On Chinese Trade

Cross-posted from Credit Writedowns

Here’s an interesting note from UBS’ Andy Lees this past Friday:

Mexican steel maker Altos Hornos de Mexico (AHMSA) may return from a 12 year bankruptcy due to rising steel demand and prices. The 11 7/8% dollar notes jumped 21 cents in the last 5 months to 46.5 cents. "There’s an initial agreement, an initial understanding with creditors and they’re working this off". It made USD34.1m in Q1 by cutting costs and buying iron ore from its own mines. "There’s no question that this company has the ability to service debt. The question is when they’ll do it" according to Barclays. AHMSA defaulted on USD1.9bnof debt back in 1999 so how come after 12 years the company is possibly on the verge of coming out of receivership?

According to the attached economics note on Mexico "labour costs differentials have compressed sharply in recent years vis-à-vis key competitors: Mexican manufacturing wages in dollar terms were three-and-a half times those of China only 10 years ago; they are now only marginally higher."

So what’s happening in China that is creating this loss of competitiveness? Last April I postulated that it could be that China has reached an inflection point commonly known as the Lewis Turning Point:

Informed researchers are asking what happens to China based on the recent demographic shift from rural labour surplus to rural labour deficit. The answer may be slower growth and higher inflation, according to a paper released last month by China’s Center for Economic Research at Peking University. But other impacts may also be increased consumption and a deteriorating external balance.

Labour shortage could spell inflation and trade deficits for China

It does seem likely that this is what is behind the increase in labour costs in China. But, no matter, the cost competitiveness – a major reason foreign manufacturers produce in China – is being eroded.

Andy continues:

I’ve highlighted before that a US company was finding China no longer competitive and that it was looking at either shifting production to Vietnam or more likely bringing production back to the US, but this seems to be further evidence that China is losing its competitive position.

Back in January China said it will introduce collective wage negotiations in all enterprises over the next 3 years in a bid to reduce labour disputes after mediation organisations received about 406,000 labour dispute cases last year, an increase of 12.1% from 2009.

He says that economists are beginning to think about replacing labour with capital as a labour arbitrage, something we have already seen as a major factor in suppressing wage gains in developed economies. This is also in line with what economists say developing nations need to do to counteract the problem. More importantly, developing economies that reach this juncture must move up the industrial ladder to production of higher value-added goods or they will see their export competitiveness severely eroded. The problem with these strategies is that it they may be energy and resource-intensive, Andy says. So there are no easy fixes to the Lewis Turning Point conundrum.

He concludes on this troubling note, which is very much in line with what I wrote over a year ago:

China’s trade surplus had deteriorated steadily since 2008 and I think will continue to do so. We know that Japan has been running on and off a trade surplus with China over the last 12 months for the first time since China’s massive (66%) currency devaluation in 1993. I wouldn’t say that we should be dumping China, but I think that China’s factor mobilisation story has gone past its peak and is now going to increasingly struggle to compete in the outside world.

Also see: Multinational manufacturers: Moving back to America | The Economist

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About Edward Harrison

I am a banking and finance specialist at the economic consultancy Global Macro Advisors. Previously, I worked at Deutsche Bank, Bain, the Corporate Executive Board and Yahoo. I have a BA in Economics from Dartmouth College and an MBA in Finance from Columbia University. As to ideology, I would call myself a libertarian realist - believer in the primacy of markets over a statist approach. However, I am no ideologue who believes that markets can solve all problems. Having lived in a lot of different places, I tend to take a global approach to economics and politics. I started my career as a diplomat in the foreign service and speak German, Dutch, Swedish, Spanish and French as well as English and can read a number of other European languages. I enjoy a good debate on these issues and I hope you enjoy my blogs. Please do sign up for the Email and RSS feeds on my blog pages. Cheers. Edward http://www.creditwritedowns.com


  1. kaan

    Oh boy where to start?!
    A realignment of supply chains which were needlessly stretchedis a necessary development. So some return of manufacturing to Mexico etc is necessary and desirable.
    But I wonder the compression of wage differential between US and China can progress how far?
    Much more importantly, the final demand for manufactured goods are inceasingly coming from emerging markets mostly an ocean apart from US. Do you thing you can manufacture an bulky appliance or machinery in US and export back to the other part of the world notwithstanding increasingly deterioting educational and physical level of US labor force?
    Also many emerging markets will soon get much smarter and start exerting immense pressure on many multinationals for insourcing their local sales.
    I advise anyone to take some time and visit some univerities and factories and many emerging markets and reevaluate their basic assumptions.

