Economy

INFOCUS|CHINA|ECONOMY

Rising wages in China is eroding the advantages that the manufacturing sector had earlier. Now the cost of production is rising rapidly and the cheap labour trend on which the phenomenon of ‘Made in China’ was built, is no longer viable.

Sriparna Pathak

C

ost advantage is the basis of the ‘Made in China’ phenomenon. China capitalised on its vast labour pool and low wages and instantly began the process of assembly line manufacture of cheap products. At the time of Deng Xiaoping’s enunciation of reforms, wages were extremely low-ensuring low production costs for manufacturing enterprises. At the time, the average yearly wage in the manufacturing sector was 597 Yuan. In 2009, the hourly compensation in the manufacturing sector remained far below most of its East Asian neighbours such as Japan, wherein the figure stood at US$ 30.03, the Republic of Korea at US$ 15.06,

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and Singapore at US$ 17.54. However, the hourly compensations in China were roughly at par with those in Philippines, wherein the figure stood at US$ 1.70.

Lately, wages have been increasing in China, reducing cost advantages in manufacturing. Manufacturing sector wages, according to statistics from the National Bureau of Statistics, have risen 71 per cent since 2008. The announcement of minimum wages is leading a lot of investors and foreign companies to shift away from China to other countries offering cost advantage in production. The rationale behind setting up minimum wages’ is visible in the country’s 12th Five Year Plan (FYP 2011-15). FYP depicts three legs to the consumer led growth; boosting employment, increasing

After the Setting Up of Minimum Wages The issues of wages became even more troubled for manufacturing enterprises after minimum wages were set in the country in 2004. Production costs soared by 7.56 per cent in agriculture owing to increase of 10 per cent in wages. Manufacturing industries’ production capabilities also got affected by the same. Textiles, apparels and handicrafts were the worst affected ones, followed by extraction industries such as coal mining and the purification of water and related works.

Increase in Average Yearly Wages in Manufacturing 45000 40000 35000 30000 25000 20000 15000 10000 5000 0

19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11 20 12 20 13

and Rising Wages

wages and shifting allocation of the resultant increment in labour income from savings to spending.

Increased wages will lead to more buying power for consumers, however, it will also negatively impact cost advantages of enterprises. From 2002-11, average annual wages have increased by 3.3 times. As such, the manufacturing sector has reached the Lewis Point.

According to Lewis (1972) and Ranis and Fei (1961), the Lewis point is the period during which expansion of labour demand exceeds labour supply, Since 2003, the phenomenon of labour supply exceeding labour is no longer the main characteristic of the Chinese labour market. As the average age of the working population increases, labourers from rural areas, particularly those whose human capital endowment if weak, are less capable and less willing to migrate. Combined with other reasons, the rural labourers’ supply is decreasing, whilst the demand in urban areas is unremitting resulting into labour shortages. In addition to the labour scarcity, rising costs in China’s traditional manufacturing clusters, which include land prices, tightening environment regulations and wage overheads have already been posing serious challenges for manufacturers. Lack of labour and an increase in wages is bringing about a steep increase in the production costs of various industries, especially in labour intensive industries. The scenario in 2015 is not expected to change much.

Source: National Bureau of Statistics, China Statistical Yearbooks.

A minimum wage increase by 10 per cent on an average, leads to an average increase in production costs in manufacturing industries between 0.4 per cent to 0.5 per cent. Also, the minimum wage policy contributes more to the average wage hikes in labour intensive firms or in firms which have lower asset per capita compared to other firms. In terms of employment, a rise of minimum wages by 10 per cent leads to an employment loss of about 0.6 per cent.

Minimum Wage Levels in China There is no uniform minimum wage level for the entire country. Minimum wages are set by local governments.

Each province, municipality, autono-

mous region and even district sets its own minimum wages keeping local conditions, including economic conditions and living standards, in mind.

The provincial government sets out multiple minimum wage categories for the region as a whole, and each city and each county within the region chooses the appropriate minimum wage level based on local conditions. In Zhejiang for example, four minimum wage classes were set across the province, with top tier cities such as Hangzhou, Ningbo and Wenzhou choosing the highest minimum wage level, known as ‘Class A’, while other cities such as Jiaxin, Jinhua and Taizhou settled on the next highest minimum wage level, or Class B. For cities such as Shaoxin

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INFOCUS|CHINA|ECONOMY

and Yiwu, the local governments have not yet decided on the most suitable minimum wage level.

