China's Wage Raise

In another effort to deflect demands for its currency to be untied from the dollar, China is making a major public focus on big wage rises to spur domestic demand and cut its trade surplus. However it may prove too little too late to prevent a major clash with a United States determined to make China play by its interpretation of the currency rules in exchange for continuation of its current trade access to the US market.

Specific action against China seems likely if the US economy stalls again, unemployment remains high and the China trade deficit huge. This is election year in the US and President Obama is seen to need to be more forceful on several fronts than he has seemed so far. Meanwhile China, puffed up by its economic success and the size of its reserves, is not only refusing to budge but making a show of not doing so.

Increases in minimum wages have been announced before the Chinese New Year ranging from 10 percent in Beijing to 15 percent in export-oriented Shanghai and Jiangsu. These are hefty increases even if one assumes that that consumer prices have been rising significantly faster than the annual 1.5 percent reported by the official statistics.

However, the impact of such an increase will be reduced by two factors. Firstly, it is likely that increases for workers other than those on the bottom rung will be less as Beijing makes a conscious effort to be seen to do a little to reduce income gaps.

Secondly, Chinese firms, whether state or private, are largely autonomous in their wage policies. Most too have in recent years shown a determination to maximize profit and reinvestment. Getting bigger has been the main goal. So there is plenty of resistance to paying higher wages unless deemed necessary to retain workers.

There does now appear to be a shortage of labor in several areas. Reports in Hong Kong say factory owners in the Pearl River delta, the major export hub, are having difficulty luring workers back to the region. Export orders have picked up since late 2008 when a collapse led tens of thousands of migrant workers to be laid off and forced to return to central and western China. Now many are reluctant to return, probably because of government stimulus measures to build rural and small city infrastructure. It is also likely that increases for workers other than those on the bottom rung will be less as Beijing makes a conscious effort to be seen to do a little to reduce income gaps.

A broader factor is that the total workforce growth rate has slowed to very low levels with particularly noticeable falls in the young cohorts now entering the workforce and thus more liable to be mobile.

But although there is underlying improvement in the labor market – as far as the workers are concerned – wages as a percentage of national income remain very low by the standards of the rest of the world, developed or developing. Hence even a large increase in wages even if applied nationally will have limited impact on total domestic demand.

Big wage rises, even if they occur nationally, made not be the stimulus assumed. Increases for lower paid workers would likely be quickly spent on consumption, but middle income ones might well save it, whether for protection against ill-health or as down payment on the ever-rising cost of home ownership.

Much of the strength of the economy over the past year has come from the property development and auto industries, supported by the huge increase in bank lending. This is now having to be reined in. Meanwhile big wage rises will not be enough to bring most urban property into the affordability level given the rises in property prices which have resulted from the credit surge.

China's trade surplus has narrowed with the current account surplus declining 35 percent in 2009. It may continue to fall – but much more gradually as global demand recovers. However, its relationship with the US is very troubling. A continued pick-up in the US economy will likely cause imports to rise and the deficit with China to remain huge. A weak US economy will see a sharp reduction in the deficit – but increased political pressure for trade action.

China's stubborn currency stance may seem illogical given that the US market has gradually been becoming less important. Indeed, developing countries now account for some 55 percent of its exports. But a peg to a weak dollar helps not just in the US market but in third markets with flexible currencies, such as most of Asia and Latin America. So it is undoubtedly helping China continue to increase its share of global trade.

Few in the developing world want to offend China, a source of aid or outlet for commodity exports. But there is growing resentment too, particularly in India, at China's inroads into their markets for manufactures which they attribute in part at least to its cheap currency policy.

For them resentment of American hegemonism is still too recent to take sides with Washington. But one can be sure that if the US took unilateral trade action against China some major developing countries would quickly but quietly ratchet up anti-dumping and other restrictive measures as well. China can take pride in having become the "workshop of the world." But the world is not necessarily comfortable with that.