  2. alex

    Ed Harrison: “It is not clear that a small increase in the Yuan would have an appreciable impact on the U.S. current account with China.”

    Ok, so what about a a big increase in the yuan? Everybody seems to have a different estimate of how undervalued the yuan is compared to the USD, but what about say a 20% change? I wouldn’t call that small.

    As for the alleged Chinese labor shortage: where’s the evidence? Is it official stats (always trustworthy from the Chinese government) or is it more anecdotal in nature (hence subject to the usual self-serving problems).

    1. Cedric Regula

      The anecdotal stories I hear is that labor shortages exist with skilled engineering and technicians. It’s probably the only thing slowing down US-Euro-Japanese multinationals from airdropping the latest and greatest high tech assembly lines and other capex on China and getting them up to developed world “labor productivity”. I also wouldn’t underestimate the chances of that happening.

      Then we shouldn’t generalize either. What happens will depend a lot on the industry. Sophisticated electronic assembly and manufacture may move from Taiwan to the mainland. But China’s apparel and textile sector has been going to other parts of Asia.

  3. Schofield

    Helicopter Capitalism works wonders for any labour arbitrage problems you might be suffering from back home. Give the Chinese Socialists a call.

    1. Cedric Regula

      Then at the same time tell developed world governments that you need lower corporate taxes to be world competitive.

      Arbitrage is a many splendored thing!

      1. MyLessThanPrimeBeef

        Let’s track here:

        Corporations can migrate

        Laborers can’t

        Birds can migrate

        Humans can’t.

        1. Cedric Regula

          You can if it’s to China, China says it’s ok, and you want learn Chinese.

          But that’s too complicated to work into the rhyme, IMO.

          But we can stay here with no jobs and pay everyone’s taxes. That’s easy.

  4. Dean Sayers

    In fact, Kevin Hamlin made this point last year on the Lewis Turning Point & China:


    China, once an abundant provider of low-cost workers, is heading for the so-called Lewis turning point, when surplus labor evaporates, pushing up wages, consumption and inflation, said Huang Yiping, former chief Asia economist at Citigroup Inc. The result may prompt manufacturers to switch to cheaper countries such as India and Vietnam.

    Actually, I just noticed that you guys both cited the same journal, so its mostly just confirmation of your analysis…

  5. Paul Tioxon

    Well, who knew, in the petri dish of economic development, even an economist observes the obvious constraints to growth.
    And the even more obvious tendency of craving for more from the people, which can only be temporarily assuaged by giving in and granting …more. Until they want, still, more. But, an upside, more money, more domestic demand. Not bad, as far a historical process goes. But the slowing of growth. Why is that a problem. Well, with a gargantuan population, you can’t have a midge economy. So, from all accounts, it seems, that growth should stop its rapid rate and only be commensurate with growth in the population or productivity gains from tech, management or the seven day work week.

    DEVELOPMENTAL GROWTH SHOULD STOP AT SOME POINT. Every process has a point where it levels off and then declines. You can’t just grow and grow and grow. You know. But let’s take a look at some alternative to Mr Lewis’ insight as regards the particulars of China running short of people to move into meaningful industrial employment. What is China really up against in regards to complex constraints.


    From p.Two Fifty of The Journal Of World System Research:

    “In the demographic-structural approach, demography is not determinative in itself (as for
    Malthus) but must be examined in conjunction with social structure (as for Goldstone). The
    authors present a simple model of agrarian societies, which they define as those in which at least
    50% of the population and more often over 80%-90% of the population engage in agriculture.
    They reduce agrarian social structure to two classes (elite and non-elite) and study how the
    relative demographic weight of each changes over time. They posit four demographic-structural
    • Expansion phase: population grows from nadir; elite numbers low;
    • Stagflation phase: population is high; elite numbers rise;
    • Crisis phase: population begins to decline due to Malthusian pressures; elite
    overpopulation leads to political conflict;
    • Depression phase: population stagnates; elite numbers are decimated by war and
    economic collapse.
    The key driver of capital – H “History” in their model – the elite history of politics and
    wars, kings and castles – is elite overpopulation. To put it bluntly, as long as there is plenty of
    empty land to develop (expansion phase) or plenty of peasants to exploit per member of the elite
    (stagflation phase), elites focus on living the good life. However, once the carrying capacity of
    the land is reached (crisis phase), intra-elite competition starts to tear apart the fabric of society.
    Interestingly, Turchin and Nefedov see the rise of elite education and commoner artisanship as
    signs of crisis: elites seek university degrees and consequent bureaucratic employment only when
    opportunities to exploit rural peasants are scarce, and commoners turn to craft production for elite
    markets only when there is no free land available to farm. I had never thought of museum-quality
    artifacts in this way, but their analysis makes complete sense.”