Article 48 of the Labour Law states that the mandatory minimum wage should be set at a level which is adequate to meet the daily needs of employees. Nevertheless, it was not until March 2004, that the Ministry of Labour and Social Security implemented its Minimum Wage Regulations, and guidelines were put in place to establish a framework for calculating and adjusting the minimum wage.

By increasing minimum wages, the government is shifting from preferential policies for foreign investors towards favouring its local labour pool.

The rationale is that wage hikes will boost domestic consumption, which will keep the economy expanding, while overseas demands for Chinese goods remain weak. Also, the attempt is to retain public support for the Communist Party of China and to accelerate the country’s shift away from capital intensive and polluting manufacturing to a more services driven economy.

Therefore, in 2012, China’s Ministry of Human Resources and Social Securities revealed the latest minimum wages, and accordingly provinces and cities have set up minimum wage levels.

In all, 23 regions across China adjusted minimum wage levels in 2012. Additionally, since January 1, 2013, four regions, i.e. those of Beijing, Henan, Zhejiang and Shaanxi have improved their wage levels. Zhejiang’s ‘Class A’ cities now rank second in the country in terms of minimum wages set up, which stand at 1,470 Yuan. Beijing has the country’s highest minimum wages per hour, which stand at 15.2 Yuan per hour, followed by Xinjiang and Shenzhen at 13.4 Yuan and 13.3 Yuan respectively. This is an attempt by the Government to lure labour into the Western provinces-which lack developed industrial set ups so far. Guangdong and Beijing are provinces with the highest minimum wages. Given property price hikes and lack of access to social welfare in more developed coastal provinces, migrant labourers now prefer to stay in their areas of ori-

What is Leading to Wage Increase?

Wage increase can be traced to a number of factors.

1) China reaching its Lewis turning point: When the ratio of jobs to job seekers exceeds 0.96 per cent, labour shortages emerge. In May 2010 for example, in Eastern China, the availability of number of rural workers suitable for labour intensive work in the region dropped steeply from 120 million in 2007 to just 25 million in 2010.

2) Rising living costs in urban areas: The Consumer Price Index (CPI) in 2011 for the entire country stood at 5.4 per cent and the cost of living in cities like Beijing and Shanghai remained out of reach for labourers. This is the case in most of the coastal provinces which are richer than the other provinces of the country. Therefore, some multinational companies (MNCs) like General Motors, Intel and Motorola have moved manufacturing facilities inland to

gin. Simultaneously, as manufacturing enterprises face a shortage of labour in the coastal regions, they will attempt to move inland, which have lower minimum wages, which will enable to keep the enterprises’ costs of production low. Thus, this particular distribution of minimum wages makes sense, given the fact that a certain level of wages in provinces like Xinjiang and Tibet will spur consumption in the autonomous regions, while manufacturing enterprises which are feeling the pinch of high labour costs in the coastal regions will move inland, which will lead to a more equitable distribution of industries across the county.

Impact on ‘Made in China’ Government policies including increases in the minimum wages and currency revaluation, are shifting in favour of improving domestic workers’ welfare and away from maximising benefits for investors and manufactures in the country. However, as companies seek to move up the innovation ladder, focus on productivity gains is leading to rising costs, as companies seek to invest more in sophisticated technology and equipment. Additional costs due to wage increases adversely

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avail benefits of greater supply of labour.

3) Ageing population and increasing education levels among the younger generation workers: Members of the one child policy generation are now entering the labour force, and are contributing to the changing labour mix immensely.

Compared to the older counterparts, the younger ones seek different terms of labour than earlier generations did.

4) Wage increases and higher minimum wages: The Labour Contract Law of 2008 improved wage standards and enlisted the provision of the protection of workers from baseless dismissal. Also, Beijing’s government increased the minimum wage by 20 per cent in the third quarter of 2010. Manufacturing companies are not at ease with the increased rise in production costs, and many have even started seeking viable options in countries like Vietnam.

affects the manufacturing enterprises.

While some manufacturing firms are relocating to other countries which have cost advantages, others are moving to the central and western regions of the country. Processing and manufacturing firms like Foxconn have begun to move in greater numbers as rising wages eliminate cost advantages.

Wage Increases= Boon For Labourers?

