The End of Cheap Chinese Labor

2013 February 24
by SJ Leeds

You’ve probably read that China is no longer the “cheapest manufacturer in town”.  While I heard this many times, I didn’t know much about it.  So, this past week, I read a really interesting paper about the subject, “The End of Cheap Chinese Labor”, by Hongbin Li, Lei Li, Binzhen Wu and Yanyan Xiong.  The paper was published in the Journal of Economic Perspectives in late 2012.


This paper is interesting because it explains how wages are increasing in China.  But, I think that there’s something even more interesting to think about…as the Chinese work force becomes more educated, will they start to compete with some of the more sophisticated manufacturing that we have in the U.S.?


Here’s a summary of the paper:


Background Numbers – Rising Wages


1. Cheap labor has played a pivotal role in the Chinese model (which has been to grow through exports).


2. In 1978, the average Chinese urban worker was making $1,004 (in 2010 dollars). Now, that same worker is making $5,487.


3. From 1978 through 1997, the average salary of the urban worker only increased .1% per year (from $1,004 to $1,026). This was much slower than real GDP growth.  (NOTE: the growth rates in this paper are low because they are measuring wages in “real U.S. dollars”.  The Chinese currency was actually overvalued in the late 1970s – so as it lost value, the result is that wages were not rising at a high rate in “real U.S. dollars”.)


4. From 1982 through 1997, labor productivity grew almost 3 times faster than real wage growth. This means that Chinese labor was becoming cheaper.


5.  From 1998 through 2010, the average annual growth rate of real wages was 13.8%.


6. Since 1997, China’s wages have increased at a much faster rate than productivity. This means unit labor costs were increasing.


7. Wages are increasing for all levels of workers. The fact that low skill workers are also seeing this increase suggests an overall rise in wages.


8. Wages are rising in both the more developed coastal regions and the less-developed inland regions. They are rising for both exporting and non–exporting firms.


9. Major exporters are labor-intensive. As a result, their costs are increasing.



Three Reasons Why Urban Wages Have Grown So Fast (in China) Since 1997


1. Compensation has become tied to productivity. This resulted from the privatization of state-owned enterprises in the mid-1990s. Workers were no longer allocated by central planners. Firms gained the right to pay higher wages to more productive employees. Private sector employment went from nearly zero in the 1980s to approximately 80%.


2. There was a growing shortage of labor. China had a baby boom from 1950 through 1978, with women averaging 5.2 births. In 1979, China started the “one child policy”. For many years, China has benefited from the “demographic dividend” – where a large percentage of the population was working and there were relatively few dependent children or elderly people. China’s population is expected to begin declining by 2015 and of the labor force may have already peaked.


3. There was slowing migration of rural workers. Prior to 1997, the growth rate of migrant workers was 10.8% per year. Since then the growth rate has been 4.6%. Those who are most willing to migrate already have done so (the low hanging fruit has been picked). The Chinese registration system means that rural citizens cannot enjoy public services in the cities (such as education, medical insurance, housing or pensions). Many migrants want to stay closer to home now. At the same time, it is difficult for firms to move inland.




The Cycle is Ending


1. In the 1980s and 1990s, Chinese workers had low unit labor costs.


2. Foreign firms earned profits by outsourcing to China.


3. This triggered fast employment growth and rural-to-urban migration.


4. There is no longer a huge amount of slack in the labor supply and the “underpricing” of Chinese labor is coming to an end.


5. Wages are rising faster than productivity, particularly in labor-intensive exporting industries.


6. If wage growth continues at this pace, the average real wage in urban China would reach $20,000 by 2020.



China Will Move Up the Technological Ladder


1. Labor productivity has been increasing at 11.3% per year for over a decade.


2. Manufacturing firms have made heavy investments in research and development (R&D per worker has increased 16.9% per year in the past 20 years).


3. Capital is deepening (total assets per worker increased to $94,000 in 2010).


4. Human capital has risen dramatically. College entry class enrollment increased from 1.1 million in 1998 to 6.6 million in 2011.


5. By 2050, 40% of China’s labor force can be expected to hold a college degree.



So Where is China Headed?


1. The end of cheap labor does not mean the end of economic growth.


2. Rising productivity and education mean that China’s comparative advantages are shifting.


3. If China can improve the quality of education and foster innovation and entrepreneurship, they can become a force in the high value added manufacturing sector.



Have a great week.

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