Rising wages should propel the next wave in productivity gains

PUBLISHED : Wednesday, 15 September, 2010, 12:00am
UPDATED : Wednesday, 15 September, 2010, 12:00am

Here's yet another reason why we don't need to worry about factories on the mainland losing their competitive edge.

As we know, wages on the mainland are rising. Governments in the rich coastal provinces have increased their statutory minimum wages by between 10 and 20 per cent this year. And with the media full of stories about a deepening labour shortage, many foreign-invested factories have been forced to jack up workers' pay by 20 per cent or more.

The size of these rises has spooked many observers. Businesspeople and investors both fret that such big increases in factory wage bills at a time when the mainland's currency is appreciating, when commodity prices are going up, and when developed market demand is soft, will compress profit margins and erode the country's manufacturing competitiveness.

They can relax. It will be a long time before rising wages threaten China's competitiveness at either the country or company level.

As this column has pointed out before, this year's wage rises might sound generous, but few workers got any increase in 2009. A 25 per cent pay rise now in an economy growing at 10 per cent a year with inflation running at 3 per cent means factory workers' pay doesn't even keep pace with the overall increase in national income.

In fact, with workers' productivity climbing faster than their pay over recent years, manufacturers' unit labour costs have actually declined rather than increased. As a result, as the first chart below shows, the mainland's wage bill has fallen relative to overall economic output. And even following the recent increases, as the second chart shows, Chinese workers remain extremely cheap by international standards.

Fears that rising wages mean individual companies will no longer be able to compete look overblown as well. For one thing, profit margins at mainland manufacturers aren't as wafer-thin as they like to make out. That's because many sell their goods at little more than cost price to their Hong Kong affiliates who then mark them up and re-export them to buyers elsewhere.

Called 'transfer pricing' by economists, this dodge both reduces a company's mainland tax bill and neatly shifts its profits offshore to Hong Kong, where owners have more freedom to do what they want with the money.

So companies have more room than they would like to admit to absorb recent pay increases - a lot more.

And if they are worried that rising wages will eat into their competitive advantage over factories in lower-pay countries like Vietnam or India, there is plenty Chinese factory owners can do to improve productivity even further.

For a start, say Rosey Hurst and Dionne Harrison of supply-chain consultancy Impactt, they could stop regarding their workers as a necessary liability and begin to treat them as an asset instead.

Despite recent improvements in workplace conditions, mainland factory owners still tend to have a low opinion of their employees. Motivation is typically through the stick rather than the carrot, with most factories keeping workers in line through a system of fines.

Modern manufacturing management techniques are practically unknown. Workers are seldom entitled to halt production lines to deal with problems on the spot, and employees are not rewarded for suggesting improvements to the production process. Not surprisingly, avoidable quality problems are endemic.

According to Hurst and Harrison, many factories in southern China suffer a staff turnover rate of 10 per cent a month, which hugely exacerbates the inefficiency of the workforce. As a result, factory workers produce only a fraction of their potential output.

All this means there are enormous gains in productivity that can still be made. Manufacturers on the mainland have made big gains by introducing new production technologies, but they have lagged far behind in terms of their management.

With rising wages, they will have a powerful incentive to get more out of their workers by treating them more considerately, training them better and retaining them for longer.

The impact could be substantial. Studies indicate that changes in workforce management could boost manufacturing productivity anything between 50 and 400 per cent.

If the mainland can make even some of those gains, its manufacturing industries will remain competitive for a long time to come.