The worrisome fact is that while average monthly wages for Chinese rural migrants in 2013 increased by 13.9 per cent over the previous year, living expenses increased at a much faster rate, effectively cancelling gains made. According to National Bureau of Statistics, released on May 12, 2014, per capita living expenses increased by 21.7 per cent on average to reach 892 Yuan per month. The primary reason behind higher living expenses was a 27 per cent increase in accommodation costs which make up about 50 per cent of the total living costs for migrants. 90 per cent of low skilled labourers personally interviewed, complained of sky rocketing living costs, and stated that the increased wages

were not enough to meet the living expenses in cities. The greatest challenge currently for the economy is to implement the Henry Ford principle of paying the workers enough so as to enable them to buy the products they make.

Rising wages are also leading to greater inflation in China, which may lead to an erosion of China’s advantage in its prime export destinations such as the US and the EU, which in any case have been affected since 2008 global financial crisis. As such, the wages are growing much faster than the overall economy, which has been fuelling in-

flation and real estate bubbles in a scenario where banks are willing lenders.

In all, while the intention behind raising wages is noble, the fact remains that they are not serving any purpose to the workers-the ones it is supposed to bring advantages to.

Will the Wage Increase Help?

China’s GDP growth has slowed down to around 7 per cent per annum, and wages are growing much faster than the overall economy. Wage growth in the private sector was around 14 per cent in 2012. As such, manufacturing

firms need to increase productivity in order to maintain margins through technological investment, cut manufacturing costs or grow sales.

Labour productivity improvement has the potential to offset some but not all of the wage growth in any case.

So, will wage increases hold China in good stead? The outlook for ‘Made in China’ in 2015 is grim in the present circumstances. Instead of wage increases, which reduce the country’s edge in manufacturing, a reinvigorated effort in fulfilling the previous reforms would prove to be a better solution to ensure economic growth and political stability in the near future. The belief that a higher minimum wage is socially beneficial for the workers is a delusion in case of China. Workers who retain their jobs are made better off, but this comes at the expense of unskilled labourers who go jobless, or are unable to find employment. If the minimum wage is higher than the prevailing market wage-which is determined by the forces of demand and supply, considerable number of workers will either lose their jobs or will have their wages cut. Given the fact that the plans to hike wages will continue well into 2015, the prospect for ‘Made in China’ seems to be grim as much as for the tag as for the workers.  The author is Associate Fellow, Observer Research Foundation, Kolkata

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INFOCUS|INDIA-CHINA|ECONOMY

Exploring the India-China

Trade Deficit

Few months in power, the Narendra Modi led government has put India’s Southeast Asia diplomacy in high gear. Aimed at intertwining economies, interlinking destinies and creating an arc of prosperity across the region, India’s “Act East” Policy is now cruising along on a high trajectory. Against this background, the article examines the economic relationship between India and China and explores the trade deficit issue from an economic perspective. |10| India-China Chronicle  January–February 2015

Samridhi Bimal and Devyani Pande

I

n the recent times, India has taken a slew of steps to galvanize relations with Southeast Asia, the economically vibrant region. India’s foreign relations policy has now acquired substantive economic and strategic weight with negotiations under Regional Comprehensive Economic Partnership (RCEP) agreement. The RCEP is believed to define economic integration in the world’s most dynamic region of Asia. China and India are the key economies in this agreement. The stakes in the negotiation are very high,

A Background Trend Bilateral trade between India and China increased rapidly since the mid90’s and picked up significantly after China became a member of the WTO in 2001. In 2013, the India’s exports to China stood at $16.4 billion, whereas imports stood at $51.6 billion.

India’s exports to China have been growing at a much faster rate than its total bilateral trade. In 2012, total bilateral trade between both countries was around $68 billion with an exponential growth of 28 per cent over the period 2000-13. Even though the current bilateral trade is among the highest with partner countries for India, there exists enough potential to reach $100 billion by 2015.

Trade data clearly demonstrates the dominance of Chinese exports in the bilateral trade between India and China (Refer Figure 1). The fact that India’s imports from China were 10 per cent of its total imports from the world in 2012, points to China’s significance as a trade partner.

India’s main imports from China have been electrical equipments, machinery and telephones. Its top export items to China include cotton, copper articles, organic chemicals, cathodes and iron ore (Refer Figure 2).

