Bill Emmott - International Author & Adviser

Article

China´s ever-changing economy
La Stampa - May 14th 2011

No sooner do you think you have puzzled out how the Chinese economy works, than it changes, dramatically. That is what happens when an economy grows its GDP by 10% a year, and therefore doubles in size every seven years, with huge accompanying social changes. It has to keep on evolving, adapting, transforming itself. Now the change is that China is ceasing to be the world’s low-cost manufacturing centre. And as it does so, it will increasingly look like Japan—but the Japan of the 1970s, not now.

            The announcement on May 12th by Coach, the huge American leather goods and accessories brand, that it plans to move half of its manufacturing out of China because of rising labour costs is the latest signal of this change. Wage levels in China are increasing by about 20% a year, outpacing productivity growth, thanks to new labour laws that have boosted workers’ rights, as well as growing competition for skilled and semi-skilled labour.

            A recent study produced by the Boston Consulting Group explored the implications of this wage inflation for China, the US and Europe. The BCG analysts concluded that, combined with the gradual depreciation of the US dollar against the Chinese currency, the yuan, Chinese wages would rise during the next five years from being just 9% of American wages now to 17% of US wages by 2015. In 2000, Chinese wages were only 3% of US rates.

            This still sounds like a big gap, and it is. But labour is not the only cost that matters for multinationals such as Coach. Transport costs and time matter too, and the rise in energy prices mean that shipping and air freight costs have been climbing as well.

            Moreover, China is not the only country that changes, or that improves its workers’ productivity: US productivity is currently rising rapidly too. For that reason, the BCG report listed other multinationals that have already shifted production out of China, some to lower-cost Asian countries and others back to America itself: Caterpillar, Ford, Flextronics and even a toy manufacturer, Wham-O. America’s manufacturing sector is, on this analysis, set for a strong revival over the next five-ten years.

            That is not, however, happening in much of Europe, and certainly not in Italy, according to the BCG analysis. Our productivity growth is lagging far behind the US, thanks to inflexible labour markets and too little free competition; the gap between Italy’s wages in manufacturing and those in America is the widest compared with France, Germany and the UK.

            What does this mean for China? It does not mean that China is going to cease to be a manufacturing giant. In fact it may well still be the world’s biggest manufacturer. But it will be manufacturing much more for its booming domestic markets and less for exports; and, second, its own exporters will have to move upmarket, to manufacture more high-value, high-tech products in which labour costs are less significant.

            This is where the analogy with Japan in the 1970s is helpful. During the 1950s and 1960s, Japan’s economy grew by double-digit annual rates like those of China in recent years, based on low labour costs, heavy industry, huge investments in urbanisation, a cheap currency fixed at a low value against the dollar, and having no laws against pollution. Then that all changed: Japan was forced to revalue its currency; wage rates started to rise, dramatically; the oil-price shock of 1973 sent inflation and especially energy costs soaring; and popular protests forced the government to introduce strict environmental laws and to enforce them, strictly.

            For a while, it looked like a disaster for Japan, the end of the Japanese miracle. But in fact it was just the beginning of a new phase in that miracle. The combination of private-sector initiative and some state intervention transformed Japan from being the dirtiest, most energy-guzzling developed country in 1970 to the cleanest, most efficient such country by 1980. And Japanese industry ceased to compete on the basis of steel, chemicals, toys and low-quality cars and radios: it moved upmarket, eventually to dominate the new sectors of consumer electronics, semiconductors and compact cars, especially during the 1980s.

            A similar outcome can be imagined for China, over the next decade. It is no longer going to be a cheap production base for multinationals’ exports. Its currency is being revalued, gradually, and probably will soon revalue quite rapidly, in order to keep control of inflation. For political reasons, the Chinese authorities feel the need to allow wages to rise, to stop workers from demonstrating against the government—and to discourage them from emulating the Arab revolutions. Similarly, the pressure to enforce the country’s environmental laws more strictly is growing every month and every year.

            In an authoritarian, nominally communist country such as China, there is a danger that this transformation may not happen as smoothly as it did in democratic Japan. There is a risk of political instability. However, the Communist Party has studied the lessons from Japan and understands the need for the country to be transformed in this way. It is working out how to organise the change without allowing a challenge to develop its own power. So far, it has always succeeded in managing such changes. So far.


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