Pros and cons of rising labor costs

But there is a silver lining to these seemingly negative developments. The increase in ULCs in the industrial sector may contribute to the needed shift in China's economic growth model. Three structural trends are supportive of this aim.

First, labor shortages have begun to loom large in China's increasingly fragmented market not only because of a decline in the supply of labor, but also because specialization in production requires workers with specialized skills. In addition, the shift of enterprises to the inland has led to creation of jobs closer to migrants' homes. In 2011, workers getting employment in their home provinces accounted for more than half of total migration. Proximity to inland urban households could soon be of greater relevance beyond the labor cost issue, given the prospects of higher incomes and, hence, consumption in China's inland cities.

Second, the services sector is to a large extent underdeveloped and has the potential to contribute to job creation on a wider scale. Services account for the largest share in employment but for less than half of GDP growth.

Third, ULCs are rising fastest in labor-intensive sectors. ASEAN countries have been the main beneficiaries of this development through closer integration into China's supply chains - although ASEAN's advantages are not without limits. In Vietnam, for example, real wages in the manufacturing sector increased 9.7 percent a year from 2006 to 2011, not far behind China's wage growth, while its labor productivity was only 26 percent of China's. Other countries, like Indonesia and Thailand, have increased minimum wages in key industries not unlike the increase in China's minimum pay.

In conclusion, the structural changes taking place are sometimes masked by the sole focus on China's diminishing cost advantage. Wages are sure to increase , and are in fact a political imperative, but increasing efficiency can offset them at least partly. The labor market can be a contributor to growth if urbanization and reform of the hukou (house registration) system allow for a better matching of skilled labor with specialized demand in higher value-added industries.

The author is an economist with Deutsche Bank.

(China Daily 05/28/2013 page10)