Items of trade between India and China, classified into segments such

similar refractory ceramic constructional goods. This sets to rest the concern that many analysts have raised regarding Indian consumer goods market being affected by a surge in imports from China.

as raw materials, intermediate goods, consumer goods and capital goods according to the WTO classification, gives a more insightful inference on trade trends. The data shows that 89 per cent of Indian exports comprised of raw materials and intermediate goods and 83 per cent of imports comprised capital goods and intermediate goods. This is contrary to popular perception that India imports more of consumer goods.

In fact, in 2013, share of imports was just 14 per cent of India’s total imports from China. Within consumer goods too, India mostly imported articles of plastic for industrial use and refractory bricks, blocks, tiles and

Widening Trade Deficit Keeping in view the trends of exports and imports between India and China, it is clear that the trade balance started swinging in favour of China 2003 onwards. Since then, this has continued and there has been a widening trade deficit for India against China. The trend has been attributed to a host of factors, particularly, export restrictions and export duties

Figure 1: India-China Trade over the years (1996-2013)

India-China Trade over the years

India’s Export to China India’s Imports from China

60 Trade Value (in USD billion)

but trade analysts are apprehensive about the kind of effect it would have on the economic relations between both the countries. Trade is already swinging in China’s favour and signing of the agreement may aggravate the existing trade deficit.

The widening gulf between India’s exports to and its imports from China has brought forth issues of achieving a more sustainable and balanced bilateral trade between the two countries. It also brings forth questions that pertain to utilizing the inherent trade complementaries. What have been the trends in trade between India and China? Is the burgeoning trade deficit with China actually bad? What measures should the Indian economy undertake to combat the growing deficit?

50 40 30 20 10 0 1995

2000

2005

2010

2013

Years

Source: Authors calculations using UN COMTRADE data

Figure 2: Top 5 items of trade between India and China (2013)

Top exports of India to China

Top imports of India from China

Trade Value (in billion USD)

Trade Value (in billion USD)

Cotton yarn, single (excl. sewing thread)

0.5

Urea

1.23

Polypropylene, in primary forms

0.5

Parts of telephone sets

1.34

Iron ores & concentrates, non-agglomerated Cathodes & sections of cathodes, of refined...

Cotton, not carded or combed

Portable automatic data processing machines

1.05

Comodities not specified elsewhere

1.93 2.76

Telephone for cellular/wireless...

2.2 2.45 4.52

Source: Authors calculations using UN COMTRADE data

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INFOCUS|INDIA-CHINA|ECONOMY

on iron-ore and copper, lack of market access for Indian pharmaceuticals, IT and fishery in China and the surge of petroleum and gold exports to India.

In 2013, India’s largest trade deficit, among the partner countries, was with China. An astronomical trade deficit figure of USD 35.21 billion does raise a few apprehensions and concerns.

To view the deficit problem in a holistic way, one needs to delve into the economics of trade deficit and analyze the consequences thereof.

Aggregate and bilateral deficits are largely attributable to macroeconomic factors. The other reason for deficit is the ‘triangular trade’, which pertains to cross-country differences in the patterns of demand and supply. It means that a country will run bilateral deficits with a country which is usually an important supplier of goods.

Bilateral trade deficits are basically a perennial policy issue. There are not just two countries in the world, so one cannot analyze the bilateral deficits and surpluses in a multicountry world. India’s obsession in solving bilateral trade deficits with a specific partner has taken it far afield from the fundamental problems of overall trade deficits and underlying

Tackling High Trade Deficit: India’s Response

T

rade deficit is not a new phenomenon for the Indian economy.

India has been recording sustained trade deficits since 1957. Today, India has trade deficits with over 80 countries and for the year ending March 2013, it recorded a trade deficit of $87.8 billion. A trade deficit simply represents outflow of domestic currency to foreign markets. A large and unsustainable increase in sale of domestic currency can drive value of domestic currency down; thereby making imports more expensive. India runs a trade deficit with two kinds of countries. Under category 1, there are countries which are rich in petroleum, oil and natural resources, the demand of which is inelastic for a country like India. Under category 2, there are countries like China, Taiwan and South Korea from which high-tech machinery are imported in India to raise productivity levels.

