South China’s Balancing Act Between Raising Wages & Keeping Investors

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Vietnam Beckons as South China Governments Walk a Development Tightrope 

Op-Ed Commentary: Alberto Vettoretti, Managing Partner, Dezan Shira & Associates

Annual increases in Chinese worker salaries and the increasing mandatory welfare costs associated with this are making some local governments in China have to strike a fine balancing act. On one side are investors facing increasing overheads at a time when Chinese exports are weak. On the other is social discontent from workers demanding higher salaries and benefits.

In South China for example, minimum wages were last increased in Dongguan, Foshan, Zhuhai and Zhongshan on a mandatory basis on May 1st of last year. This year, no announcement has been made, although rumors are the increase is being deferred a few months to August.

There are signals that local governments are now having to strike a balancing act between making companies happy (with no further labor cost raises) and workers demanding higher salaries – which will attract more workers and increase local consumption. In terms of social insurance, although this is compulsory, some local companies have been late in paying their obligations in full.

Interestingly, although workers can complain to the local government about such practices, the local government also has the ability to turn a blind eye if it suits them and to suppress discontent. The push to force companies that aren’t up to speed with social welfare payments can be described in South China as “mild.” Furthermore, a project undertaken by Dezan Shira & Associates a few years ago looking into the legal due diligence of whether mandatory welfare payments really were mandatory or could be “negotiated” with the local government found that the government held the upper hand – and does have the right to accept negotiated settlements on behalf of workers. “Mandatory” it seems, is negotiable, albeit probably not for foreign investors.

While this does create an unlevel playing field between what local Chinese companies can get away with compared to foreign investors, foreign investors too can face some strange paradoxes as a result of mandatory welfare payments.

For example, local companies often ignore the mandatory welfare altogether but buy the assent of Chinese workers by passing on part of the savings to them in increased cash-in-hand.

A recent strike at a large shoe manufacturer in Dongguan was due to the fact that the foreign investor wanted to “pass on” to the local worker the individual contribution part of social welfare – in accordance with the law – while the workers demanded the same take-home pay they had been getting without being in full compliance. The governments then get stuck in the middle as a result of this duplicity and discrimination. They tend to limit their role to ensuring that the situation does not get out of control by deploying local police, while at the same time gently squeezing the foreign employer to raise salaries to keep workers happy – and in compliance. It is uncertain how long this state of affairs can last.

Suffice to say that for local governments, the balancing act between ensuring investors can survive and that workers expectations are met, is a complicated one.

China has high compliance costs for operating a business and employing a large number of staff, and even more so in the case of closing down or moving elsewhere with the related HR implications for investors.  Many investors would, if pushed, simply scale down their operations and start elsewhere.  That may yet become an issue in South China especially, with Vietnam expected to come into ASEAN Economic Community (AEC) compliance at the end of next year.

If that happens, and the lower corporate tax rates of 20 percent, which Vietnam (compare with 25 percent in China) has said it will introduce occurs, local governments could start to face some serious headaches in the drive to maintain increasingly higher salaries and social welfare, yet still keep investors happy.

But not all is doom and gloom, and there is possibly a way out. The problems discussed tend to be limited to certain sectors only, with textiles, and light manufacturing being hard hit, but added value hi-tech and electronics manufacturers remaining, for now, relatively unscathed.

Local Chinese governments having to find a balance to increase employee wages and welfare, yet keep investors happy, are finding this balancing act increasingly linked to specific industries – and their integrated supply chain. If this state of affairs starts to become expensive to maintain though, problems will occur. Logistics costs in China need to be kept low to compensate for increasing worker expenses.

What’s Hot in South China?

Electronics, especially high-end electronic equipment, new materials, high-end accessories and fashion products, spectacles, high-end white goods, plastic  moldings, PCBs and similar industries – these market sectors are all doing well. One of the advantages of a city such as Dongguan is the fast and efficient “time to market” factor, from a product’s conceptual design to final mass production. All this can be done in an efficient and swift fashion given the fact that the region still boasts a dynamic and highly integrated supply chain.

What’s Cold in South China?  (and likely to relocate to Vietnam)  

Low-end manufacturers in traditional industries such as shoes, garments, textile, and leather have long expanded operations elsewhere. Chinese, Taiwanese and Hong Kong subcontractors of larger brands have been the first movers by adding additional production facilities in cheaper locations either in China or in Southeast Asia.

Vietnam, as part of ASEAN, is especially seeing a trend towards manufacturers in these industries leveraging ASEAN to take advantage of the ASEAN-China Free Trade Agreement and sell Vietnamese-manufactured products back onto the China market.

Larger brands involved in more high-end products are also looking at geographical diversification. While in the past they were sourcing all their products from China, right now they want to move some of their production to other countries like Vietnam and Indonesia to lower overall costs, tap into other regional markets, and also benefit by the new free trade agreements which will potentially increase their sales margins in traditional markets like the U.S. or the EU.

The Japanese and Koreans are also investing a lot in Vietnam at present, where they are finding a more welcoming political and operational platform, and better tax incentives from which to develop an export hub. A recent example is the massive Samsung mobile phone plant in Thai Nguyen, a US$3.2 billion facility. Vietnam’s FDI performance last year far outstripped expectations.

Whether or not China’s local governments can maintain what is fast becoming a three-way balancing act to keep business in China in the face of rising labor costs, regional competition and a seemingly insatiable demand for more money by its own workers remains on a knife edge. A decision by one of the local governments not to raise annual minimum wages may yet draw a yardstick as to how much is too much.

Dezan Shira & Associates is a specialist foreign direct investment practice, providing corporate establishment, business advisory, tax advisory and compliance, accounting, payroll, due diligence and financial review services to multinationals investing in emerging Asia. Since its establishment in 1992, the firm has grown into one of Asia’s most versatile full-service consultancies with operational offices across China, Hong Kong, India, Singapore and Vietnam in addition to alliances in Indonesia, Malaysia, Philippines and Thailand as well as liaison offices in Italy and the United States.

For further details or to contact the firm, please email china@dezshira.com, visit www.dezshira.com, or download our brochure.

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