China's exports: Is the golden age of cheap labor coming to an end? (Part 5 of 6)
(Continued from Part 4)
GDP in the United States and European Union
The below graph reflects ongoing trends in the gross domestic product (GDP) growth rates in the United States and European Union, major destinations of Chinese exports.
With slow economic growth in the United States, and the EU gross domestic product finally hitting positive territory (+ 0.3%) after six quarters of recession, rising labor costs in China have led to higher prices, as noted in the previous parts of this series. As a result of soft global growth and rising prices in China, China’s GDP growth forecasts have been revised downward by the International Monetary Fund to 7.75% from 8.0%. Slow growth in the United States and European Union, as reflected in the above graph, have cooled demand for Chinese exports.
One study by Alix Partners estimates that, should the Chinese yuan continue to appreciate at 5% per year and labor costs by 30% per year, basic labor costs in China would be roughly equal to those in the United States by 2015. Such estimates might be a little stretched given current economic developments, though the trend should be clear: if not in three years, perhaps within six years, China could see its “terms of trade” advantage of abundant and cheap labor winding down. Plus, the advantage of a weak currency continues to wane, as the China Central Bank (PBOC) allows the yuan to continue to appreciate against the dollar and euro.
As noted in the prior sections in this series, the Chinese yuan has appreciated rapidly against its regional competitors of Japan and Korea during the past year, while the more recent rate of appreciation against the U.S. dollar of closer to 3% has slowed to closer to 1%. Should this trend continue, China will face increased export competition from its regional competitors of Japan and Korea, while selling its products into soft U.S. and European economies. These developments suggest that the growth rates of China will likely be under pressure for some time, and that the age of cheap labor is on the wane.
China’s economy has grown significantly from a very low base over the past 20 years, while being pegged to a fairly weak U.S. dollar. China has sold its exports into an increasingly consumerism-based economy in the United States since 1980. After the creation of the euro post-2000, China has also enjoyed strong markets in the European Union. Things haven’t been so rosy since 2008, and should the current environment of slow growth continue in the European Union and United States, there’s little doubt that China will have to rely increasingly on its own domestic consumption to support its historical economic growth rates.
Can China replace export growth with domestic consumption?
Japan was also in this position after the 1990 bubble burst, and had little success in stimulating domestic consumption in a deflationary environment. In contrast, nothing seems to stop the U.S. consumer. The Asian penchant for saving was a blessing during the early phase of economic development, requiring aggressive capital formation and investment. However, high savings rates can be a curse when exports, domestic economic growth, and interest rates decline, setting the stage for a deflationary spiral. You’d hope China could achieve post-2013 what Japan failed to achieve post-1990. Perhaps China will have greater success in fostering the culture of consumption over savings, and thereby rely less on strong growth and consumption from both the United States and European Union.
For investors that think that China can orchestrate a soft landing without significant disruptions to the banking system, contain inflation, enhance productivity, and grow domestic consumption, perhaps the weakness in Chinese equity prices over the past two or three years would present a more attractive price. China’s iShares FTSE China 25 Index Fund (FXI) is down roughly 25% from its November 2011 post-2008 highs. For China skeptics seeking to embrace the more recent economic trends seen in Japan and the United States, as reflected in Japan’s Wisdom Tree Japan Hedged (DXJ) and the iShares MSCI Japan (EWJ), as well as the USA S&P 500 via the State Street Global Advisors S&P 500 SPDR (SPY) and Blackrock’s S&P 500 Index (IVV), the U.S. and Japanese markets may appear more attractive than China’s iShares FTSE China 25 Index Fund (FXI) and South Korea’s iShares MSCI South Korea Capped Index Fund (EWY).
Continue to Part 6