China has reached its ‘Lewis turning point’. This is a critical milestone for a developing economy, when urban factories, restaurants and other businesses have to start raising wages faster than the inflation rate to attract rural workers. Until that point, factory wages can remain flat and still attract farm workers living on subsistence incomes at home. It will take years for China to reach the end of the turning point, when urban and rural wages are equal. In the meantime, real wage hikes for unskilled workers are here to stay.
We saw further evidence of this in our recent survey of manufacturing clients in the Pearl River Delta region, the industrial powerhouse in southern China bordering Hong Kong. The annual survey, conducted after the Lunar New Year holidays, showed that manufacturing wage growth across the region is likely to accelerate to an average 9.2 percent rate this year, from 7.6 percent last year.
Salary increases are outpacing consumer price inflation, which we estimate will accelerate to 4 percent this year from 2.6 percent last year. This extends a long-running trend of rising real wages, and provides further confirmation that China has arrived at the Lewis turning point, named after Nobel prize-winning economist Arthur Lewis.
The implications of rising wages are huge. Higher incomes help China move closer towards its goal of becoming a domestic consumption-driven economy and away from its current investment-dependent structure. At the same time, they leave companies across the Pearl River Delta facing three choices: move their factories inland, where labour costs are cheaper; shift plants overseas; or step up automation to save on labour costs. The majority of the companies in our survey say they plan to go for the third option, at least for now, although an increasing number are looking at the other two.
Although the rise in remuneration may be partly driven by minimum wage increases and stricter enforcement of social insurance contributions, the majority of our clients believe that growing labour shortages are the main cause. Fortunately, most companies also say that output per worker has risen faster than wages, a sign that wage growth is backed up by productivity.
Wage pressures have clearly increased over the past 12 months. Relative to last year’s survey, more companies expect salary increases of more than 10 percent this year, while fewer companies expect no hikes. Almost one-third of the companies surveyed said labour shortages have gotten worse since 2011.
Our survey results indicate that there were no material job losses during last year’s downturn. They also show that demand from both within China and overseas is picking up again. More than half the companies in the survey said they expect their orders to increase over the next three months; a quarter were operating their plants at full capacity, while the majority were running at more than 80 percent capacity.
Last year’s slowdown triggered in part by government policy measures to cool the red-hot domestic housing market and exacerbated by Europe’s economic crisis caused China’s economic growth to slump to 7.7 percent — the slowest pace in more than a decade. We expect growth to accelerate to around 8.3 percent this year.
Wage increases are partly government-driven. China’s 12th Five Year Plan aims to raise the national minimum wage by an average of at least 13 percent each year, faster than in previous years. Localities are free to set their wages above the national level. In fact, provinces have increased minimum wages by an average of 16 percent this year, following a 20 percent increase last year. Shenzhen province in the Pearl River Delta tops the list in terms of minimum wage levels, with minimum monthly pay of CNY 1,600 ($258). This has forced more than half the companies in our survey to raise wages more than they had planned, particularly for the least skilled part of their workforce.
As salaries rise, only the fittest will survive. Naturally, larger companies are better able to compete by investing more in technology and securing larger, longer-term orders from overseas customers. Three out of five companies surveyed said they are responding with bigger investments in machinery. They are also investing in process automation tools, outsourcing or partially sub-contracting production, boosting in-house design functions, and hiring employment agencies to find new workers.
Moving production to cheaper locations is also an option, but it is a costly one and such decisions are not driven purely by labour cost considerations. Relocation means losing proximity to suppliers and customers, dealing with new tax and regulatory regimes, and bearing higher transport costs. That said, our survey suggests that companies are increasingly willing to consider moving out of the Pearl River Delta or expanding to new locations.
Around 30 percent of the companies surveyed said they plan to move factories inland, while 10 percent said they plan to move out of China altogether. Both of these figures more than doubled from last year. Within China, many companies in the Pearl River Delta want to move westward to Guangxi province, where wages are 30 percent lower. Other popular destinations include Jiangsu, Hunan, Hubei and Jiangxi provinces. The favoured overseas destinations are Cambodia, Bangladesh and Vietnam.
Labour shortages have long been a challenge in the Pearl River Delta. But we have found in past years that manufacturing wage trends in the region reflect the national situation because the labour market is highly mobile. A squeeze on the surplus labour pool in the Delta leads to rising inland wages and pushes up real wages for migrants leaving agriculture jobs.
There is also a new element fuelling the wage spiral — China’s aging workforce. The number of people aged between 15 and 59 fell by 3.45 million in 2012, the first absolute decrease in the labour force since the late 1970s. Add this ingredient to the mix, and it is easy to see why the Lewis turning point has arrived in China a few years earlier than many had anticipated.
Kelvin Lau is senior economist and Stephen Green is head of Greater China Research at Standard Chartered Bank.