Feature Stories | May 01 2008
(This story was first published on Tuesday and was initially only available to paying subscribers)
By Greg Peel
The rapid industrialisation of China in the past decade has created a seismic shift in the global economic landscape. While China’s desire to emerge from its aged and inefficient communist economy to join the world as a capitalist powerhouse is fundamental to the shift, the root of China’s explosive growth lies in one simple factor – its enormous population. With over one billion worker bees available to provide the basis for the plans of a handful of queen bees, China has been able to build a globally influential economy almost overnight at very little cost – a capacity that was not lost on the rest of the world.
The label “Made in China” has long been held in derision by Westerners, a hangover from the avalanche of cheaply assembled knick-knacks and consumer goods that hit the world years ago, clearly the result of an army of exploited workers who were doing their bit for the mighty communist regime in generating some foreign income, and gladly earning a pittance from it.
Next came the great running shoe evolution, which turned the humble sneaker into a ubiquitous fashion statement, and an expensive statement to boot. It was running shoes that first revealed to the world the concept of the global “sweat shop” – an expression that was previously reserved for the likes of migrant seamstresses pumping out cheap clothing for a low wage in a foreign land. While shoe manufacturers were forced to back down from their exploitation of overpopulated but underdeveloped nations, what the Reebocks and Nikes of the world did achieve was to highlight the vast labour pool that was the emerging world.
But it is unlikely a more general exploitation of foreign labour would have occurred if it wasn’t for one other coincident development – the growth of the internet, and the exponential acceleration and miniaturisation of computer power. By providing the capacity to send large amounts of accurate information instantaneously across the globe, the internet allowed for a safe and efficient means for developed nations to export their manufacturing bases, while retaining the profits. And those profits would only be greatly enhanced if costs were greatly reduced.
If the production process is simplified into three steps – design, manufacture, sales – the manufacturing step is the most labour and plant intensive, the most risky, the most cyclical, and the most costly. Outsource the risks and costs of manufacturing and what you’re left with is where the profit is really made – in design and sales.
And China provided that opportunity. Having learnt from the disastrous experience of the “Little Tiger” Asian economies which rapidly bubbled and burst in the nineties due to overinflated currencies unsupported by foreign reserves, China pegged its currency to the US dollar, thus providing a stable economic playground to be exploited without currency risk. Lack of meaningful lending controls meant that credit was not a problem, and the hangover from the communist ethic meant that funds would be provided to anyone who wanted them, but particularly if they were to be used to build a factory and participate in China’s glorious industrialisation. Whereas foreign direct investment had previously been eschewed, now it was welcomed and encouraged.
In a very short space of time China began sucking up the world’s natural resources and spitting them back out in the form of ever cheaper consumer goods. Commodity prices have skyrocketed, but the price of manufactured goods have fallen, thus balancing out the global inflation effect. The steady fall in retail prices reflected the seemingly endless source of labour on hand to man the mushrooming factories and production lines. Hoards of Chinese workers downed their pitchforks and gave up a life of subsistence farming in rural areas for a life of steady wage-earning in the crowded cities and provincial centres. While wages were comparatively pitiful by Western standards, they were a king’s ransom as far as unskilled Chinese were concerned.
The Western world in turn sucked up China’s cheap products with abandon, leading the US in particular down the path of burgeoning current account deficit. While America’s “platform companies” were reaping the benefits of having outsourced manufacturing, the US domestic manufacturing industry was slowly diminishing at the expense of the American worker. While US factory wages were significant compared to their Chinese equivalents, additional costs such as health care, pension fund contributions, the provision of safe working conditions, and environmental compliance costs were an additional burden to US companies that did not exist across the Pacific.
