Why a pay raise for workers signals key shift for China's economy

Workers at Foxconn and Honda won hefty pay raises this week. Higher wages will help Beijing move China's economy away from relying on masses of unskilled workers and toward higher-value manufacturing.

When two giant employers in southern China offered their workers big wage increases this week, their goal was to dampen labor unrest. But the hikes do more than soothe factory floor anger; they signal huge changes in the way “the workshop of the world” is feeding global consumers.

Rising salaries, say economists and labor experts here, are sounding the death knell for the production system that has fueled much of China’s phenomenal economic growth for the past three decades. Instead of relying on huge numbers of workers making miserable wages at unskilled jobs, and churning out cheap exports, the government is keen on moving up the value chain.

At the same time, rising incomes are laying the foundation for another seismic shift in China’s development model, as the government seeks to base economic growth more on domestic consumption and less on exports.

Foxconn, which makes the iPhone and other famous electronic items, announced an immediate 30 percent pay hike on Wednesday, more than originally planned, in a bid to raise morale and efficiency after a spate of employee suicides. Honda offered a 24 percent pay raise to striking workers at a parts factory on Monday, tempting them back to work.

The moves followed a decree from the regional government of Guangdong, the hub of China’s manufacturing industry, that boosted the minimum wage by 20 percent a month ago.

Workers gain bargaining power

The pay raises reflect a shortage of workers that employers on China’s east coast have been complaining about for several months. In February, the state-owned news agency Xinhua reported a shortfall of two million workers in the Pearl River Delta area.

Fewer migrants are seeking jobs on the coast partly because China’s population is rising more slowly than before, partly because more factories are opening in the interior and offering people work closer to home, and partly because “the new generation of workers is less prepared to put up with a low-paid job and a boring life,” says Lai Desheng, a professor of labor economics at Beijing Normal University.

At the same time, adds Jim Leininger, who works for Towers Watson, a human-resources consulting company, “the trend towards higher quality and production efficiency requires more experienced and skilled workers … who can command higher wages.”

Factory shakeout

Rising wages pose a serious threat to small, low-end manufacturers making shoes, clothes, or toys, whose profit margins can be as slim as 2 percent. Such companies, often owned by Taiwanese or Hong Kong investors, are already beginning to move their factories to lower-cost countries such as Vietnam, Cambodia, and Indonesia. Others are moving inland, taking advantage of lower wages and taxes there.

More sophisticated manufacturers, however, are likely to stay put in southern China. Some, like Honda, are producing mainly for the Chinese market, so moving abroad would make no sense. Others, like Foxconn, rely on a close network of local suppliers who can react quickly to design changes – a network that cannot be moved elsewhere wholesale.

Wage costs are a relatively minor factor for such companies – witness Foxconn’s readiness to raise salaries by 30 percent overnight – and “despite wage pressure, companies think holistically about the system and the business environment generally” when they are deciding whether to relocate, says Mr. Leininger.

“Low-end, labor-intensive stuff will move, but the more interesting things that the government talks about wanting will stay in China,” predicts Arthur Kroeber, head of the Dragonomics economic consulting firm.

Companies making those things, however, will not be able to operate in traditional ways, Mr. Kroeber warns. “This is a zero-sum game between wages and profits,” he points out. “If wages rise faster, profits will rise more slowly or fall.”

That, he says, means that Chinese factories will be forced to follow the path that American and Japanese factories have taken before them: increased automation.

“The writing is on the wall for the model of using vast armies of workers paid $100 to $200 a month,” Kroeber says. “We are at the beginning of a very, very different stage of the growth process.”

That is what the Chinese government hopes, as Beijing seeks to move the nation’s industry away from sweatshops and up the value chain.

“Higher wages are good for China’s economic structural changes,” says Professor Lai. “If wages rise, it will discourage foreign and domestic companies from investing in low-value production and separate them out from the ones interested in higher value-added production.”

Turning to Chinese shoppers

Although average Chinese salaries have risen by about 8 percent a year over the past decade – a little short of GDP growth rates – industrial manufacturing wages have risen considerably more slowly.

In his annual work report to the National People’s Congress last March, Prime Minister Wen Jiabao pledged to rectify this, promising that poorer people would be given a greater share of the country’s rising prosperity.

“We will energetically expand consumer demand,” he pledged, while continuing “to increase … people purchasing power, especially low- and middle-income earners.”

This is essential if Chinese consumers are to buy the things that the government hopes they will buy, to keep the Chinese economy humming.

“For 30 years, we have relied on investment and exports as engines of the economy,” says Lai. “Investments have caused pollution and other social problems, and exports depend too much on the international economy.

“Now we need to increase salaries to increase consumption, which would boost the economy and thus create more jobs,” he argues. “It’s a virtuous circle.”

It would not necessarily be so virtuous for consumers worldwide, however; rising wages will mean rising prices for the goods produced if manufacturers pass on their higher costs to customers.

“The rest of the world may pay more, but they will be paying more for a better product,” says Leininger. “As China works its way up the value chain, lots of my clients are making things better than they did three or four years ago.”

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