China in Transition

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China in Transition

From 2000 to 2011, China's economy grew by an average of 9.6 percent annually. In 2012 and 2013, growth slowed to 7.7 percent, and estimates place 2014's growth at 7.4 percent, short of the government's benchmark of 7.5 percent. For 2015, the outlook is for even slower expansion. The Economist Intelligence Unit expects China's economy to grow by only 7 percent.1

According to a report on FoxBusiness, "There is general agreement on the economic steps China must take to further improve citizens' lives, maintain sustainable growth, and boost its global role. These include shifting from heavy government spending to consumption and services; moving low-end manufacturing into high-end production; and automating and innovating as labor costs rise."2

However, each of these steps is risky, and China's success is hardly assured.

First, shifting from heavy government spending to consumption and services would allow China's economy to grow. The rapid rise in China's manufacturing wages, discussed in previous issues of Trends, has made China's exports less attractive to consumers in the U.S. and Europe. The minimum wage has doubled over the past five years alone in several cities.

But now that demand isn't keeping up with wages, workers are becoming too expensive for factories to employ. According to research by the International Monetary Fund, every increase of 10 percent in the minimum wage leads to a 1 percent increase in unemployment.3

As Gordon Orr, a director in McKinsey's Shanghai office, explains at McKinsey.com, manufacturing wages have gone up 400 percent in dollar terms in the past ten years. Now that other economies are offering cheaper labor, factories are downsizing.4

Suddenly, the vision of a broad middle class of billions of Chinese consumers driving China's growth into the next decades is in peril. As long as workers are employed and wages are rising, they can afford to buy the goods that will drive China's transition into an economy whose growth is driven by consumption rather than exports or government spending. But if factories can't afford to hire more workers, consumer spending won't increase.

The fact is that as workers have become more expensive, it's becoming more cost-effective for factories to replace them with automation. At the same time, technology costs have plummeted. As a result, Orr points out that, "Chinese assembly lines today bear no resemblance to those of a decade ago."

The solution, it would seem, is to shift many of the unemployed factory workers into service jobs, much like the United States transformed itself from a manufacturing economy into a service economy in recent decades...

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