China's export model

From "Wage Increases and Labor Trouble" by Wang Tao, UBS Senior China economist, June 8

Labor productivity in the industrial sector has grown rapidly. As a result, unit labor costs (ULC) in the industrial sector have grown only moderately over the past decade. We believe that ULC in the manufacturing sector have grown by less, more in line with inflation. This is because the industrial sector also includes mining and utilities, while it is the manufacturing sector that has likely seen more rapid productivity growth … Also, the official wage data is widely believed to over-state average wage level and growth in the economy. What does this mean? Normally, when the real wage rises along with real labor productivity, the higher cost of labor over time is fully paid for by labor producing more product, and the shares of wages and profit in total output remain constant. In nominal terms, nominal wage growth should be in line with growth of real productivity plus inflation, that is, unit labor cost should grow in line with inflation. When this is the case the wage increases do not increase inflation or squeeze profits …We can [also] look at profit margins in the industrial sector and core manufacturing goods prices … The average profit margins in China’s industrial sector have stayed quite stable in the past decade, except for plunging sharply in late 2008 before recovering in 2009.

From "The China Diviner: Less growth, inflation and rates" by Paul Cavey, Macquarie head of China economics, June 14

On a sequential basis, inflation doesn’t look scary: Food prices have been falling in recent weeks, and the softer housing market will dampen the residence component of the CPI. The biggest impact of slower property will be on PPI inflation … We now expect [the CPI] to average 3.1% this year … However, our medium-term outlook for inflation in China is unchanged. We expect higher rates of inflation in the coming years, because we think the economy is operating close to full capacity. Recent spates of worker unrest have highlighted the steady closing of the gap between demand and supply in the labor market. We also think there is less industrial overcapacity than is often perceived. The high rates of profitability in China are not suggestive of overcapacity. Neither is the way those profits have been generated: through higher rates of asset turnover. This is significant. Historical episodes of overcapacity – be it the structural example of China’s auto industry in the early 2000s, or the more cyclical episodes of overcapacity in global semiconductors – are always accompanied by low or falling asset turn.

From "China – The importance of exports" by Stephen Green, Standard Chartered head of research, Greater China, June 15

About 15% of nominal GDP growth … and 30% of industrial-sector growth will come from exports in 2010, barring a second, serious financial crisis in Europe. These are significant contributions, almost back to pre-crisis levels. However, the 2010 increase starts from a sharply-contracted 2009 base, and even the most optimistic observer will wonder about the ability of exports to continue to grow at such a pace in 2011 … The concern for China’s leaders is that in 2008, they implemented a stimulus package based on a view that the world economy would be in decline for two years. The end of that period is now just six months away, and the possibility of a slowdown in G7 demand is high, and the chances of serious financial stress appearing again are significant. This means China is concerned about exports. The main driver of growth, however, is domestic activity … China’s is not an "export-driven" economy. For this reason, the first signs of a domestic moderation are even more important than what is happening in Europe. This moderation is driven by policy, including the beginnings of credit controls, fewer new infrastructure project approvals and a neutral budget. We believe that the leadership will keep any policy changes on hold until late Q3 when the extent of the global and domestic slowdowns will be clearer … VAT tax rebates will continue at present levels until early 2011 at the earliest.