Foxconn and rebalancing

The rebalancing of Chinese economy is going on at warp speed.

On the heel of its wage concession, Foxconn, of the suicide fame, has announced ambitious plans to relocate inland. A brand new plant at Henan, China’s most populous province, is slated to create 300,000 positions when it comes fully onstream. Existing facilities at Tianjin in the North and Chongqing in the Southwest are also undergoing major renovation and expansion.

Most western commentators, like the FT here, automatically assume that the relocation is to take advantage of wage disparity between the inland regions and Shenzhen. However, wages at Foxconn Henan, are reported to be at par with that of Shenzhen. What motivate Foxconn apparently is a slew of other incentives and government regulations, for example, its Chongqing plant will operate without the obligatory dormitory which has become the hallmark of many an exporters’ town. A new generation of workers prefer to churn out iPods at their home provinces and relax in their own homes after work.

But the FT is right in noting that wealth is being spread more widely within the nation and the expected climb in value-chain:

Starting with Japan, country after country grew rich by following the same playbook: step on to the lowest, dreariest and most labour-intensive rung of industrialisation and gradually move up the value chain as you build up skills and capital, letting poorer countries take on the tasks you shed. This is how the “Asian tigers” copied Japan, and how successive generations – including China itself – followed. The current relocations are no less momentous for happening within a single country.

In fact, there has been rumor that Foxconn has been effectively pushed out of Shenzhen by the local government to make way for a car manufacturer. China’s game plan for the coast is to upgrade to higher value-added manufacturing and service. To encourage automation, the government has offered tax incentives for capital goods. Japan’s relatively robust recovery in this current round of malaise is largely riding on Chinese demand for advanced machinery. Reuters has a good article on the expected beneficiaries of this automation drive.

“The automation equipment industry is growing very, very fast. Sensors, frequency converters, conveyor belts, pneumatic systems, power tools — you name it,” said Raymond Tsang, head of consultancy Bain & Co’s Greater China industrial practice.

“We’re seeing anywhere between 20 to 30 percent growth in those sectors year over year.”

According to Nomura Securities, the ratio of machine tools in China that use numerical controls, a good measure of the level of automation, climbed to 27 percent in the quarter to May, up from 22 percent in 2009 and 19 percent in 2008.

This brings China to the level of Japan in the 1980s when it was in still in a phase of strong economic growth. Japan’s numerical control ratio has since risen to a world-leading 82 percent, offering a glimpse of where China may be headed as its economy develops.

Bottom line, the look of Chinese industries and societies is changing rapidly. China participates in the global extend and pretend game basically to buy time for this transformation. However, given the likelihood of a double-dip, there just may not be enough time even with China’s astonishing speed.

Chinese labor disputes and consumption

The AP has a nice article on the recent labor disputes, in the context of the transition of Chinese economy.

Boosting wages fits in with Beijing’s strategy of closing the income gap and promoting more equal growth in coming years, said Liu Shanying, an analyst at the Chinese Academy of Social Sciences’ Institute of Political Science in Beijing.

“If incomes won’t go up, how can domestic demand be boosted? Strikes for better pay are very much in line with the big trend of Chinese economic development,” he said.

One reason behind the more assertive work force is a shifting job market since China pumped up its economy with massive stimulus spending to fend off the global recession. Manufacturing has begun to expand into the Chinese interior, leaving traditional industrial enclaves on the coast competing for labor and giving workers a stronger bargaining position.

Workers “have the upper hand, and also sense the government is trying to address inequalities, so the workers feel more comfortable in pushing for high wages,” said Lee. [Chang-Hee Lee, a specialist on industrial relations at the International Labour Organization’s Beijing office.]

As I said before, all these are part and parcel of China’s push to rebalance its economy geographically (away from the Eastern coast) and structurally (towards households and consumption). Therefore, China is going down the path of internal revaluation rather than external adjustment via the currency. As a result, we are going to see an explosion of Chinese consumption in the coming decade. But GDP is likely to be more moderated. There already have been discussions on the viability of the current 8% “minimum growth target”. Not that China needs that high a growth rate anymore, with less people entering the workforce due to changes in demographics.

Does this mean the recent change in currency regime is nothing but a hoax? Yes if you are an exporter competing against China. But for China, this is just a necessary step towards turning the RMB into a reserve currency in the future. With substantial internal revaluation and the elimination of many export subsidies, some punters are already calling the RMB overvalued. Li Dao-kui, a member of the Chinese Monetary Policy Committee, suggested that it would take the RMB 10-15 years to be fully convertible and competitive as a reserve currency.

