Say Goodbye To The China Price

Co-blogger Steve Dickinson recently wrote an article for the China Economic Review, entitled, "Farewell to the China Price". 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 unequal), 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 multistory 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 revised target 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-oriented manufacturers. 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 a big impact 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.