For a few weeks starting in May, Tan Zhiqing, a 24-year-old migrant worker from Hunan province in central China, did something that not so long ago would have been unimaginable — he joined his colleagues in a protest at the gates of his employer. Having worked at Honda’s auto-parts factory in Foshan, Guangdong province for more than nearly three years for less than RMB 1,200 (US$175) every month, Tan had had enough and became one of the major organizers of the strike involving hundreds of his fellow workers to demand pay raises. Similar strikes took place at Honda’s other plants in China, paralyzing assembly lines up and down the country. After several rounds of negotiation with its employees, the Japanese auto maker agreed on June 4 to increase monthly salaries by about 35%, to RMB 1,620 (US$235).


The strikes followed the shocking news earlier this year of the suicides of 12 workers, all in their 20s, at the Shenzhen complex of Taiwan-based Foxconn Technology. In response, the company — one of the world’s biggest OEM companies, manufacturing, among other well-known products, Apple iPhones — announced on June 6 that it would raise monthly salaries at its Shenzhen factories from RMB 900 to RMB 2,000.


These incidents, combined with the government’s drive to reduce the country’s dependence on exports, are drawing attention to China’s role as the world’s low-cost factory. One consequence of the heightened attention, say many economists and scholars, is that more blue-collar wages in the country will rise. But while local and foreign companies in the country may face smaller profit margins in the short term as a result of those increases, some of the losses might be offset if Chinese workers with bigger pay packets go shopping more. But does that mean China’s competitiveness as a low-cost production base is under threat and how much can the pay raises help the country address its demographic time bomb?


While those answers are open to debate, it is widely agreed that rising wages are a natural progression for China’s economy. “With the current pressure on labor costs, some prices will have to rise and the costs passed on to customers in low-margin industries, like clothing and inexpensive household appliances, where profit margins are very thin,” says Marshall Meyer, a management professor at Wharton. “China will be less competitive in those sectors, but higher wages will help China become a more ‘normal’ economy.”


Much Ado About Labor Costs?


Shane Oliver, head of investment strategy and chief economist at Australia-based AMP Capital, commented in his weekly market update on June 11 that concerns about a wage boom in China are misplaced. “First, the wage increases so far mostly relate to minimum wages, which have been boosted by around 20% in some cities,” he wrote. “However, average wage increases are more likely to be around 15% this year. Second, the recent resurgence in wages reflects a catch up, as minimum wages were frozen last year in many cities.”


Oliver also wrote that the 15% wage growth is not that high when the economy’s breakneck growth is taken into consideration. The economy expanded 12% over the year to the first quarter of 2010 so that rising wages are largely being paid for by productivity growth. What’s more, double-digit wage growth had been the norm in China up until 2008. Finally, according to Oliver, Chinese wages remain relatively very low: The hourly minimum wage is about one-eighth of the U.S.’s.


One important factor working in China’s favor is the enormous scale of its economy. It enables some industries to be geographically concentrated, making vertical integration easier, says Charles Freeman, director of the Center for Strategic and International Studies (CSIS), a Washington, D.C.-based public policy research institute. In textiles, for example, Chinese factories can take care of all the various processes — design, stitching, assembly and packaging — in one city, which greatly decreases costs and increases efficiency. “The tremendous productivity gains outstrip the current wage increases in China, and the sizable margin allows China to increase wages in its export sector without crushing the competitiveness of exports,” says Freeman. “Moreover, if the wage increase in the eastern coastal areas of China is too rapid, Chinese exporters can move some manufacturing to inland China, where the labor cost is lower,” says Freeman.


Distributing Wealth


The proportion of China’s GDP that goes toward labor income has dropped for 22 consecutive years from 56% in 1983 to 37% in 2005, according to recent research by the All China Federation of Trade Unions (ACFTU). Zhang Jianguo, an official at the ACFTU, told journalists in May that raising workers’ wages so that they make up a larger proportion of national income than they currently do is imperative for the sustainability of the country’s growth. The research found that 23% of blue collar workers have not had a salary increase in the past five years.


