Rising Wages in China: Causes and Consequences

Wages are rising fast in China – many economists believe that China has hit a stage in its development at which demand for labour starts to grow faster than supply, creating labour shortages and pushing up the price of labour (something economists refer to as a Lewis Turning Point).

Why is this and what are some of the key business implications?

Why are wages rising so quickly?

The fundamental reason for the acceleration in wages is that China is ceasing to be a labour surplus country. Keep in mind, however that wages in China remain low compared to richer advanced countries and many other emerging nations. Here are some of the key reasons:

Demographics: an ageing population and a shrinking labour force

The median age in China’s 35.2 years and it is rising

The demographics for China are incredibly important for her future growth prospects. To some commentators, China is getting older before she has got rich. Life expectancy has soared, while fertility has plummeted due to strict birth control policies.

In 2009 there were 167 million over-60s in China, about an eighth of the population. By 2050 there will be 480 million, while the number of young people will have fallen. In 2000 there were six workers for every over-60. By 2030, there will be barely two.

Under the "one child policy" the fertility rate dropped to between 1.5 and 1.8, well below the 2.1 figure required to keep the population stable. This policy has now been relaxed.

The old age dependency ratio will double in the next two decades, and the size of China’s labour force is projected to start shrinking as soon as 2015

Social pressures:

Wages are rising because of growing concerns among the Chinese authorities about the consequences for income inequality of rapid growth. Tens of millions of workers have migrated to the Chinese cities where average wages are higher but creating a deeper imbalance in rural areas which already suffer low incomes and low quality public services.

In early 2012, the Shanghai authorities announced the minimum wage will rise 13 percent prompted by labour shortages and worker unrest.

The government’s most recent five year plan states that firms must increase wages by at least 13% every year but in certain areas the local authorities mandate much higher rises.

Multinationals under the microscope

There has been increasing international pressure on foreign multinationals operating in China to lift wages for their workers. Many media reports have highlighted factories with miserably low wages and appalling working conditions. Organisations such as the Fair Labour Organisation have been active in raising concerns about low wages and possible exploitation by monopsony employers.

Foxconn Technology Group is a Taiwan-based company that has figured often in the headlines in recent years. It is China’s largest private-sector employer and was heavily criticised after fourteen worker suicides at one of its mainland Chinese plants over a 10-month period in 2010, prompting local protests.

Some consequences of China's rising wages

Costs and profits: Short-term squeeze on profits for manufacturers such as FoxConn, Nike and other manufacturers reliant on labour-intensive production.

FDI shift and onshoring: There might be a shift of foreign direct investment away from China to lower-cost countries such as Vietnam and Bangladesh or back to developed economies (onshoring) such as the US which is benefitting from much lower energy costs.

However, many experts argue that the relocation of manufacturing and FDI will be small because of factors unique to China – for example, high manufacturing reliability, close access to growing Chinese domestic markets, excellent supply chains built up over twenty years, the existence of external economies of scale in China and commitments to raising labour productivity and product quality – which makes the wage rate less important. Relocation of manufacturing is more likely to happen within China away from the eastern coastal provinces to lower cost interior regions (supported by increasingly excellent transport and communication links).

Income and consumption: China is currently a middle-income country but it is well positioned to join the ranks of the world’s high-income countries if growth can be sustained. Rising wages will help to boost demand for consumer durables, leisure activities and housing - providing a key new source of demand as China looks to wean itself off heavy investment and export-led growth. Rising wages are helping grow China's middle class and can be seen as part of the process of economic rebalancing away from investment and towards consumption.

Trade balances: Higher wages and incomes may lead to a rise in demand for imports into China – an opportunity for advanced countries – and might stimulate foreign direct investment for consumer-facing businesses such as retailers and financial services companies

Productivity and innovation: A decade or more of high wage growth will fast-forward the drive by Chinese producers to raise total factor productivity by investing in human capital and technology to lift output per worker. Annual labour productivity growth in China from 2010-2015 is forecast to be 8,3% which means that 10% annual growth in real wages will have little effect on unit labour costs.