worry Beijing.

“Income inequality is too high in China,” Davies said. “Anything that reduces that is a good thing.”