Figure 3: The widening India-China trade balance

The Widening Gulf

Trade Value (in billion USD)

60 50 40 30 20 10

India’s Export to China

India’s Imports from China

Source: Authors calculations using UN COMTRADE data

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2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

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1997

1996

0

macroeconomic conditions at home (low GDP, inflation, low investment, etc). Overall trade deficit is essentially a macroeconomic issue and cannot be resolved with trade policies. That is to say trade policies targeting particular industry or trading partner may only work to affect the composition of trade but not the aggregate balance.

A Cause for Worry?

Trade is vital to the enhancement of economic and political cooperation between India and China. In the third India-China Strategic Economic Dialogue meeting at Beijing in 2014, both sides recognized that as major developing economies, they needed to raise the level of economic engagement.

With a view to promoting greater economic and commercial engagement, both sides also acknowledged the need to explore potential synergies in areas where the two sides have mutual complementaries, improve trade and investment environments and work towards removing market barriers.

This came in addition to recognizing the need to enhance cooperation in project contracting, deepening business to business exchanges, improving transportation links, encouraging greater bilateral investment and working towards achieving a balanced and sustainable bilateral trade. Trade deficit came up as a prickly issue for India, in particular, its sustainability. India’s trade deficit crossed the US $30 billion mark in the latter half of the 2000’s and has now become unsustainable.

In this context, the Indian side iterates the need to reduce the deficit to a sustainable level by increasing exports in competitive sectors like niche engineering products, IT-enabled services, cotton textiles, home furnishings and pharmaceuticals.

Though deficit is a cause of anxiety, it is important to recognize that India’s overall aim must not be to balance trade with China, or target a particular trade deficit. At this juncture, India needs to look beyond the concerns of trade deficit with China to strengthen its collaboration and enhance trade in

Shifting Capabilities

I

n the India-China context, both countries have distinct capabilities: one is referred to as the “world’s office”, the other “world’s factory”, reflecting their comparative strength in services and manufacturing respectively. The massive diversified manufacturing sector in China has propelled its manufacturing exports. Chinese strategy of building big manufacturing companies that can sustain large R&D budgets has enabled them to not only compete on the basis of just cheap labor or costs but also on the basis of technological innovation.

With the changing industrial structure of the country, a large portion of Chinese exports are becoming high-tech exports. In contrast, manufacturing sector in India has not been performing too well in the last few years, thus increasing its dependence on imports for competitive and technology intensive manufactured products to intensify its domestic industrialization.

The government has been trying to curb the influx by applying protectionist measures. Economists believe that such protectionist moves will hurt India much more than China in the long run, depriving Indian consumers and producers of goods they cannot find at home. Rather than regulating imports, India needs to boost exports and particularly in the services sector.

segments over and above the existing ones. The World Trade Report, 2013 states that some of the main trends that will affect world trade would be— emergence of Global Value Chains (GVC’s), growth of trade in services,

rise of emerging economies and evolving perceptions about the link between trade and development. GVC’s have assumed importance with trade and production fragmentation among countries leading to specialization in

production since no country can have comparative advantage in all segments or for all stages of production in a product/sector. China has emerged as a hub for GVC activities with the local firms setting up various production assembly lines and subsequently emerging as transnational corporations. Unfortunately, India has not been able to capitalize on this phenomenon, despite its proximity to China. Electronics and electrical goods have been the prime mover of global production networks in East Asian markets. India can benefit from China’s import dependent participation in the global production network for IT and electronics. Exporting IT and electronics intermediates to China can provide a boost to India’s domestic manufacturing and lead to its eventual integration into the value chain for IT and electronics.

Strong adherence to such production processes and spirit of regionalism has increased interdependence between countries, with which bilateral trade between India and China is most likely to increase. The need for firms to organize their supply chains across different countries has led to demand for regional trade agreements that cover much more than preferential tariffs.

India’s proactive approach towards regional integration will have a strong bearing on the dynamics of IndiaChina trade relations also. If the RCEP agreement comes through, it will be a paradigm for regional trade co-operation offering significant opportunities to engage for the key players of RCEP in Asia-India and China. A natural path for economic integration between India and China would be to then enter into a Free Trade Agreement (FTA), if benefits of bilateral integration (through greater market access for Indian goods to China and increase in Indian exports to China) are realized under the RCEP. 

The authors are researchers at Indian Council for Research on International Economic Relations (ICRIER), New Delhi. The views expressed are personal.

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