SCDigest: Will Rising Wages in China Significantly Change Outsourcing Economics?

May 27, 2011

Through a special arrangement, presented here for discussion is a summary of a current
article from Supply Chain Digest.

In a recent interview, William Fung, CEO of
trading giant Li & Fung, predicted
China’s wages will increase an amazing 80 percent over the next five years,
significantly changing the cost dynamics for sending production to China. It
is also among the reasons the Chinese government is making aggressive efforts
to move the country into more complex, higher value goods that have a lower
labor costs as a percent of total costs.

"What we [China] will have for the next 30 years is inflation," Mr.
Fung told The Wall Street Journal. "A lot of Western managers have never
coped with inflation."

With its huge population and millions of people
moving into eastern cities from rural areas, China for most of the last decade
had ample supplies of workers, even as production and export levels surged.
Unionization is illegal in China, other than pseudo-unions tied to the government,
and workers rights have generally been extremely limited.

But some of that is
starting to change. Mr. Fung says that worker shortages will start to be seen
as the effects of China’s "one child" policies
meant to reduce population growth are felt. Some observers say there’s already
a shortage of workers in the key 15-to-34 age demographic.

Chinese wages also
took a sharp turn upward last year. Unusual strikes and other labor actions
drove a number of companies to raise wages 20-30 percent and local provincial
governments to do the same on minimum wages.

High levels of inflation in China,
driven by economic growth and rising commodity prices, place further pressure
on the government and companies to increase wages to keep up, leading potentially
to a vicious circle other economies have faced where rising wages perpetuate
an inflationary cycle.

Finally, China’s efforts to keep the value of the Yuan
low to pump up exports in turn leads to higher prices for its imports, adding
to the pressure on inflation and wages.

The result: the wage gap between China
and other developing countries will shrink, Mr. Fung says, adding that the
damper China has put on price increases generally over the past decade is ending.

"Things will be more expensive and people will buy less," Mr.
Fung warns, saying that the West will have to adopt new consumption trends.

Discussion Questions: Are Western-based vendors and retailers underestimating the fallout from rising labor costs in China? How do you see these inflationary pressures playing out?

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6 Comments on "SCDigest: Will Rising Wages in China Significantly Change Outsourcing Economics?"

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Joan Treistman
10 years 11 months ago

I could be mistaken but the effect of almost doubling the wages of Chinese workers will have a great effect on Chinese workers. It may give thought to those in other countries who want to manufacture in China to save money that they will be saving less and perhaps not enough to make it worthwhile. But I’m inclined to believe that 80% more for the Chinese worker is still incredibly less than workers in many countries. And we haven’t heard what the Chinese government plans for that 80% increase. Does it stay in the hands of the Chinese worker? If so, does that raise the opportunity rate for US brands to be purchased there?

Gene Detroyer
10 years 11 months ago

Anyone who is dealing with China is experiencing and understanding these pressures. Rising wages is the least of the problems. The biggest issue is the rising consumer power of the Chinese. Chinese manufacturers are finding domestic sales more profitable. Additionally, selling in China is considerably less troublesome than serving the needs of American retailers and marketers.

The effect on the U.S. is going to be horrendous. The U.S. economy is based on consumer consumption. Consumer consumption is based on Chinese products. The rising costs will be directly passed on in prices.

Hopefully, the U.S. government keeps the issue of the undervalued Yuan very quiet. An increase in the value of the Yuan plus the increases in Chinese pricing would have a devastating effect on the U.S. economy.

Ted Hurlbut
Ted Hurlbut
10 years 11 months ago

It’s hard to imagine retailers and importers sitting by while costs out of China increase due to increases in Chinese wage rates. While the sheer volume of products imported from China is considerable, retailers and importers across all product categories are continually probing for lower cost sources of supply throughout the world. Increases in costs from China will only make those sources more competitive, and while China can’t be replaced, the impact of those cost increases can be moderated.

Roger Saunders
10 years 11 months ago
If vendors and retailers keep an eye on the data points about rising labor costs and inflation, as well as consumption patterns in China, they should not be surprised by these topics. One merely has to consider a few of the macro-economic patterns: 1. China is the world’s second largest economy. 2. It is the world’s largest export nation. 3. The Renminbi (yuan) has strengthened against a declining U.S. dollar. 4. Consumption, which had been 35% of China’s GDP at the outset of 2010, is likely to jump to 42% of GDP in the next five years, based on the 12th Five Year Plan released in February. 5. Credit and credit markets are opening up in China, leading to added consumption 6. China is working to contain inflation by forcing banks to increase reserve funds (about 3 times more than U.S. banks have to hold), insisting that consumers place cash into homes (no silly “no money down” as was the practice encouraged by Fannie and Freddie), and by raising interest rates, strengthening the Renminbi, and… Read more »
Kai Clarke
10 years 11 months ago
With offices in China and the USA, and as a monthly traveler in China, we have a good grasp on the impact of China’s labor concerns. These, however, are not as prominent as the impact of the rising RMB compared to the falling Dollar, or the global rise in materials cost, as well as overall inflation. However, Mr. Fung is clearly out of touch with the USA when he declares that we have never had to deal with inflation (our inflation and “stagflation” of the late ’70s and ’80s comes to mind) or rapidly rising prices (like oil and food) which we encounter daily, whereas the Chinese encounter on a quarterly or biannual basis since the Chinese government controls the price of oil. Most important to note is that many factories do not pay an hourly wage, but instead pay a piece rate wage, which gets them over some of the inflationary impact. Wages have NOT gone up 30%, but workers are getting more scarce as the traditional shift from workers going to the big… Read more »
Fabien Tiburce
Fabien Tiburce
10 years 11 months ago

Low labor costs attracts manufacturing which stimulates employment which drives labor costs up. This has been going on since the days of Adam Smith! Some manufacturing will eventually move to India, Vietnam and further down the road, Africa. Personally I think this is very good news for Chinese workers who are essentially exploited while China builds its manufacturing might on the back of exports not the strength of its domestic demand.


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