Be Careful for What You Wish

Rising labor costs in China may result in increased competition for higher value services.
Jul 02, 2010
Volume 34, Issue 7

Jim Miller
Recently, the business press has been full of articles about manufacturing workers in China demanding higher wages and better working conditions. The highest profile developments have been at the electronics contract manufacturer Hon Hai Precision Industry (Tucheng, Taipei County, Taiwan), which makes a broad range of products, including Apple's (Cupertino, CA) iPhone and iPad. A spate of suicides in recent months has shown a spotlight on the company's employment and led the company to promise a doubling of wages for many of its 800,000 employees. Around the same time, Honda (Tokyo) faced strikes at its Chinese plants and those of some of its suppliers, which forced it to grant a 24% wage and benefit increase.

Government policies are also driving up labor costs, according to press reports. Local governments have decreed increases of 5–25% in the minimum wage paid by companies operating in their jurisdictions, and they are getting tougher in their enforcement of labor, worker safety, and environmental laws. New government policies are also making it harder to fire or lay off workers.

The rapid rise in labor costs is a result of economic and demographic factors in China. The rapid growth of the Chinese economy, which grew almost 12% in the first quarter of 2010, has made it tougher for companies to attract new staff as competition for labor increases. According to the Wall Street Journal, job vacancy postings in China were up 35% in the first quarter.

The pressures have been particularly extreme in Beijing and the coastal cities where much of China's industrial base is located. Costs of living in cities such as Shanghai and Shenzhen are growing rapidly. Although companies and the government are looking to make more investments in inland cities, where wage rates are currently cheaper, it is expected that the wage increases will be felt even there, thanks to fewer people entering the labor force as a result of the government's one child policy.

Rising wages are likely to be accompanied by an appreciation of China's currency, the renminbi. The exchange rates between the renminbi and the US dollar and the euro have been managed by the government to protect the export sector. China has been under growing international pressure to let the currency rise, and the need to control domestic inflation is another driving factor for revaluation.

Good news for bio/pharma

While causing near-term dislocations, most observers believe that the improving wages and work conditions and appreciating renminbi will create a more sustainable Chinese economy, one driven more by domestic spending and less by volatile exports. That's good news for global bio/pharmaceutical companies because it validates one of the major legs of their corporate strategies: pursuing growth opportunities in emerging markets. As they have faced declining opportunities in North America and Europe, global bio/pharmaceutical companies have focused their strategic resources on emerging markets, especially the BRIC countries (Brazil, Russia, India, and China). The key underlying assumption for that strategy is that rising incomes and living standards in those countries will trigger greater spending on drugs. Industry-watcher IMS Health has projected that spending on drugs in China will grow 20% during the next five years.

To take advantage of that growth, global bio/pharmaceutical companies have been investing heavily in those countries through acquisitions, establishment of research and development (R&D) and sales organizations, and in-licensing of products to build their local pipelines. The wage increases in China are an indication that the assumptions and projections underlying those investments are sound.

lorem ipsum