Feb 01, 2014

China: Opportunities for Private Sector in 2014?

For years, many American companies have been shifting their production bases to China in order to lower costs. However, the Chinese market is changing and business inputs such as interest rates, energy costs, and real estate have become more expensive, making it difficult for businesses to sustain their ‘low cost’ competitive edge. As migrant workers are finding more job opportunities at home, labor costs have soared by 40 percent. The country’s one-child policy has diminished the pool of young workers. Bank lending is tightening and the renminbi, Chinese currency, is appreciating by around 6 percent a year against the U.S. dollar, impacting factories with low margins.

Labor shortages, especially a lack of a tech-savvy population, along with cost cutting by factories is impacting quality, and American companies are starting to feel that the risks associated with production in China are not worth the cost.

A Slowdown in Manufacturing

China’s Trade Balance

Experts predict that in 2013, China’s economy grew by 7.6 percent, it’s slowest pace since 1999. This indicates that the industry-led development model is starting to yield diminishing returns.

Economic indicators also support this assessment. China’s annual trade in goods, at $4.16 trillion in 2013, pushed the United States out of the way as the world’s largest trader. Trade surplus for 2013 was $260 billion, up 12.8 percent from 2012. Yet the surplus for December fell short of targets of $31.15 billion at $25.6 billion, down from $33.8 billion in November.

Exports for December rose 4.3 percent compared to the prior year, lower than the expected 4.9 percent rise, and down from November’s 12.7 percent rise. Imports, though, increased an annual 8.3 percent in December, exceeding the expectations of 5.3 percent. This means that China continued to claim a huge share of global demand to help drive its economy.

China Imports and Exports (Goods and Services)

Analysts believe that despite the trade surplus disappointment, strong import numbers indicate that the economy remains strong.

”[The] pick-up in imports reflects that domestic demand is stronger than people expected. We think China is still capable of growing 7-7.5 percent in 2014.” ~Geoff Lewis, Global Market Strategist at J.P. Morgan Asset Management

The Chinese composite Purchasing Manager’s Index (PMI), which measures business activity in both the services and manufacturing sector, dipped to 51.2 in December 2013 from 52.3 in November. Meanwhile, the Global Manufacturing 2013 wrapped up 2013 at 52.70 in December, up from 51.60 in November.

“Both domestic and overseas demand was weaker than expected. Domestically, tight liquidity is weighing on factory output and orders.” ~Li Heng, Economist at Minsheng Securities

Economists are still positive, pointing out that despite the slower new business growth reflected by the PMI Index, labor market conditions continued to improve for the fourth month in a row. And despite the diminishing labor cost advantage, China’s highly developed supply chains remain among the best in the world.

Analysts attribute the weakness in the manufacturing sector as a natural consequence of Chinese policy makers trying to promote the growth of services and shutting down excess capacity in over-extended sectors such as steel and glass. Experts say that China has to develop a strong service sector in order to support rapid growth and avoid environmental destruction.

“It’s inevitable that China’s manufacturing growth will fall, with more growth coming from services” ~Chen Xingdong, Chief China Economist at BNP Paribas

Experts point to both manufacturers and service providers experiencing weakening in rates of output and new orders as a reason for the lower PMI in December. Additionally, manufacturers reduced their payroll numbers, while service providers hired additional staff.

Employment Demographics

In 2012, China’s total population was 1.35 billion, of which the working population was 937 million, a decrease of 3.45 million from 2011. Of this working population, statistics released by the Ministry of Health and Human Resources reveal that 767 million were employed. Accounting for 48.4 percent of the overall working population, 371 million workers were employed in urban areas. From 2008 to 2012, the number of workers in urban areas has had a steady increase while employment in rural areas dropped by 6 percent over the same period.

