China hits a welcome turning point

June 17, 2010


China’s massive supply of cheap labor may at last be drying up, a development that in time will bring higher wages, inflation, a stronger yuan and help to right dangerous global imbalances.

If these trends hasten financial liberalisation they could eventually set the stage for a broader Chinese bubble.
The formerly extremely unequal balance of power between workers and employers in China appears to be shifting.

Workers for a Chinese company which supplies Honda with auto parts have struck and successfully won large wage increases. Other strikes have followed, and firms have often been quick to compromise.

Hon Hai’s Foxconn, an electronics unit that supplies many leading western brands, moved to more than double many salaries as part of a series of reforms after a spate of suicides among workers at its highly regimented factories. Several regions have implemented or are debating increases to the minimum wage, a standard which didn’t even exist in China as recently as 2004.

Much of China’s economic development in the past 25 years has been built on the back, or backs if you like, of rural workers who were desperate to relocate to coastal manufacturing centers, wave upon wave of whom kept wages in check even as the economy boomed.

The one child policy and rapid development of the manufacturing base may finally be about to collide. A US Census Bureau analysis of Chinese data estimates that the number of 15-24 year olds joining the work force will fall by 29 percent over the next decade.

“China is likely experiencing a Lewis Turning Point, after which the disappearance of surplus labour will raise real wage inflation and trigger a rise in wages’ share of income,” Wengsheng Peng, an economist at Barclays Capital in Hong Kong wrote in a note to clients.

“China’s vast size and the differing stages of development of its regional economies suggest that the turning point is likely to be a gradual process lasting many years, or a turning phase, rather than an abrupt shock.”

Named for the Nobel Prize-winning Saint Lucian economist Arthur Lewis, a Lewis Turning Point describes the stage in the development of an emerging economy when labor shortages bring on inflation and slowing growth.

While slower growth brings on its own challenges, the emergence of a newly well paid class of workers helps to drive domestic consumption and the development of the service sector.

This is what the world has been waiting for from China.

To be sure, all of this is highly speculative and will only be known in retrospect. The new labor militancy may simply be the result of workers seeking to make up ground lost during the cyclical downturn of the past two years, when many took pay cuts or received scant raises.

There are some signs of emerging inflation in China, but the headline figure of 3.1 percent, though above government targets, is not yet the kind of stuff to remake the world.

If, however, wage inflation is becoming structural then the arguments to allow the yuan to strengthen against the U.S. dollar will become stronger. Besides pacifying its trade partners, a stronger yuan would make imported goods cheaper, dampening a source of artificial inflation built into China’s policy of pegging the yuan well below its likely value as a free floating currency.

This would be a godsend for the U.S. economy, which has been distorted towards consumption by rates kept low by Chinese policy and which needs desperately to earn its way out of its debt hole by rebuilding exports.

It will be a less attractive prospect for China, but the pill would be sugared if a stronger yuan came along with stronger domestic consumption.

Here is where we get to the bubble part, but maybe not for years. As China transitions to a more service-oriented economy it will want, desperately, to build up that most lucrative part of the service sector, financial services.

With currency and capital controls in place Shanghai will never be able to challenge New York or London as a financial center and the government will have to look on as a portion of even Chinese capital intermediation takes place off shore.

If, on the other hand, China allowed the yuan to float and capital to move freely, things might be very different. As outlined by Societe Generale strategist Dylan Grice last year, currency and capital deregulation could set the stage for a massive bubble.

Money will pour in to an appreciating yuan, and while Chinese growth may be less than it was in the past ten years, it is still likely to be very attractive relative to global norms.

A compelling story, a rising currency, and the world’s biggest and newest middle class  – prices could easily spiral. From a Chinese standpoint, from a U.S. standpoint and from a sum of human happiness standpoint, that might just be a bubble worth having.


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Posted by yuelucia | Report as abusive

Dear James,

Thank you for the article, all good thoughts on the topic.

I think global trade will be greatly enhanced when wage/labor normalisation occurs in China as a manufacturing center throughout world history as a massive boon to China’s Economy aiding their internal growth in standards of living and competetion in the global economy as not only a consumer of unrefined commodity product(s) but an increasing share of technically manufactured products.

It is important to note that this could result in a decline in historic western technological dominance and a rebalancing of global trade as suggested and once witnessed after a brief period of western industrial dominance during the post-classical period.

However as with the western short-term dominance of the post-classical period, emergent automated technological manufacturing capabilities in Japan and assimilation of more perfect perceptions of automation within production machines (“Robots”) would also work to re-normalize global trade imbalances and increase demand for high-productivity/pay enhancing knowledge workers.

They entering into wage/labor pro-rata parity, assuming saticfaction of fuel demands innovations, should provide a global rise in trade, particularly in technical ideas (“INTELLECTUAL PROPERTY PRODUCTS”)advancing human society on the whole.

We can only hope that recognizing this slow incremental change in China’s more broad power in the global economy will provide for an increase in compensation for global knowledge workers and by productive mutual agreements open information markets.

Navigating the multiple complexities and nuances of these changes is a principal challenge to global economic diplomacy and international economic policy.

or something expanded to that effect.

Our Old Problems in the Modern Era.

Posted by sdf | Report as abusive

Yet another article touting how successful China is. Yes wages there do need to rise but when they do, watch the flood of companies relocating back to the West when wages for the lowest paid worker reach parity with the same workers in the West.

Only multinational companies profited from the wage imabalance as western workers couldn’t compete with people who could be paid a fraction of what we were paid.

