For well over a year now, we have been hearing predictions that double-digit annual labour cost increases are at last about to throw grit into China’s apparently unstoppable export machine. So far, they remain confounded. China’s exports not only grew 27 per cent last year; according to US official data, their prices in the US have actually fallen – even though the renminbi has risen by more than 6 per cent against the dollar since mid-2005.
That performance is not just the result of excess-capacity industries, such as steel, dumping output abroad at cutthroat prices. Real money is being made. A recent Deutsche Bank analysis finds many exporters’ margins even increased last year. In textiles and clothing, a classic low-margin business, producers are celebrating record profits.
So what is going on? An under-valued currency has certainly helped keep exports buoyant, all the more so because appreciation of the renminbi’s trade-weighted exchange rate has been far smaller than against the dollar. But that is only part of the story. At least as important has been Chinese manufacturers’ success in containing higher labour costs.
They have been able to do so, first, because labour is still only about a quarter of their total input costs. Second, official Chinese statistics cover only workers in the “formal” sector. Wages in the “informal” sector, which does much of the subcontracting for exporters, have grown far more slowly. The third reason is impressive productivity gains, as modern automated plants, many of them foreign-owned, have replaced old state industries.
Although China’s productivity statistics are notoriously unreliable, independent estimates put the annual gains in manufacturing as high as 15-20 per cent annually – putting the US productivity “miracle” to shame. Nicholas Lardy of the Washington- based Peterson Institute says that, when that is factored in, the renminbi’s real effective exchange rate is lower than three years ago.
That goes a long way to explain why China has defied forecasts that it would soon be squeezed out of low-end industries such as toys, clothing and textiles. Not only has it clung on to those markets; it has also expanded fast into new ones: a recent US Federal Reserve staff study finds that between 1989 and 2005, China increased its share of exports to the US in 48 industries.
Now China’s manufacturing miracle is entering a second phase, as producers start to drive aggressively up-market. Exports of aircraft parts, ships, microchips and cars all grew by about 70 per cent last year, more than four times faster than traditional exports such as shoes and clothing. At the same time, it is set on becoming more than a processing economy that just screws together components made elsewhere. With official backing, industries such as steel, vehicles and electronics are steadily raising the value added locally by performing more advanced processes and making more parts in China.
Ultimately, those developments should make China wealthier and swell its demand for goods and services from abroad. But as things stand they spell an alarming further rise over the short- to medium-term in its trade surplus, which ballooned to $177bn last year, as exports continue to grow while more locally sourced inputs substitute for imports.
That outcome is not inevitable. Many things can be done to change it and Beijing is doing a lot of them. They include moving towards a more flexible exchange rate, eliminating export incentives, channelling domestic demand away from fixed asset investment into consumption and, above all, reducing the excess savings that fuel over-investment.
But notwithstanding this week’s move to boost consumption by raising social spending, China is not acting fast enough. In any case, many of the measures it needs to implement will take time. Its leaders’ preference for gradualism paid off while directed towards the domestic economy. But China’s impact on the global economy is now too large for it to expect the rest of the world to live comfortably with a gradualist timetable.
Sinophobic protectionist sentiment is rising again in the US Congress, raising the pressure on Hank Paulson, Treasury secretary, to show quick results from his so far fruitless “strategic dialogue” with Beijing. Concern has also spread to Asian countries such as Thailand and South Korea, which are struggling to contain upward pressure on their currencies while facing loss of exports in third markets to Chinese competition.
Faster currency appreciation alone will not rectify China’s growing external imbalances. Broad and deep domestic reforms are also needed. But unless the renminbi is allowed to find its own level, it risks becoming even more of a political flashpoint than it already is. Fear of job losses is a steadily less credible argument for going slow, when Chinese exporters are laughing all the way to the bank.
China’s chosen industrial development path should strengthen its incentive to avoid a protectionist backlash. As a processing economy, its income from exports is far smaller than commonly believed – probably only 10-12 per cent of gross domestic product. But as it makes at home more of what it sells abroad, that proportion will rise and with it the importance of foreign markets to its national prosperity. China matters increasingly to the world economy. But Beijing needs to remember that the reverse holds just as true.