China’s economy exploded, but then so did its stock of foreign reserves. Its currency became seriously undervalued, forcing the Chinese monetary authorities to continuously revalue the renminbi, while at the same time imposing ever tighter controls on banks and lending. The overnight mushrooming of ever more Chinese factories competing, mostly unregulated, in the same export market meant profit margins were paper thin and reliant on steady volume. But as the cost of raw materials rose precipitously, very soon small revaluations to the renminbi were wiping those margins out. Chinese exporters were forced to begin raising output prices.
At the same time, the great migration of peasant workers to the cities eventually began to slow. As the economy had been growing consistently at rates above 10%, wages also began to rise. Economists always knew that the entry of China and other emerging economies would ultimately result in an equilibrium of world wages, but the sheer size of population meant that this day would be a long time coming.
What they didn’t count on was Chinese trade unions.
There is a certain irony in the fact that China had transformed in the space of a few years from a communist system, where the state supported everyone equally, to a pure form of capitalism – Dickensian in nature – which saw workers exploited as much as possible by Chinese companies. No longer was the state in charge of workers’ welfare – it was up to company management. And in a game of survival of the fittest, and paper-thin margins, there was nothing to prevent companies trying to wring as much as possible out of their workers – the lowest possible pay, the longest hours, the most dangerous conditions.
Much to the chagrin of the Western capitalist world, which had been down this path so many times in the past, trade unions began to grow and exert their authority in China. But unlike Western democracies, in which conservative governments had tended to hold sway for longer periods than socialist governments, China’s trade unions received the immediate support of government. And why not? The government is still the Communist Party, and the socialism of trade unions is about as close to communism as you can get in a capitalist society.
One might say a turning point came in the history of Chinese industrialisation when in 2006, US retailing giant Wal-Mart was forced to accept the unionisation of the workers in its Chinese-based factories. Wal-Mart did not go down without a fight, no doubt seeing some future writing on the wall.
That writing realistically came on January 1st, 2008, when the Chinese government introduced a new labour law.
The new law introduces overtime bonuses, contributions to pension funds, and severance pay on termination – all conditions Western workers have expected as mandatory for decades. For Chinese workers, these are a revelation. But for Chinese employers, the impact is significant. The Chinese manufacturing industry has long been taking 80-hour weeks for granted. Suddenly the great Chinese labour pool is no longer an endless source of cost reduction.
Economists at Credit Suisse believe this development, now four months old, has not been sufficiently recognised by the economic community. Strictly the law has not yet come into practice, as the finer details are still being ironed out with input from both sides, although compliance has been required since January. The All-China Federation of Trade Unions (ACFTU) encouraged submissions, and 190,00 responses came in from workers, employers, students, academics, judges, lawyers, and the Ministry of Trade. The most remarkable thing is the government is listening.
This is China!
The government, while astonishingly receptive, is now under pressure from ACFTU to get the law ratified. It is pushing for June. The world’s factory is about to be hit with a shock.
Credit Suisse estimates the new law adds about 15-20% in additional operational cost to China’s labour-intensive manufacturing sector. While overtime and super payments are one thing, the severance cost issue is greater than it first may appear, as Chinese factories have been able to exploit a lack of laws to hire workers only when new orders come in and fire them again as those orders are filled. And if workers are hired for more than a “casual” period, the law now requires permanent employment.
The Chinese worker suddenly has a voice. Credit Suisse expects him/her to use it, and expects a sudden growth in labour disputes and lawsuits. The government is on the side of the worker.
The labour law is the latest in a number of measures that have impacted on China’s export industry recently. Mindful of the need to gradually slow the economy from runaway train to simple strength, lest a bubble form and a bust set China back a decade, the government has slowly been introducing restrictive measures. Apart from allowing the renminbi to appreciate, it has gradually lowered VAT rebates for exporters, and increased the corporate tax on foreign direct investors from 15% to 25%. And to top it off, environmental protection measures are beginning to be introduced.
The Federation of Hong Kong Industries conducted a survey and found that Hong Kong-based owners of factories in China’s manufacturing hub of Guangdong ranked the new labour law as their top concern. Half reported that the law would raise costs by at least 20% and around 30% reported having already had disputes with workers. The survey also found that 10-20% of Hong Kong-owned businesses in Guangdong had already been forced to close down and another 10-20% would be gone in one to two years.