    So surplus population, borrowing from the model as outlined above, goes into manufacturing of finished goods for export to the US and other luxury absorbing developed nations. And really smart kids from China go to university to become trade negotiators and currency traders and so on and so forth.

    The problem is then twofold for China. NOt only are there too many laborers but too many elites. Labor may push up costs reducing competitive advantages in world trade, but leadership starts competing as well for other goodies that start to diminish even as their numbers increase. Political conflict over who becomes a failed artist, and who gets gold, the girls and the glory creates a nasty secondary front, diverting a unified external front from the challenges of the international competition and redirecting it internally. China has problems that have not been measured before, due to size, peculiar nature of world wide relationships, but not due to something it has not seen before.

  6. DavidE

    The higher the price of oil, the more expensive it is to ship goods across the ocean and across the country. That has to effect the competitiveness of China and other countries compared to the United States. There have to be some goods which are now too expensive to ship to the U.S. as a result of the higher oil prices.

  7. Livello di vita

    competitiveness severely eroded. The problem with these strategies is that it they may be energy and resource-intensive, Andy says. So there are no easy fixes to the Lewis Turning Point

    China is on the brink of spontaneous dissolution into totally independent and competing provinces. The added competition will add fuel to the fired up explosion of competitiveness that Chinese are about to master. With dissolution will come the relegation of communism to a rarely recalled historical curiosity. You will see this fragmentation unfold as a replay of the Final Emperor’s Decline and Fall. Chinese will never change. They will never hang with an empire for long. They are individualists, natural born competitors, natural entrepreneurs.

    But labour will hardly be their problem with Overpopulated India so nearby. Japanese didn’t cotton to Indian Immigrants. Chinese, by contrast enjoy foreigners. Capital will not be problem for Chinese. Everyone wants to buy Chinese Stock, and Chinese Bonds. Technology will not be a problem. The patent offices of the world are chock full expired patents to guide the hands of the eager Chinese. Had England had a shot at such resources, the industrial revolution would have unfolded 9 times faster, and then some.

    Think about it

  8. Philip Pilkington

    Is it just me or does the Lewis Turning Point not look remarkably like the Marxist ‘Reserve Army of Labour’? You could even push it back one further and say that it looks like Ricardo’s ‘Iron Law of Wages’.

    In keeping with these two theories, this labour shortage will soon be, erm, ‘cured’ by some destructive dynamic inherent in the economy itself — probably one that has to do with a fall-off in aggregate demand and a resulting recession/depression… or, to use the classical terminology, a ‘crisis’.

    This is probably the right direction to look, too. What will happen when the Chinese property bubble — or the overinvestment bubble, more generally — pops in China? I’m thinking: large layoffs.

    Then the ‘Reserve Army’ should expand once more pushing wages back down (to ‘subsistence level’, as Ricardo would say — but this is probably an exaggeration in this case).

  9. French Fry

    fall-off in aggregate demand and a resulting recession/depression… or, to use the classical terminology, a ‘crisis’.

    This is probably the right direction

    *Foreign to China demand* has taken a tumble, a tumble buoy-ed up by nearly unlimited Chinese-poverty driven demand. Add to that demand future poverty driven demand from influx of poor-foreign-workers into China should sustain the process until the next international bubble takes hold. After that? Labour division and, sadly, *division of income* will propel expansion for years to come.

    We got some good news
    we got some bad news

    N E W S

  10. martini

    haha, China certainly does not plan to the low wage earner for ever, in fact, after China transforms itself as high tech innovator with world best infrasturcture, the so called developed world will bitterly find themselves as un-developed countries, and by then a wave of low wage jobs will flow back to these countries, this may happen in next 50 years.

    I always laugh when Au, NZ, Canada Britian are lablled as industrial country. Pray, what do they manufacturing? haha

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