Posted by MagAodh | Report as abusive

It seems that the people of China have begun to realize their value to their nation and want to be adequately compensated for their efforts. It’s about time. They were being worked like slaves in the past. Now that China is growing its people should be able to enjoy a better standard of living. It’s only right since they’ve been working in sweat shop conditions for decades now.

With increased income comes increased access to the world around them. Maybe now the Chinese will truly become members of the global community.

Posted by Benny_Acosta | Report as abusive

Excellent article. Workers of the world, unite.

Posted by AdamSmith | Report as abusive

i think they should overthrow the government they have the number. i think dictatorship will never bring anygood. power to the people

Posted by haass | Report as abusive

Posted by haass | Report as abusive

Hi James
Thanks for your articles I have frequently learned from and enjoyed them .
Re current article having spent most of the last 8 years in China I feel you underestimate the complexity of the society .
I would completely agree with your views if Shanghai could be regarded as typical[which it is not] however in my experience the disparity between areas like Shanghai should not be underestimated [yes an office worker in Shanghai may be earning 5000-7000 RMB ,750-1000ish USD per month] and be aspiring to home ownership and the trimmings ,+ car and holidays etc etc . The average person in most of the regions [ Laioning, Herbei, Jiangzu , Zehjiang, Shandong, Shanxi etc etc]I know , the average is closer to 500 – 1000 RMB [75 -150 USD] per month ,given that most are raising families and paying in full for health care and children’s education ,it’s hard , and the US’s problems are a matter of indifference.
Yes they aspire to home ownership too ,and the costs are relative ,but like here in London the gap between the have and have nots is widening . The aspiration remains and will remain a dream ;Remember there is fine line between a dream and dissolution , and between dissolution and unrest!
For me this fact is the flaw in your argument.
As far as I can see the Chinese government’s greatest concern is to maintain social stability and it’s eyes are constantly on the interior where traditionally social disruption comes from . I can see no substantial move to accommodate super rich countries like the US until people in the interior are at least within sight at least, of places like Shanghai .
Even in Shanghai ,in April, when I was last there , people were grumbling about disparities between the rich and the poor and rising prices. I know people in the provinces are finding it really hard . your benign scenario with just the Chinese suffering a bubble to everybody else’s advantage is a wish fantasy .
It won’t happen unless it is clearly to local advantage ,the rich there can already afford the Benz and the other status symbols. Who would benefit from Yuan appreciation ? Not the masses as you suggest but the rich who already can easily afford these toys . they will just get richer and in my view the tensions will increase .
Jiang Zemin chose to ape the US model yes , but, Hu Jintao has chosen to row back from that position , the last couple of years of funny money and political instability or impotence has done nothing to convince the people on the street let alone the political elite that the western system is stable . All the people in China now in power were brought up on
Karl Marx ” Capitalism contains within itself the seeds of it’s own destruction ”
Have we shown that this is not true ?
For a progressive agreement on how to manage the world economy there has to be trust , the level of corporate fraud and economic instability in the “developed” economies ,notably the US ,have in my view only confirmed the Chinese suspicions that we [the west] are not to be trusted .
The more the US bullies the harder it will be unless there is a deal e.g. a Chinese company taking over Boeing or similar and there is a regulatory hurdle that a Yuan adjustment would smooth .
Apart from this I suggest that China will pursue it’s own self interest just as hard as the US feels entitled to do all the time .
At this moment I suggest that we all work to make the necessary adjustment to our own system ,primarily by eliminating the ease with which the gigantic frauds from our system have been carried out , the fear of which are after all are the things that make the Chinese seem rich when clearly they are not. To do this we have to accept our own failings and not try and shift the blame or the solution to others outside our very privileged world .We need political dynamism not a vacuous managerial style based on blame as we are now all suffering.
If 1/3 of the worlds population represented 1/3 of the world’s economy would that be so imbalanced ?
If the US produced 1.5 tonnes [per head as China] of CO2 per head not 20 tonnes as now would that be such an unreasonably thing ? or even 10 tonnes as Europe ?
If US defense spending was halved to 24% of global totals it would still spend 3 times more than China [and given relative populations that is still 12 times as much per head]would that be such a bad thing ?
Just these 3 statistics show that a significant realignment is inevitable , but is 30 years of resistance and 30 years of arrogant exploitation albeit that we now realise we have been outwitted a good place to start the building of trust ?
At a time when we need their help too !
You judge !
For what it is worth

Posted by battersea2 | Report as abusive

There are still billions of workers who are ready to fill the Chinese and Indian workers shoes. This division of labour, as envisioned by Adam Smith, will continue until a 16 year old from England and a 16 year old from India and China, with no qualifications or experience, will command a similar wage.

This division of labour will find increasing equilibrium in qualified jobs as well. Its good for the world. The West as we know it will lose its power and propensity to bully. Less people will be killed needlessly and less hatred.

Posted by SurajZ | Report as abusive

I think it depends on how much freedom it is willing to give up to the people. My own thought is probably not much and I expect the yuan to stay strong, so I think China is just making more troubles for itself in the future.

Posted by twiceshea | Report as abusive

“Yes wages there do need to rise but when they do, watch the flood of companies relocating back to the West when wages for the lowest paid worker reach parity with the same workers in the West.”

This will never happen. At most, it will dilute the extremes. Parity? Never. It’s not just about economics. It’s about work ethics as well. And this will never change.

Posted by doctorjay317 | Report as abusive

[…] is not alone in seeing an end to China’s labor surplus: A Reuters column Thursday made similar points, talking of a turning point in China’s massive supply of cheap […]

Posted by China’s Worker Shortage – China Real Time Report – WSJ | Report as abusive