In the run up to the 2008 global financial crisis, China’s manufacturing
sector was epitomised by a predominant focus on exports resulting in a
constantly rising trade surplus and a hefty accumulation of FX reserves.
In the aftermath of the crisis however, the situation has dramatically
changed, partly due to a lack of external demand but also amid rising
concerns that China appears to be losing its global competitive edge.
The main draw card for Chinese manufacturers to focus on these so-called “low-end”, labour-intensive production lines was the abundance of a readily available, “cheap” workforce and, as some would argue, a competitive advantage from an artificially suppressed currency.
A recent “Blue Book” report from China’s Academy of Social Science (CASS) acknowledged that since late 2008 China’s exports to the U.S. have been in decline (China was knocked off its perch as the lead exporter) and eventually China saw its first trade deficit in six years in March 2010. But what were the reasons behind this decline?
In its Blue Book report, CASS suggested the major factors were government policy directives, which increased the cost of manufacturing in China, and escalating raw material/energy costs. This forced a number of manufacturers out of business and hence exports suffered. Indeed, if we take a quick, broad look at some of the inputs for end-product pricing - cost of raw materials is one but wage costs, shipment costs and currency pricing can also all be influencing factors, though some of these are not particularly unique to China. Specifically, raw materials and shipment costs are the same for all exporters, regardless of location, so does it boil down to wages and currencies being the major influences for end-product pricing? The USA certainly has a view on this especially if you have been listening to the constant commentary about China’s undervalued currency for the past few years.
Overall Chinese exports to the US averaged $30.41 bn in 2010 and $31.15 bn in the first 7 months of 2011 (Source US Census Bureau) yet the CNY has risen 5.7 percent versus USD in the same period – hardly a compelling argument that the exchange rate is a dominant factor affecting exports. However, when the trade surplus is compared as a share of GDP it has actually been falling since 2007 (some two years after the first “de-pegging” of the USDCNY rate).
Yet, if we were to break down the exports in the so-called “light manufacturing” sector, one that is perhaps more susceptible to labour issues, then China’s market share of US imports has been in steady decline (as mentioned above) with a noticeably faster decline since late 2010.
A report from the Boston Consulting Group in May this year suggested that the wage gap between the U.S. and China is currently shrinking rapidly and is expected to converge within the next five years. Chinese wages are currently rising between 15-20 percent per year and any other workplace with more flexible practices could eat further into China’s competitiveness. But is the U.S. the only “threat” to China’s competitiveness? In the above-mentioned “low-end” manufacturing categories, it would appear that China’s lower-income neighbours such as Vietnam, Bangladesh and to a lesser extent Indonesia are slowly eating into China’s export pie (with regard to the U.S. and European export destinations) while Mexico is also seeing greater gains in certain “higher-value” categories such as furniture and precision instruments. So it would appear that wage costs are playing a significant role in affecting China’s competitiveness and, with inflation currently running above 6 percent annually, the pressures are unlikely to disappear soon.
When it comes to the Chinese economy, exports have accounted for as much as 42 percent of China’s GDP in 2008 (subsequently easing to 37 percent in 2010) (source US BEA) and loss of competitiveness may have serious growth implications. Is it possible that the Chinese recognised this and that is why they have switched to lower, more sustainable growth targets in the country’s latest five-year plan?
The 12th Five-Year-Plan has shifted focus from “quality growth” to “inclusive growth”. Outright promotion of exports has been dropped as a byline (in response to declining competitiveness?) and replaced by enhancing households’/citizens’ abilities to consume, redistributing wealth and aiming for slower but higher quality growth. Investment in industry is now targeted towards the energy generation and alternatives (sustainable power bases rather than pure manufacturing) and is perhaps testimony to Chinese authorities acknowledging falling external competitiveness and recognising the need for more internal-focused policies.
In summary, China is facing an erosion of its global competitiveness with wage pressures linked to high-flying inflation being the dominant factors. The Chinese currency, and its gradual revaluation, is also playing its part and China’s loss of competitiveness may be seen as a helpful factor in the global rebalancing process. But Chinese authorities do not see any need to panic. If (and some may argue it is a big “if”) they can succeed in pulling off the latest Five-Year-Plan then this development, and its impact on the trade balance, will not be a major issue.
