Chinese factories fight a wages inferno

China is short of people. More specifically, there is a shortage of skilled labour, a trend that is driving wages higher and threatening to undermine China's international competitiveness – especially when compared to low wage competitors such as India, Vietnam and Indonesia.

As a result, China is opening its doors to targeted immigration specifically for the purpose of providing cheap labour as it tries to dampen the wages boom. Workers from North Korea are being allowed and encouraged to go to China and to work for wages around $US200 to $US300 a month, a rate some 60 per cent lower than locals are paid.

In recent months, China has allowed around 40,000 "industrial student” visas for North Korean workers to work in Chinese factories and mines. Various press reports suggest that by the end of 2012, there will be 120,000 North Korean industrial student workers in China.

North Korea allows its citizens to participate because of the boost to incomes for those involved, including the benefits that come with the repatriation of cash back home. North Koreans factory wages are around $US110 a month, making the move to China potentially lucrative. For the Chinese authorities, these workers are a type of quick fix to the labour shortage problem.

Not only are labour costs in China well above those in emerging Asian economies, but current estimates suggest that factory wages in China are set to rise above those in Mexico and will overtake those in Brazil if current trends continue for the next few years. This could present additional problems for China given the close trade ties Mexico and Brazil have with the US.

China's unrelenting economic boom over the last two decades means that strong real wages growth is inevitable. It is also a highly desirable aspect of China's industrialisation as the benefits of the boom are shared, but there are some consequences for its long-run competitiveness. As this unfolds, there are risks that the global economy could be starting to see the end of the era of falling prices for many manufactured goods from China that helped to keep global inflation low.

While the new Chinese leadership remains committed to strong economic growth, and with that rising incomes, it recognises that the economic boom needs nurturing. In other words, a good old fashioned wage price spiral is to be avoided at all costs.

Average urban wages in China have risen at an annual pace of 12 per cent so far in 2012, a little below the 14.4 per cent rise of 2011 and 13.3 per cent in 2010. Part of this moderation is due to the fact the economy has slowed and inflation is decelerating, both of which have lessened wage demands. That said, at a time when inflation is around 2 per cent, 12 per cent wages growth is clearly very hot.

Over time, such wage gains are unsustainable. High wages growth at a time of slow economic demand, particularly in the global economy, also eats away at company profits. The surge in wage costs is an important reason why the Shanghai Composite stock index has been one of the weakest stock markets in the world in the last few years. The Shanghai Composite index remains weak, having fallen around 30 per cent since the start of 2011, and it is down around 65 per cent since the peak in late 2007.

But herein lies the possible dilemma for China. Economic policy is being set to drive GDP growth at around 7 per cent per annum for the next decade, a growth rate that will inevitably lift living standards and real wages. At the same time, productivity must rise rapidly if the loss in competitiveness from higher wages is to be contained. On that score, education, skills development and the adaption of technology will help unpin productivity growth, but the race between wages growth and productivity is currently very close.

The rise in wages growth is not all bad news. On the contrary, the surge in real wages has obvious benefits. It is part of the long-run rebalancing of the economy towards domestic demand with higher personal consumption a major beneficiary of strong wages growth. Rising wages and living standards also supports spending on education, a vital element behind higher productivity. Politically, rising wages helps keep the population happy and lessens the risk of social unrest.

China's economic boom continues to roll on. It is good news. That said, there are some risks that flow from it, particularly from wages costs and skills shortages. The scope for North Korea to keep on providing cheap labour can only go so far. The challenge for policy makers will be to increasingly link wages growth to productivity or to keep a lid on wages via some other means. It is a challenge that Australia and the rest of the world hopes China gets right.