Window of Opportunity for South Asia

The 10th National People’s Congress and the Chinese People’s Political Consultative Conference held in March this year have been an excellent platform to understand which way China is heading as far as its economic and political reforms are concerned.

China’s future pattern of economic development received top priority in the assembly. In this connection, one of China’s key strategic imperatives is to shift its economic structure towards high value-added manufacturing and services.

Such a move will produce winners and losers – both at home and abroad. With this likely transformation, China could lose competitiveness in low value-added manufacturing but stand to augment its share in high-end manufacturing and services.

Such transformation is likely to affect South Asian economies that have abundant supply of labour owing to their favourable demographic windows, with the exception of Sri Lanka. Most South Asian countries’ transition from agriculture to industry has been suppressed due to, among other things, the rise of China, the de facto global factory.

Banking on low labour cost advantage along with other supporting policy measures, South Asia could see the rise of low value-added labour-intensive manufacturing activities. Nevertheless, India is well-positioned to become an important centre for even high-end manufacturing.

Development constraints

China’s focus to develop high value-added industrial and service sectors is owed to several imperatives. China’s scarcity of arable land constrains the expansion of its industrial production horizontally. A survey released in 2006 by China’s Ministry of Land and Resources revealed that the country lost eight million hectares (6.6 per cent) of its arable land in the period of 1995-2005. China’s arable land is merely 15 per cent of its total land. Its per capita arable land is 0.11ha, which is less than 20 per cent of the United States’ and 75 per cent of India’s. Further shrinkage of cultivable land could jeopardise China’s food security.

Unit labour costs is one of the important determinants of low valued-added industrial output. Per unit labour costs in China is skyrocketing. Its rising labour productivity grew at 7-13 per cent in the past two decades.

As China’s demographic window closes, its median age population approaches to 35 years old (compared to 25 of Bangladesh). China’s young population between the age 14-25 is projected to decline from 229 million in 2010 to 199 million in 2015. The corresponding figures for India are 234 million and 242 million respectively. So, the rise of labour cost would be a permanent rather than a temporary phenomenon.

Nevertheless, higher real wages are a corollary of economic growth.

The shortage of labour is indeed already felt in thousands of factories in China. The lack of workers is particularly acute in the country’s two major manufacturing hubs – the Pearl River Delta and the Yangtze River Delta. The Chinese government data shows that in Guangdong province there was a shortage of half a million workers in 2009. The figures for Fujian and Zhejiang provinces were 300,000 and 200,000 respectively. This has lifted factory wages 20 to 30 per cent.

In recent months, some factories (Foxconn, for instance) raised wages as much as 70 per cent. Many companies are already moving from coastal areas to inland, particularly to Wuhan, Chongqing and Hunan. A Goldman Sachs research report shows that there are plenty of workers in China but the supply of unskilled workers is shrinking.

Then there is a much-debated issue – China’s exchange-rate policy and global imbalances which is prompting China to go vertical. Beijing’s undervalued exchange-rate policy that suppresses the consumers and rewards the producers is believed to be a cause of strain in the global economy.

Following the recent global financial crisis, there is a realisation among the top Chinese leaders that the country’s current growth model that relies excessively on exports and investment needs to be rebalanced, with a greater emphasis on consumption. Development of high-end manufacturing and service sectors is the key in this regard.

Economic literature suggests that service sector places less pressure on natural resources and creates more jobs than manufacturing. A higher share of employment in the service sector raises both labour income and the availability of services which can raise private consumption. Empirical evidence shows that China has a far lower share of employment in the service sector than other comparable economies that experienced a similar economic transition.

For instance, in China only 33 per cent people work in the service sector. Whereas in the case of Japan, the share of employment in the service sector rose around 60 per cent in 1987 from around 38 per cent in 1955. In South Korea, employment in the service sector rose around to 65 per cent in 1995 from 30 per cent in 1961.

To transform high value-added manufacturing and service economy, China is spending billions on research and development (R&D). China’s R&D expenditure amounted over US$122 billion in 2008, making it the third largest spender after the US and Japan, and accounted for 11 per cent of global R&D.

Low-cost labour

China’s vertical economy could create much room for South Asia’s low-end labour-intensive manufacturing that had faced Chinese competition until recently. Bangladesh’s per capita manufacturing value-added, for instance, is less than US$100, compared to over US$700 for China. China’s shift is already felt in some parts of South Asia. Bangladesh, for instance, is set to become a hub for low value-added apparel products. According to Jassin O’Rourke, a textile consulting outfit, with 22 US cents per hour or five times lower than in China’s richest coastal areas, Bangladesh is the lowest-cost producer of apparel items.

This is prompting the world’s leading apparel buyers – from Wal-Mart to JCPenney – to strengthen their presence in Bangladesh. Jassin O’Rourke also reveals that seven Asian countries are now offering lower labour costs than China. Similar opportunities could arise in the production line of toys and sporting goods equipment.

However, India’s manufacturing potential is not merely limited to low-end products. As consulting outfit Deloitte observed in one of its recent reports: ‘Beyond low-cost, Indian manufacturers gained experience in quality improvement and Japanese principles of quality management, with the largest number of Deming Award winners outside of Japan.’ India is rapidly expanding its capabilities in engineering design and development and embedded software development, which form an integral part of many modern-day manufactured products, the report noted.

This said, South Asia’s favourable demography might not be enough to reap the benefits from China shift. In two key areas pertaining to manufacturing competitiveness – talent-driven innovation and labour cost – South Asian economies have substantive advantages. However, they need to work on a plethora of issues – energy supply, physical infrastructure, labour law, land acquisition, legal and regulatory system and government investment in R&D – to become Asia’s next manufacturing centre.

This article appeared in the BUSINESS TIMES, July 9, 2010