Enter the Chinese supply side

There are a lot of things about the Chinese economy to be worried about and critical of; for example huge growth disparities between urban and rural areas, a shaky financial sector (see the whole Economist survey on China here) and an undervalued currency. However, if there is one thing which is certain it is that China is and will continue to be a provider of an infinite supply of cheap(est) labor ... right?

(hat tip to Mark Thoma and Edward Hugh) 

Well as we review some of the recent news coming out of China it appears as if conventional wisdom as presented above perhaps needs revision. (walled FT article; see Mark Thoma for a near full version)

"The competitiveness of China’s manufacturing industries has suffered serious erosion over the past year, according to one of the world’s largest trade sourcing companies. Hong Kong-based Li & Fung group (...) “China’s costs are all going up,” Mr Fung said. “It is no longer the most cost-effective country in the region...”"

Businessweek is also on the mark with a very good description and analysis of what is happening.

"Reports of labor shortages first cropped up in late 2004, but companies thought the phenomenon was temporary. Now a surge in both turnover and wage costs is convincing multinationals and their suppliers that the China game is changing permanently. With the gap between wages in China and those elsewhere gradually closing, the pressure to pass price increases on to consumers in the U.S. and other markets will start to build."

What does this mean then?

To answer this I believe we need to look at one of the most notable effects of Chinese exports as it have surged in the recent years; i.e. the deflationary pressure on especially consumer goods which have helped fuel consumption patterns in the west. The 10 mill. $ question obviously is whether (how) we will begin to see the higher price materialize in our own backyards or whether as Edward Hugh points out that activities of production will shift within the Asian region;

"(...) is that China's labour market may well be tightening in the low value added end of the market, and this may see a migration of these sectors to places like Bangladesh, Cambodia and India, in search of ever lower prices. This does not mean that China itself may not be migrating towards higher value added activities where its comparative price advantage may still be significant."  

So China is maturing and moving towards production/activities which yield a higher value added; the big question still is  whether or not this shift in production will mean status quo for price levels or not?

Another thing is the more general supply side discussion; a tightening labour market in certain sectors and/or general bottleneck issues because the educational system cannot keep up with demand and because rural China is still living outside the mainstream perception of the global Chinese manufacturing plant?