Spin of the day

[jpatokal]

Sometimes it just seems so depressing to see news like this quoted like the sky is falling down...
The competitiveness of China's manufacturing industries has suffered serious erosion over the past year, according to one of the world's largest trade sourcing companies. .. He pointed to a "double-digit" rise in Chinese labour costs.
Or in other words, 1.1 billion people just got "double-digit" (>10%) richer last year. And this is bad news how? :confused:

[Scuba22]

I hear what you're saying, economics can be pretty unsentimental, but I'm sure you can see the answer to your question.

If something that I sell in the US costs me $100 to make in the US, then to decide if I want to make it in China, I need to factor in the logistics and transportation costs - not just the shipping, but the cost of managing supplies from far away. For example, if my factory is nearby and there's a mistake in an order, I can fix it quickly. If the factory is in China, it may take weeks or months - all the while I'm missing sales.

Plus, realize that labor rates are only one portion of production costs. Prices for commodities like steel or wood aren't that much different in China, in fact those prices might even be higher.

So, let's say that the US production cost of $100 has a labor component of $40. Then let's say that the transportation and logistics of sourcing from China costs $20. In that case, the most I would be willing to pay for Chinese labor is $20 - about half of US labor. If Chinese labor is now 20% of US labor, that's great for me - I pay the Chinese $8, material costs of $60, logistics of $20; now my total costs are $88, and I save $12.

But there's another complication - since others are probably doing the same thing, then some part of this $16 is going to wind up in a lower price to the consumer. So whereas before I could sell the thing for $110 and make a $10 profit, now my competitor who also sources from China drops his price to $100 to steal my customers. So I drop my price to $100, and now I'm making $12 (since the cost is $88).

Notice that my profit has only gone up $2. That means that if the Chinese labor rates increase by 25% - from $8 to $10 - it may not make sense to manufacture in China at all. So now the Chinese guy has less work to do, and the price in the US goes back up to $110.

This is how poor people making more money can be bad news. Nothing's simple or free, especially poverty reduction.

Cheers,

Scuba22

[GWR]

Sometimes it just seems so depressing to see news like this quoted like the sky is falling down...

Or in other words, 1.1 billion people just got "double-digit" (>10%) richer last year. And this is bad news how? :confused:

I'm not even sure that the idea of creating a strong domestic market, by paying the working class a reasonable wack, is still in vogue. This idea seemed to die out at the end of the seventies. Since then, I seem to have been serving rather than being served.;)

[Scuba22]

Actually, creating a strong domestic market is not only in vogue, it actually happens and is quite powerful.

In my example above, even if the Chinese person gets only 20% of the US wage, that's more than zero and it's now injected into the local economy. He's either got to spend it or save it. If he spends it, someone else locally earns it, who then either spends it or saves it. The more the money gets spent around in the local community before someone buys something from outside the community, the greater the "multiplier effect" of that initial wage.

If you go out to the Thai countryside, every now and then you see a giant factory in the middle of nowhere - and then you see the little shops and restaurants springing up to serve the employees of the factory; none of those would be there without the factory. Of course relying on one big factory is a problem, but not as much as not having itthere in the first place.

The savings situation is another question. If there is effective banking, those savings can be lent out to others to create new enterprises; of course this doesn't happen if people put savings under mattresses.

Domestic consumption in China has indeed been growing, and the improved local economy is part of what's increasing wages. Unfortunately, most of this has happened in the coastal provinces, leaving the rural areas pretty upset. The Chinese government is trying hard to correct this, because they know full well that rural resentment is probably their biggest threat, but it's not easy to control economic outcomes!

Cheers,

Scuba22

[BangkokPundit]

Sometimes it just seems so depressing to see news like this quoted like the sky is falling down...

Or in other words, 1.1 billion people just got "double-digit" (>10%) richer last year. And this is bad news how? :confused:

I agree with what Scuba has said from the economics side on increasing labour costs, but will build on what he has said.

If you have 10 workers and pay them $10 a month, your labour costs are $100. If workers strike demanding a 25% rise which you give to them, your labour costs, if other things remain the same, have suddenly gone up to $12.50 a worker or $125. As Scuba outlines this might mean it is no longer profitable to produce products in that country.

However, increased labour costs don't even mean an increase in individual's salaries. Using the example above, say productivity falls and now it takes 13 workers to do the same work that 10 workers were doing beforehand. You now have increased labour costs ($130 compared to $100), but individual worker's salaries haven't increased.

Also, an increase in an individual's salary doesn't necessarily mean increased labour costs because say that in exchange for the factory raising worker's salaries 25% that workers agree to work more productively. Now, after this increased productivity you only need 8 workers to produce the same number of items as it took 10 workers to do beforehand - your labour costs remain the same ($12.50 x 8 or $10 x 10 = $100) and you move 2 of the labourers to another part of the factory.

When individual salaries are increased in line with increased productivity you don't get increased labour costs. This way individuals can become richer, but there are not the problems that come with increased labour costs. Increased labour costs often mean that increases in individual's salaries are rising higher than increases in productivity.

The decline in the manufacturing of shoes in Indonesia is a good example of what increased labour costs can do to an industry or even an country. It is difficult to find non-subscriber web links for some figures I have, but this article (http://www.smh.com.au/articles/2002/09/22/1032055035701.html) does talk about some of the labour costs problems:

Wage rises have also alarmed investors, even though the national average weekly wage is only about $A20.

Some of the 350 local governments, backed by more militant unions, have started to use newly granted powers to set higher minimum wages. While many welcome the pay rises, they make the country a less desirable place in which to set up business.


Yes, there are a number of factors which caused the decline in Indonesia's shoe manufacturing industry but one factor was the dramatic increase in wages with no subsequent increase in productivity which meant increased labour costs. A FEER article from 12 September 2002 ("Just Quit It") gives one example of the minimum wage rising from 420,000 rupiah per month to 589,000 rupiah in a single year in one locality. The same article also says that labour costs for production went from 15% in 1996 to 22% in 2002.

Finally, the same FEER article also states that it was Thailand that gained the most from foreign shoe manufacturers leaving Indonesia, this was despite the fact that individual salaries in Thailand were higher. Why? One reason (and I state only one reason) was that worker productivity in Thailand was much higher.

[jpatokal]

Interesting analysis but it wasn't actually what I had in mind at all. For years, China has been touted as having a bottomless pool of labor that will suck investment from everybody else. Now it's clear that, at least at the current price point, this is no longer the case. Those employers who are happy to pay $10 stay in China and the Chinese workers are happy. Those employers are aren't and are willing to stomach an additional risk/hassle premium move to Bangladesh or Cambodia or somewhere and pay $8 (or $6), and the Bangladeshis/Cambodians/... get jobs and are happy. The ability to pay low wages and manufacture cheap things only becomes a 'problem' when everybody on the planet is sufficiently competed for to demand higher wages... which obviously isn't going to happen anything soon, and even when it does, they'll also have higher purchasing power and thus ability to pay more for their widgets. Globalization is good :D