China's low-cost workers have richer days ahead

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The widening gap between rich and poor in China is on full display each morning in Beijing's Sanlitun Village, where labourers on their way to work file past glimmering storefronts advertising a bounty of high-priced goods including Apple computers, Swiss watches and Starbucks coffee.

Thanks to the soaring wealth of its business elite, China is expected to become the world's largest consumer of luxury goods within five years, a projection that means very little to the estimated 100,000 people in the city who earn the minimum wage of 800 yuan ($123) a month.

A small latte at the Sanlitun Starbucks costs 25 yuan, more than half a day's pay for a minimum-wage earner.

Cheap labour has propelled the strong economic growth that has made China the world's factory floor and No. 1 exporter. Yet there are signs the country's massive low-cost work force is on the cusp of winning major improvements to their working conditions that will have significant implications for the Chinese economy.

Better wages will increase inflation pressures and crimp corporate profits, raising concerns about an economy that is already showing signs of a slowdown. At the same time, however, a Chinese consumer with more spending power will help the country achieve its long-term goal of boosting domestic consumption and reducing reliance on investment and export demand.

In Beijing, the government recently unveiled an increase in the monthly minimum wage, to 960 yuan from 800 yuan, beginning in July. The move follows a number of minimum-wage hikes in China's southern provinces and at factories in the manufacturing hubs of the Yangtze River Delta and the Pearl River Delta after a series of unprecedented labour actions and protests amid a shortage of migrant workers.

The Chinese operations of Japanese auto maker Honda were crippled for weeks after workers at a transmission plant in Guangdong province went on strike in May demanding better pay. The company has offered wage increases of between 24 and 32 per cent to the disgruntled employees, bringing their pay to about 1,900 yuan per month.

The Honda unrest comes after a spate of suicides by workers at Foxconn, a Taiwanese company that employs more than 400,000 people in Shenzhen, China, to assemble electronics products including Apple iPhones, iPods, iPads, laptop computers and mobile devices.

The Foxconn workers, who have complained of cramped dormitory living conditions and long work hours, have been given a 30-per-cent pay increase and been offered counselling to deal with work stress. On Sunday, Foxconn said it would go even further by doubling the salaries of many employees.

"Workers' bargaining power is rising as the labour market tightens," Patrick Lawrence of research firm GaveKal-Dragonomics wrote in a recent report to clients highlighting inflationary pressures in the Chinese economy.

The wage increases "remind us that labour tensions are set to become a much bigger issue over the next few years as workers fight for larger paycheques and improved working conditions," Mr. Lawrence added.

Analysts at UBS Securities suggest that a 30-per-cent wage increase will have a significant impact on the profits of PC makers and suppliers in China. Foxconn's earnings could fall by as much as 13 per cent this year and 19 per cent in 2011, UBS said.

Tao Wang, the head of China economic research for UBS, expects the impact on inflation will be limited. She expects labour productivity improvements to absorb some of the costs and predicts that producers, rather than raise prices, will accept lower margins in the short term to retain competitiveness.

In the long term, however, rising wages will be a positive not only for workers, but also the economy. China's government hopes to boost consumer spending and shift the economy away from such a strong dependence on export demand. Higher wages for Chinese workers are part of the evolution and maturation of the economy that Beijing has long tried to engineer.

"Pushing wage and salary increases is an important policy adopted by the Chinese government.  The policy target is to adjust the income distribution in China by raising the proportion of national income that goes to labour compensation," said Na Liu, founder of CNC Asset Management Ltd., a Toronto-based firm focused on helping Canadians invest in the Chinese equity markets and the global raw materials sector.

"This is highly desirable as the Chinese economy is in the process of rebalancing from an investment-driven economy to a more consumption-driven economy.  The impact on the economy is neutral in the near term and positive in the medium to longer term," Mr. Liu said.

One of the government's major concerns continues to be housing affordability. Real estate prices have soared in China's major cities including Beijing, Shanghai and Shenzhen, and the government has reacted with a series of measures aimed at cooling the overheated market, driving out speculators and making housing more affordable for China's workers. Property sales in Beijing plunged 70 per cent in May from the month before in response to the measures but prices have remained high.

Perhaps the most telling sign that real wage improvements are set to take hold in China was the extensive coverage of the Honda strike and the Foxconn suicides by the country's state-controlled media. In the past, the government rarely permitted reporting on labour disputes and unrest by the Chinese media. The Foxconn and Honda stories have been front-page news in most of China's newspapers in recent weeks.

World's workshop matures

1. Labour

An increasingly tight labour market and rising living standards have provoked a series of strikes, labour disputes and worker demands that have are leading to increased wages and benefits for China's migrant workers. As China's population ages, the new generation of migrant workers who toil in factories producing computers, cellphones and automobiles are demanding and winning concessions from employers.

2. Productivity

Labour productivity growth has generally been in line with wage increases in the past. However, the sharp rise in worker pay currently under way, (a doubling of pay for Foxconn workers, for example) could squeeze profit margins. This could spur inflation and add pressures to an already slowing Chinese economy.

3. Shift to the Chinese consumer

China doesn't want to be the world's workshop and a source of inexpensive labour forever. It hopes that increasing wages will shift its economy from an investment- and export-driven model to one driven by domestic demand from its massive population of 1.3 billion people. As pay rises, Chinese consumers will have more disposable income to spend on electronics, services and automobiles. China recently overtook the United States as the world's largest auto market.

4. Currency

China has kept its currency, called the yuan or Renminbi, artificially low and pegged to the U.S. dollar to give its exporters an advantage over competitors. China is widely expected to allow the yuan to rise against the greenback some time this year. While a stronger yuan would present challenges to Chinese exporters, it would also increase the purchasing power of Chinese consumers, which would boost spending and stimulate the economy.