“We think the end of an era in terms of China’s mighty export industry has just began,” say the Credit Suisse economists.
The team has been visiting Guangdong province regularly, and has found that its initial assessment of the new law’s impact – already pessimistic – was understated. The economists predict that one third of export-oriented manufacturers in the province will be closed within three years. Guangdong produces 30% of China’s exports.
What does this mean for the global economy?
The Chinese export economy had already peaked. Replacing its impact has been the growth of the domestic economy, fuelled by higher wages and growing domestic consumption, and supported by a government flush with foreign reserves keen to bring Chinese infrastructure up to, or beyond, the standards of that enjoyed by the West. While rising wages and improved labour rights are generally bad for capitalists, as Credit Suisse notes, they are good for workers and domestic consumption. Hence the economists foresee a greater shift towards the growth of China’s domestic economy, which would lower the pace of overall growth but improve the “quality” of that growth.
Exactly what the Chinese government is trying to achieve.
Evidence suggests the pace of Chinese export growth, particularly to the US, has slowed considerably. This is good news at present as it forms part of the argument as to why the Chinese economy will not suffer meaningfully from a slowdown in the US economy. Thus economies dependent on China, such as Australia’s, can also sleep at night. But the bad news is that the price of those exports is on the rise, and will likely rise further as the new labour laws impact. This means the deflationary effect China has been exporting as a dampener to the inflationary effect its increased demand has had on commodity prices is nearing its end.
The bad news is that as China’s domestic economy matures, there is no end in sight for excessive commodity demand. It is hoped by all and sundry, including the Reserve Bank of Australia, that a slowing US economy will serve to reduce the global demand for raw materials such as oil and copper. However, it’s currently a case of all evidence to the contrary. Oil is at its historical highs, and copper is threatening to break out once more. And then there’s food. Irrespective of the biofuel effect on food supply, it is the demand from emerging nations for more meat, more Western-style foods and beverages, and simply “more” as Oliver Twist might put it, that ensures food prices will struggle to ever go down again. There’ll be volatile price movements and seasonal factors, but this is truly a secular shift.
And will we see the demand for oil and copper fall? Well apart from demanding Big Macs, China et al are demanding motor cars, and houses with electricity and telephones – in most cases for the first time. Then there’s fridges, TVs, stereos – the list goes on. Just as the consumption of the world’s resources will go on. Even the rural areas of China have seen a surge in wealth – another factor contributing to the rise in wages in the industrial provinces. The rise in global food prices has meant the Chinese farmer is no longer merely subsisting.
Credit Suisse’s projections suggest China will leapfrog the US as the world’s largest consumer market by 2020.
This suggests an interesting scenario. The global economy is shifting into a new phase of equilibrium, one where China, India, Brazil, Russia and others begin to even out in terms of wealth and lifestyle with the US, Europe, Japan and the rest of the developed world. The shift has not been without its disequilibrium, which is one reason why China’s economy is growing at a ridiculous 12% and the US economy is probably in recession. A move to equilibrium usually requires a few overshoots on the way. But if the US recession (which can be put down to the subprime debacle specifically but which has its roots in the simple profligacy of the US and other developed nations at the expense of the rest of the world) results in high levels of US unemployment, might manufacturing bases actually begin to return to whence they came?
This will not happen overnight. For there’s yet another step in the global crawl towards economic equilibrium. Already China has begun to wear the boot on the other foot, outsourcing elements of its manufacturing process to slower-developing nations such as Vietnam. And it has moved to secure its raw material base by investing directly in the underdeveloped wilds of Africa and South America – areas Western colonists have exploited for centuries.
If China’s export industry is crumbling, it is not doing so at stark risk to its own economic miracle. However, the rest of the world may need to reflect on the inflationary implications.