Rising labor costs and an appreciating currency — the government announced in mid-June that it will gradually let the renminbi float against other currencies rather than maintaining the current peg against the U.S. dollar — have similar effects on trade: They raise the price of some exports. But they have different effects on wealth distribution, says Meyer. The average worker would benefit more from rising wages, which would boost consumption, playing well into the aims of a number of China’s policy makers concerned about the increasingly uneven distribution of wealth in their country.


“Everyone in the world expects China’s economy to move from a reliance on exports to domestic consumption,” says Meyer. A multinational such as Wal-Mart “will either charge more [for the goods that it buys from China and sells around the world] or source elsewhere.” Other countries that multinational retailers and manufacturers can turn to include Vietnam and Indonesia — “but the former has poor infrastructure and the latter has political uncertainties.” Undoubtedly, companies inside and outside China will need to be weighing these tradeoffs more carefully in the near term.


Meanwhile, a perfect storm of demographic trends in China is also increasing the upward pressure on wages. The shrinking labor force is perhaps the most meaningful. “By 2015, the total labor force will shrink — it is already aging rapidly,” says Meyer. “Young workers are already in short supply. The factories in southern China, which usually only hire younger workers, are now taking on older ones.”


In addition to the population changes resulting from the one-child policy of the past three decades, a new generation of migrant workers who, unlike their parents, are much less willing to work for extremely low wages in grim conditions. Andy Xie, director of London-based Rosetta Stone Advisors, wrote in a recent column in New Century magazine that the younger generation of workers has been raised in a fast-growing economy with life in rural areas improving dramatically compared with what their parents experienced. Today’s rural youth wish to live in big cities, but increasing property prices in urban areas in recent years have outstripped their incomes.


At the same time, the once-endless supply of labor, thanks to unemployed farm workers, who moved to the coasts and work in factories and on construction sites, is drying up. Many rural workers, while willing to work in factories close to home, are refusing to move to the coasts, where it’s more expensive, jobs are often temporary and families are far away. The number of workers hired last year in eastern China fell by 8.8 million, while the number rose in central China by 6.2 million and in western China by 7.8 million. Meanwhile the pay gap between eastern and inland China is now just 5%, according to official data.


China’s booming economy makes the labor issue all the more pressing. A report by the China Labor Market Information Monitoring Center found that job openings in manufacturing in 21 major cities in the first quarter of this year soared 90% year on year, while job seekers increased 22%. In China’s 100 largest cities, there are currently 5.5 million job openings, while the number of job seekers is 5.3 million, and the gap between the two is growing, especially in the Pearl River Delta region in the south.


A Tough Transition


By shifting large number of farmers into non-agricultural jobs every year, China was once able to achieve extraordinary productivity growth, while keeping inflation under control, write Huang Yi Ping, a professor at Peking University, and Jiang Ting Song, a professor at the Center for International Economics in Australia, in a recent paper. But now, they say, it is heading toward what’s known as a “Lewis turning point” — a concept named after W. Arthur Lewis, the Nobel Prize-winning economist in the 1970s, who studied the development process of countries from subsistence to modern economies. Lewis found that as economies develop and move workers from rural to urban jobs, the supply of surplus labor is reduced, driving up wages, consumption and inflation.


In their paper titled, “What Does the Lewis Turning Point Mean for China?” the two professors assert that after 30 years of economic reform, China is now at such a critical juncture. Against this backdrop, they write, the government must carry out policies that maintain economic stability and develop a stronger culture of innovation throughout the country.


It will be a tough transition, says Meyer of Wharton, because of the shift from rapid economic growth underpinned by low-cost manufacturing for exports and low domestic consumption to more moderate growth based on higher domestic consumption.


To manage the change, he says the labor force needs to be provided with more training in service sectors and high-end manufacturing. That might be easier said than done. A country must give up some current growth if it invests in raising the quality of its labor force today to reap the rewards tomorrow. As Meyer notes, the problem is that no one wants to give up current GDP growth.


Amid worries about the strength of the dollar and the euro, he adds, “the fundamental issue is, who controls China’s economy? China can’t allow its economy depend so much on other countries… Right now, China’s economy is very vulnerable to the U.S. and Europe, and to change that requires tough measures.”