At a recent CER breakfast event, which featured Yolanda Fernandez Lommen of ADB expressing her disappointment at the low level of social service spending in the latest five-year plan, I sat next to Cary Bean, president of Eagle Ottawa Asia-Pacific, which makes leather car interiors. His company has been in China a while, producing mostly for export. After shaking his head at what he considered Lommen’s socialist sensibilities (“she sounds like Nancy Pelosi”), he went on to lament the end of the golden era of Chinese exports, which he considered to be right around the corner.
His complaint centered around Beijing’s decision to reinstitute the value-added export tax, which was suppressed during the financial crisis to keep Chinese exporters from going under. The formulae for calculating the impact of the tax are complex, but he estimated that the reinstatement of the tax would drive up his costs by 22%. “We can’t take it,” he said. Eagle Ottawa is moving production to Vietnam.
There is a debate over whether the justification for the accelerating migration of mainland manufacturing operations to Southeast Asia underway is sound; many point out that labor in Southeast Asian countries may be cheap, but it is also far less efficient (more on productivity and efficiency later). But for export-based industries, particularly textiles, there is little choice. Undeniable improvements in Chinese labor efficiency cannot offset a 22% tax hit.
The tax comes on top of higher costs in other areas. Everyone in the news is talking about labor prices hurting Chinese competitiveness, but my neighbor had no complaints on that front. Most of his costs are not from labor but rather materials, principally leather, and leather prices are going through the roof because global cattle herd sizes are shrinking. The causality chain is curious. Ranchers want to maximize output per animal due to higher feed prices, which are driven in turn by higher corn prices, so herd growth has halted. A weak corn harvest combined with burgeoning demand for beef push up the price of leather. At the same time policy winds intended to encourage domestic consumption blow sand in the face of the export sector. Eagle Ottawa, and the jobs it created here, are now pulling out.
A rep from clothing retailer H&M made a similar complaint about textiles. They can’t pass on higher prices to consumers, so they are moving production to Thailand.
On paper this is all in service of economic rebalancing, away from exports and toward the domestic market. There will necessarily be some pain, and that’s okay for those who aren’t on the receiving end: “Like surgery with a sledgehammer,” griped Bean. But the risk is, of course, that Chinese labor will not take up the slack. Chinese productivity gains have been outpacing salary increases, and that’s bad: Chinese workers can make more, but they add more value than they can buy, so all this extra product needs to be exported. Attempts to fix the problem through minimum wage increases are misguided populism; minimum wage is supposed to follow average wages upwards, not drag them, and wage hikes have not managed to significantly reverse the decline in labor’s share of GDP.