The main draw card for Chinese manufacturers to focus on these so-called “low-end”, labour-intensive production lines was the abundance of a readily available, “cheap” workforce and, as some would argue, a competitive advantage from an artificially suppressed currency.
A recent “Blue Book” report from China’s Academy of Social Science (CASS) acknowledged that since late 2008 China’s exports to the U.S. have been in decline (China was knocked off its perch as the lead exporter) and eventually China saw its first trade deficit in six years in March 2010. But what were the reasons behind this decline?
In its Blue Book report, CASS suggested the major factors were government policy directives, which increased the cost of manufacturing in China, and escalating raw material/energy costs. This forced a number of manufacturers out of business and hence exports suffered. Indeed, if we take a quick, broad look at some of the inputs for end-product pricing - cost of raw materials is one but wage costs, shipment costs and currency pricing can also all be influencing factors, though some of these are not particularly unique to China. Specifically, raw materials and shipment costs are the same for all exporters, regardless of location, so does it boil down to wages and currencies being the major influences for end-product pricing? The USA certainly has a view on this especially if you have been listening to the constant commentary about China’s undervalued currency for the past few years.
Overall Chinese exports to the US averaged $30.41 bn in 2010 and $31.15 bn in the first 7 months of 2011 (Source US Census Bureau) yet the CNY has risen 5.7 percent versus USD in the same period – hardly a compelling argument that the exchange rate is a dominant factor affecting exports. However, when the trade surplus is compared as a share of GDP it has actually been falling since 2007 (some two years after the first “de-pegging” of the USDCNY rate).
Yet, if we were to break down the exports in the so-called “light manufacturing” sector, one that is perhaps more susceptible to labour issues, then China’s market share of US imports has been in steady decline (as mentioned above) with a noticeably faster decline since late 2010.
A report from the Boston Consulting Group in May this year suggested that the wage gap between the U.S. and China is currently shrinking rapidly and is expected to converge within the next five years. Chinese wages are currently rising between 15-20 percent per year and any other workplace with more flexible practices could eat further into China’s competitiveness. But is the U.S. the only “threat” to China’s competitiveness? In the above-mentioned “low-end” manufacturing categories, it would appear that China’s lower-income neighbours such as Vietnam, Bangladesh and to a lesser extent Indonesia are slowly eating into China’s export pie (with regard to the U.S. and European export destinations) while Mexico is also seeing greater gains in certain “higher-value” categories such as furniture and precision instruments. So it would appear that wage costs are playing a significant role in affecting China’s competitiveness and, with inflation currently running above 6 percent annually, the pressures are unlikely to disappear soon.
When it comes to the Chinese economy, exports have accounted for as much as 42 percent of China’s GDP in 2008 (subsequently easing to 37 percent in 2010) (source US BEA) and loss of competitiveness may have serious growth implications. Is it possible that the Chinese recognised this and that is why they have switched to lower, more sustainable growth targets in the country’s latest five-year plan?
The 12th Five-Year-Plan has shifted focus from “quality growth” to “inclusive growth”. Outright promotion of exports has been dropped as a byline (in response to declining competitiveness?) and replaced by enhancing households’/citizens’ abilities to consume, redistributing wealth and aiming for slower but higher quality growth. Investment in industry is now targeted towards the energy generation and alternatives (sustainable power bases rather than pure manufacturing) and is perhaps testimony to Chinese authorities acknowledging falling external competitiveness and recognising the need for more internal-focused policies.
In summary, China is facing an erosion of its global competitiveness with wage pressures linked to high-flying inflation being the dominant factors. The Chinese currency, and its gradual revaluation, is also playing its part and China’s loss of competitiveness may be seen as a helpful factor in the global rebalancing process. But Chinese authorities do not see any need to panic. If (and some may argue it is a big “if”) they can succeed in pulling off the latest Five-Year-Plan then this development, and its impact on the trade balance, will not be a major issue.
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