China’s Economy Starts To Grow Up

China did its consumers a big favor yesterday by allowing its currency to appreciate against the dollar for the first time in two years. Having also tolerated a recent wave of strikes that pushed some wages sharply higher, the Beijing government finally seems to be ready to do some economic growing up.

This is good news for us as well as for the Chinese.

Over the past three decades, a nearly limitless supply of extremely cheap labor powered China’s leap from a commercial backwater to the world’s second-largest economy. But every resource, even China’s supply of workers willing to toil for a pittance, has its limits, and stitching T-shirts can take a society only so far down the path to prosperity. Something had to change, and now it has.

Chinese workers want a bigger share of their nation’s wealth. Increasingly, they are realizing that they have the bargaining power to get it. Factories in the heavily industrialized coastal regions are having trouble staying fully staffed, since unskilled workers are now finding more employment opportunities near their homes in China’s interior. The annual supply of new workers is dwindling, too, which is the inevitable result of the strict one-child family planning policies that the nation adopted in the 1970s.

All over the country, newly vocal workers are striking against long hours and low pay. Foxconn, a Taiwanese company that produces vast quantities of computer and phone components for companies like Apple (AAPL) and Dell (DELL), made international headlines when at least a dozen of its workers reportedly committed suicide within a few months. Foxconn has raised wages by almost two-thirds.

Foxconn may be an extreme example, but it is not an isolated case. Several of Honda’s Chinese factories have been hit by strikes as workers push for better compensation. Japanese companies and their suppliers, including Toyota, Brother Industries, Sharp Electronics and Nikon, in addition to Honda, have been frequent targets. But majority-Chinese enterprises, including a Chinese brewery partly owned by Danish brewer Carlsberg, also have been affected.

Over time, higher Chinese wages will drive some low-value manufacturing away to places where cheap unskilled labor remains abundant. Southeast and South Asian nations like Vietnam, Cambodia, the Philippines, Indonesia and Pakistan may be among the early beneficiaries, though none offers the political stability and relatively well-cared-for population that China provides. Since there is no perfect short-term substitute on the labor side, some of those entry-level Chinese jobs are likely to be automated out of existence.

If this sounds familiar, it is because this is the pattern that most industrialized nations have followed. A population with little access to education, health care, shelter or food will do almost anything to get by. But as that population becomes more financially and physically secure, workers tend to want more in exchange for their labor. Better education and longer, healthier working careers usually make it possible to move up the economic ladder.

This is the process that is taking place in China. Though the country is likely to remain an export powerhouse for decades, higher labor costs will prompt China to focus on higher-value goods. At the same time, more Chinese will be drawn into the country’s still relatively small service sector, and the nation will come to rely more heavily on domestic demand to drive its economic growth.

Allowing China’s currency, the yuan, to rise above the value of 6.83 yuan per U.S. dollar, where it has been effectively pegged since 2008, will increase the price foreigners pay for Chinese products. But it will make imported materials and goods cheaper for Chinese buyers, which will make the wage increases that factory workers are winning go even further.

China’s wage gains and its currency moves are two steps toward a future in which Chinese consumers will consume more and Chinese companies will concentrate more on their domestic market and less on exports. The adjustment is not going to be easy. China’s least skilled workers will have fewer opportunities to earn a paycheck, while Wal-Mart (WMT) and Target (TGT) shoppers around the world will find it harder to buy socks at rock-bottom prices. Retail stocks helped lead the U.S. stock market lower yesterday, largely due to concern that higher Chinese prices are going to hurt low-end American merchants.

In the long run, such pain will be outweighed by China’s emergence as a powerful engine of global growth. Right now, China’s annual output is a little over half the output of the American economy, even though China has four times as many people. Thus, per capita, Chinese output is only around one-eighth the American level. Simply bringing China’s output up to half the U.S. level would create enormous demand in China for materials, goods and services from around the globe. U.S. consumers would no longer be the world’s primary market. American policymakers could encourage our households and governments to get their spending under control without worrying that this would trigger a global recession.