The Urban and Rural Workforce in China

Wage Growth in 2014

Minimum Wages Across China -  January 1st, 2013

Source: China Briefing

China’s wages are expected to increase by 10 to 15 percent in 2014. The ruling Communist party supports pay increases to maintain public support and to drive the country’s shift from capital-intensive manufacturing to a more services-driven economy. Current minimum-wage increase announcements gave workers in Shenzhen in Guangdong province a 13 percent increase and workers in Yangzhou, Jiangsu province a 15.6 percent increase.

The rising wages have prompted companies such as Nike Inc. to seek lower labor costs in nearby countries, like Vietnam.

In a series of separate interviews with a dozen Chinese exporters, the New York Times reported that all cited finding enough skilled blue-collar workers and paying their high wages as their largest problem. Compensation in urban China is roughly three times as high as Indonesia, four times as high as Vietnam, five times as high as Cambodia, and ten times as high as in Bangladesh. However, these other countries have their own share of issues such as unreliable electricity grids and poor infrastructure.

In spite of continuing wage growth, a survey reveals that 14 percent of Chinese employers plan to hire in the beginning of 2014, with the strongest labor markets anticipated in the Finance, Insurance & Real Estate sector and the Manufacturing sector.

Rising Wages in China

How will China Generate Growth This Year?

Foreign investment in China has idled recently, but China still invests heavily in itself. Domestic investment is high with Chinese entrepreneurs and State-Owned Enterprises (SOEs) generating enough cash to invest in new factories and equipment.

The private sector is also expected to drive growth. The Chinese government has begun to reduce the number of items that require government approval, and SOE reform is expected to make these firms more efficient and increase private ownership of assets. An example is the banking regulatory commission’s decision to allow the creation of up to five privately financed banks in 2014 as part of the reform to make China’s economy more productive. Since state-owned banks tend to lend mostly to government companies, the entrance of private banks will help to support credit-less entrepreneurs who will create new jobs.

This reduction in government control along with deregulation should help to boost private investment.

What This Means for China’s Temp Workers

At the end of 2012, China tightened its labor laws, effective July 2013, to ensure that workers hired through contracting agents, called ‘dispatch workers’ are offered the same conditions as full employees. In 2012, contracted workers made up a third of the workforce at many Chinese and multinational factories.

The changes to the Employment Contract Law limit the type of work that a staffing agency worker may perform for an employer. The work must be temporary (less than six months), auxiliary (related to non-core business), or substitute (temporary replacement of employee on leave) in nature. The temporary worker is entitled to the same pay as the employer’s regular employee in the same position, and employers are required to bear all costs and liabilities in connection to the worker. Penalties for non-compliance were also increased to range from RMB 5,000 to RMB 10,000 per dispatch worker. Additionally dispatch labor providers operating without a license are subject to a fine of one to five times their illegal gains and many have their gains confiscated.

While China’s use of contingent labor is more regulated than in the United States, its dependence on flexible workers is comparable.

As dispatch workers are now protected by ‘equal pay for equal work’ regulations, increases in overall wages will also expand to this type of worker. A provision of the legislation that limits the total number of dispatch staff to less than 10 percent of the company’s total workforce will keep the number of temp workers in check.

Historically many migrant workers have found jobs in factories in China’s Pearl River Delta, but reports show that the employment outlook for this region is at its weakest since 2009. This is partly due to steadily rising labor costs and to the new temporary workforce regulations.

Traditionally, companies have used temp workers as a cost-saving tactic as these workers do not sign contracts with factories, thus saving tens of thousands of dollars per month in insurance payments alone. Workers have been attracted to temp work, however, by the freedom and flexibility that these positions offer and the higher frequency of pay as compared to full-time employees. Due to the low margins at factories, many employers pay workers on a monthly-basis or run late on payroll payments, while temp workers are generally paid on time on a weekly basis. However, with the extended protection of temp workers, Chinese employers might be more hesitant to maintain a temporary workforce due to the increased risk and decreasing benefits in terms of cost.

“China as the world factory, the best time is behind us” ~Tao Dong, Chief Asia Economist at Credit Suisse