The real Chinese revaluation story

The media has been busy propagating and debunking the RMB revaluation story, but I think both narratives are off-target. Yes, China is having a significant revalution, just not with its currency.

Instead, China has chosen an aggressive program of internal revaluation, i.e. raising costs for the exporters internally, by inducing wage-led inflation, cutting export subsidies, and stiffening environmental regulations etc.

Most of the recent coverage of China’s labor disputes have focused on the workers’ being simply more demanding in sharing the spoils. But one should also note the subtle, and very important, support that the Chinese government is giving them. Besides rallying behind the workers in state media, labor activists have been allowed to organize freely (rare for China’s pro-capital government), so long that they train the target on wage demand only. Raising the minimum wage is also a cue for the workers that their action is being sanctioned by the state.

Why is China going this route instead of currency appreciation recommended by the developed economies? Well, this is simply a better way of adjustment for China. With currency appreciation, the losses to Chinese exporters become gains for exporters in other countries, i.e. a net loss of wealth for China. With internal revaluation, the benefits go towards Chinese workers, i.e. only a redistribution of wealth within China. This later approach also helps in building up a middle class and reorient the economy towards more consumption.

Another way to achieve internal revaluation is by cutting export subsidies. China has announced cutting export rebates on over 400 types of products deemed energy-intensive or polluting. This allows the government to target only industries deemed inefficient and force them to upgrade, and helps soothing trade relations with the West as a bonus.

The implementation of environmental regulations has also been tightened, to the benefits of future generations of Chinese. Again, this is an area that simple currency appreciation may not be as effective.

At the end of the day, although China has decided to bite the bullet and pony up for rebalancing its economy, it still seeks to minimize the costs and maximize the benefits. It’s just that their preferred method may not be the most desirable one from the POV of the developed economies.

What does China’s May FDI tell us?

With the rhetoric over currency back up again, scant attention is paid towards real economic data. China has just released its May foreign direct investment data and it certainly warrants more examination than what the WSJ has given it.

Yes total FDI for the 1st 5 months were up only 14% YOY, and from a low base at that. But things become more interesting once you breakdown the data. Manufacturing FDI  actually slipped 4% during the 1st 5 months, not surprising as China’s cost advantage is eroding fast. However, FDI in the service sector was UP by a whopping 32%! The economic rebalancing act is working at warp speed. In fact, 58% of respondents to an earlier survey conducted by the US Chamber of Commerce saw market access as the primary incentive for investing in China.

Of course the transition will be bumpy, but the Chinese consumption story will drive economic storytelling for the coming decade.

Impact of higher Chinese wages

The successes of workers at Foxconn and Honda, coupled with tacit support from a Chinese government determined to build a domestic market, have predictably embolden workers elsewhere. What’s surprising is the speed and ferocity of the spread of the labor unrest.

Besides a second strike at Honda, there are many copycat strikes in Guangdong and in the Yangtze River Delta to the north. To the dismay of many foreign investors, the unrest has even touched provinces like Jiangxi and Shaanxi,  inland areas that previously were considered as possible sites for relocation in order to lower costs. Now they are investigating opportunities at other countries. Foxconn is looking at India, and Vietnam is already a hot destination for lower end manufacturers.

So, does this mean China’s days as world’s factory is numbered? Not likely, as labor make up only a small portion (7% by some estimate) of total costs. The lower end manufacturers are likely going to move elsewhere, and the rest simply are going to move up the value chain, following the same path of Asian tigers like Taiwan and South Korea.

Is iPod going up in price? I doubt it. Foxconn and other manufacturers are just going to eat up the wage hike. Low end manufacturers have slimmer profit margin for cost absorption. But I think they will eventually opt to move out of China to the next low cost mecca rather than raising prices collectively.

Is this going to be a boom to workers in the developed economies? Hello! What have you been drinking? The Chinese are moving UP the value chain, which means that they are going to compete head-to-head with the developed economies which have already reached peak productivity. Feel free to ask Siemens whether the rise of Chinese high-speed train manufacturers is good for their business or not, or quiz Japanese car manufacturers on the impact of Kia and Hyundai.

Hey, Chinese workers with higher income are going to consume more, benefiting some international suppliers eventually, right? Right. But they also consume more natural resources, driving up the costs of practically every commodity. Plus the Chinese market is very difficult to penetrate and China runs explicit industrial policies to promote domestic companies. Japan is exhibit A of how powerful these non-tariff trade barriers can be.

Bottom line is, I just don’t get the euphoria of many western commentators.