Chinese leaders have for years resisted pressure to boost their currency. They remain very wary of allowing any sort of internal dissent, including work stoppages, that could evolve into a challenge to the regime. So why the sudden change?

Nobody outside China’s opaque leadership can be certain, but the likely answer is that China’s government is becoming more self-confident about the country’s economic strength, and more willing to use that strength to show Chinese citizens that their authoritarian government can deliver the prosperity they want. It is not the democratic self-government that Westerners want to see in a major world power, but it is not a bad thing, either. A more prosperous and self-sufficient China is good economic news for everyone.

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About Larry M. Elkin 564 Articles

Affiliation: Palisades Hudson Financial Group

Larry M. Elkin, CPA, CFP®, has provided personal financial and tax counseling to a sophisticated client base since 1986. After six years with Arthur Andersen, where he was a senior manager for personal financial planning and family wealth planning, he founded his own firm in Hastings on Hudson, New York in 1992. That firm grew steadily and became the Palisades Hudson organization, which moved to Scarsdale, New York in 2002. The firm expanded to Fort Lauderdale, Florida, in 2005, and to Atlanta, Georgia, in 2008.

Larry received his B.A. in journalism from the University of Montana in 1978, and his M.B.A. in accounting from New York University in 1986. Larry was a reporter and editor for The Associated Press from 1978 to 1986. He covered government, business and legal affairs for the wire service, with assignments in Helena, Montana; Albany, New York; Washington, D.C.; and New York City’s federal courts in Brooklyn and Manhattan.

Larry established the organization’s investment advisory business, which now manages more than $800 million, in 1997. As president of Palisades Hudson, Larry maintains individual professional relationships with many of the firm’s clients, who reside in more than 25 states from Maine to California as well as in several foreign countries. He is the author of Financial Self-Defense for Unmarried Couples (Currency Doubleday, 1995), which was the first comprehensive financial planning guide for unmarried couples. He also is the editor and publisher of Sentinel, a quarterly newsletter on personal financial planning.

Larry has written many Sentinel articles, including several that anticipated future events. In “The Economic Case Against Tobacco Stocks” (February 1995), he forecast that litigation losses would eventually undermine cigarette manufacturers’ financial position. He concluded in “Is This the Beginning Of The End?” (May 1998) that there was a better-than-even chance that estate taxes would be repealed by 2010, three years before Congress enacted legislation to repeal the tax in 2010. In “IRS Takes A Shot At Split-Dollar Life” (June 1996), Larry predicted that the IRS would be able to treat split dollar arrangements as below-market loans, which came to pass with new rules issued by the Service in 2001 and 2002.

More recently, Larry has addressed the causes and consequences of the “Panic of 2008″ in his Sentinel articles. In “Have We Learned Our Lending Lesson At Last” (October 2007) and “Mortgage Lending Lessons Remain Unlearned” (October 2008), Larry questioned whether or not America has learned any lessons from the savings and loan crisis of the 1980s. In addition, he offered some practical changes that should have been made to amend the situation. In “Take Advantage Of The Panic Of 2008” (January 2009), Larry offered ways to capitalize on the wealth of opportunity that the panic presented.

Larry served as president of the Estate Planning Council of New York City, Inc., in 2005-2006. In 2009 the Council presented Larry with its first-ever Lifetime Achievement Award, citing his service to the organization and “his tireless efforts in promoting our industry by word and by personal example as a consummate estate planning professional.” He is regularly interviewed by national and regional publications, and has made nearly 100 radio and television appearances.

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1 Comment on China’s Economy Starts To Grow Up

  1. The last time China allowed the currency to appreciate,2005-2008, the world economy was booming. Today, there is no boom. I fear more expensive Chinese goods will result in reduced demand. If Chinese demand cools, so will China's demand for factors of production and other raw materials. The Chinese train that try to pull the world economy may end up losing steam.

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