Location, location, location
Since 2005 when China adopted a crawling peg currency regime the Chinese yuan has appreciated by over 25%[1] against the US dollar and manufacturing wages have increased by 165%. Over the same period US manufacturing wages have increased by 19%. From these headline numbers it would be easy to deduce that the cost of doing business in China has risen and that the trickle of companies opening facilities in the US and Europe rather than Asia could be about to turn into a torrent.

But labour costs in China vary considerably depending on location. The average monthly wage of a worker in Chongqing in central China is 25% lower than in the traditional manufacturing export zone of Guangdong in Southern China. In other provinces such as Gansu, Guizhou and Jiangxi wages are cheaper still. As China continues to spend on infrastructure the unlocking of lower cost labour pools should allow the fleeter-footed manufacturer to alleviate the rising like-for-like cost in wages[2].

Wages are only one part of the equation
The US has done an impressive job of improving productivity over the last eight years to the point that productivity gains of 21% since 2005 have exceeded wage growth in the manufacturing sector, suggesting that unit labour costs have fallen over the period. Productivity gains have also been an important factor in China as the output per worker has improved from around 13% of its US equivalent to 17%, which on a productivity adjusted basis accounts for approximately 40% of the increase in wages.
Wages are also not the only part of total employee expense. Benefit costs such as pension contributions, healthcare and leave entitlement account for around 35% of total employee cost across the manufacturing sector in the US. More importantly, benefit costs have grown significantly faster at 51%, on a cumulative basis, than wages (29%) since 2002. Although benefits are likely to have grown in China as well, costs tend to be far lower in the developing markets than in the West.

What about the rest of Asia?
Surely as production costs in China rise then other Asian countries will benefit as multinational companies diversify their production bases to gain access to a lower cost labour force? Indonesia and the Philippines, with unit labour costs roughly one third of China’s, have benefited from this trend but once productivity, infrastructure constraints and currency appreciation are taken into consideration then only the most labour intensive industries have made the switch.

Steeply rising costs are not just a Chinese phenomenon. In 2012 average manufacturing wages rose by approximately 13% in Thailand, 16% in Indonesia, 18% in Myanmar and 21% in Vietnam. Meanwhile, minimum wage levels were introduced for the first time in Thailand, Malaysia and Vietnam. With political tension rising over the widening wealth gap between the rich and poor in most developing Asian countries, we expect that wages will continue to rise, although not at the same speed seen in recent years now a lot of the initial adjustments have been made.

Access to local markets
The debate over the competitiveness of Asia will run for some time but the truth of the matter is that foreign direct investment is driven as much by desire to access local markets as it is to benefit from lower production costs. In 2006 58% of China’s exports were produced by foreign enterprises but by 2012 this number was down to below 50%[3]. As Chinese exports have grown on average by around 15%[4] per annum between 2006 and 2012 some commentators will deduce that this is down to China’s higher costs and lack of competitiveness. In reality it is much more likely that as China continues to grow at rates considerably higher than the developed world, more and more of the goods produced by foreign companies will be consumed domestically rather than exported.

This will always be the attraction for foreign companies investing in emerging markets because an initial investment to lower production costs ultimately becomes a base to satisfy local demand as emerging economies develop. Ironically, the rise in wage costs, which ultimately leads to an increase in production costs, is also the driver of disposable income. This in turn increases domestic demand.

Foreign investment into Asia is set to continue
In summary, Asia is losing some of its competitiveness through rising wages and currency strength but not to a point where the region will cease to attract foreign manufacturing investment. Although the focus will increasingly be on domestic consumption within the local markets, major global players will need to continue to gain access to Asia’s massive consumption potential.

Mike Kerley, Fund Manager of Henderson Far East Income Limited

All information sourced from CLSA Asia-Pacific Markets Research, 3 April 2014, unless otherwise stated.
[1] Thomson Reuters Datastream – Chinese Yuan to US dollar from 01.01.05 to 18.04.13
[2] www.China-briefing.com. A complete guide to China’s minimum wage levels, January 2013.
[3] CLSA
[4] Bloomberg