Beyond Revaluation: Why China is on the Brink of Change

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Op/Ed Commentary: David Silverman

Jun. 2 – China is approaching the end of its comparative advantage in labor-intensive manufacturing industries. This is an economic turning point. Structural change will bring unemployment and portends protests, unrest and social upheaval.

China’s coastal region and manufacturing base is suffering from a shortage of workers and many rural Chinese have refused to return after their annual pilgrimage home for Spring Festival. Based on China Daily polling data, 49 percent of non-returning workers cited low salary as their main reason. The jobs and the factory orders are there, the workers are not.

To compensate for this, local governments are increasing workers’ wages and benefits in an effort to lure them back from the countryside: 11 provinces or regions, including the manufacturing powerhouses of Shanghai, Guangdong, and Zhejiang, have announced across-the-board increases in minimum wages. Shanghai is even offering free elementary education to the 400,000 children of the municipality’s migratory workers.

Why are migrant workers refusing to return to the developed industrial clusters on the coast? It is not simply the low wages, unpaid salaries, and poor conditions; rather, China is suffering from a policy success. China’s “Go West” developmental plan, a policy directed at developing industries in the nation’s interior, is enabling migrant workers to stay closer to their homes and families now that local employment is available.

Because of an emphasis on labor-intensive manufacturing, as China’s economy expands labor demand also grows. Manufacturing is nearly 40 percent of China’s gross domestic product – a large proportion for a developing, middle-income country. This is raising the demand, and thus the cost, of human capital and labor.

Exporting firms operating in China’s interior will incur higher transport costs as goods make their way to ports and the consumers abroad. As China’s export-oriented economic model is based on cheap labor producing low-cost goods near international trade routes, if the price of labor and the costs of transport increase so too must the price of the output, and with it, China’s competitive advantage in labor-intensive goods.

Of course, China is also facing challenges from abroad. The United States, the European Union, the IMF, and now Singapore and South Korea have become more vocal in their calls for a revaluation of the RMB.

Economic and social change
The dual pressures of labor shortages and international demands for revaluation may mark the beginning of China’s economic structural change. Theories of modern economic development expect economies to move up the global value chain on the strength of improved human capital. This requires a more educated labor force.

China sends more students abroad than any other nation. Since 1978 until the end of 2008, 1.39 million Chinese students have left home for foreign universities. In 2008 alone, China sent a record 180,000 students overseas. Estimates for 2010 anticipate 220,000 applying to study abroad.

These students will become two distinct and powerful forces in China: as a prized resource in helping propel China’s economy from its overreliance on manufacturing to a more innovative economy with a larger service sector; and as a wealthy class of educated elites who have lived in freer, egalitarian societies and may demand greater liberty at home.

Beijing sees the writing on the wall. The Communist Party of China continues to stress human capital as an important commodity and, in a February statement from the CPC Central Committee, recently urged party members and provincial governments to prioritize talented individuals as the top resource for maintaining social stability and “to transform the mode of economic development.”

In periods of domestic uncertainty, the CPC has a well-practiced policy of piquing nationalist sentiment, usually against the United States or Japan, as a way of maintaining cohesion and deflecting attention outwardly. Thus, if China seemed more intransigent than usual in past months it is because they are seeing the prospect of structural unemployment and social unrest that can often follow in the wake of economic change.

Although Chinese President Hu Jintao reiterated China’s pledge to reform the nation’s exchange rate regime at the U.S.-China Strategic and Economic dialogue, expectations of a sharp revaluation of the RMB should not be expected. Instead, China will enact policies that increase the wealth of its citizens in the short-term and plan for a slow appreciation in the distant future.

David Silverman is a Merit Fellow and MA candidate at the Elliot School of International Affairs at George Washington University.