The strike at Honda Auto Parts Manufacturing in Foshan, which brought several Honda plants across the country to a standstill last week, is not as unusual as casual observers of China might think. The Chinese government has a reputation for cracking down harshly on workers who dare to organise themselves beyond the confines of the All China Federation of Trade Unions, China’s highly politicised and sole authorised union body. However, in practise there are many strikes across China each year—I witnessed yet another small-scale taxi strike near Guilin this last month, and have heard of a number of other minor incidents of labour unrest involving multinational firms in the last year.

What it does highlight is the ongoing challenge faced by foreign investors in China in dealing with HR issues. As a recent article from China Funds Online highlights, they have to face deep unhappiness at the vastly different pay scales between their expatriate employees, who often appear to have a lock on senior positions, and local staff. It doesn’t help that firms are not really moving up the value chain very quickly, as foreign companies seek to protect their IP by keeping production of more advanced parts offshore — together with the more skilled and highly paid jobs needed to produce them.

Indeed, the pay divide between Chinese car companies’ employees actually seems to be getting worse, as firms avoid investing in their employees’ development and future careers (partly for fear that in the competitive job market they will jump ship), and instead bring in more workers at the lowest end of the pay scale.

The article accurately nails one of the big causes of resentment for workers in the car industry: the flood of new “student apprentices”, who are hired partly to get round minimum wage laws. I have no knowledge of whether this happens at the Honda plant, but it’s certainly very widespread practise in the industry. What the reporters have not clarified so well is how companies use these cheap workers, often employed on temporary contracts, to give them more flexibility, while protecting a “golden core” of privileged workers on longer term contracts. It is interesting to speculate whether the recent surge of hirings to boost production in the wake of the 2009-10 boom in car sales may have upset the delicate balance between these two sets of workers. 

For the government, the Honda strike has got to be ringing alarm bells. Unions have always thrived in the hearts of the world’s automotive manufacturing hubs, and in places like South Korea their feisty members were and are often at the centre of political activism. To date, the government has managed to keep labour unrest pretty much confined to small scale incidents, but imagining the worker response if a sharp downturn in demand for cars hit production and forced massive lay-offs across the sector must keep officials awake at night.

Duncan Innes-Ker is a senior economist with the Economist Intelligence Unit, based in Beijing

Industry, Labour markets

The US China Strategic and Economic Dialogue has come and gone with no change to the yuan dollar exchange rate.  The US side appear to believe that the G20 in late June will be the new focus for pressure on China.  But market expectations of a resumption of appreciation have collapsed.

This is the view on the pros and cons (mainly cons) of yuan appreciation from Central University of Finance and Economics Professor Guo Tianyong, which I have translated in summary fashion from a recent posting on his blog:

‘We are going through a period of radical transformation in the structure of the Chinese and the world economy.  China will no longer be able to rely on the luxurious consumption of consumers in the West to drive growth, but will have to look to internal drivers.  In this context, rapid appreciation of the yuan would not provide a stable basis for changing the economic structure.

Second, as everyone knows, Chinese industry benefits from controlled domestic prices for important inputs to production - energy and water prices for example.  These controlled prices have been beneficial but have also introduced distortions into the economy and high levels of pollution.  Removing controls and bringing prices up to market levels is now a priority, but this will mean higher costs which will damage the competitiveness of China’s exporters.  Rapid yuan appreciation on top of higher factor costs would place too great a strain on our businesses.

Third, though some people claim that appreciation of the exchange rate can be used to control inflation, and China is faced with inflationary pressure, in fact the relationship between the exchange rate and inflation is not straightforward.  During the period from 2005 to 2008 faster appreciation appears to have been linked to higher inflation - not the other way around.

Turning to the impact on business, the impact of appreciation would vary from industry to industry and from company to company.  For commodity importers, and companies that want to invest overseas, a stronger yuan would be a positive.  For exporters, it would weaken their competitiveness.

For the export sector, textiles, electronics, light industry, and machinery and power generation make up 70% of exports and employ more than 70m people.  These are low value added industries that compete on price and make profits from high volume.  Our research indicates that these firms use mainly domestic inputs, so they would not benefit from cheaper imported input costs if the yuan appreciates. 

Our research also indicates that the after tax profits of these firms is already very low - close to 5% in the second half of 2007.  An appreciation of the yuan would therefore have a serious impact on them, and so on the wider economy.

For importers, the benefits of yuan appreciation would be limited.  China is a major importer of raw materials and an appreciation of the yuan would certainly reduce the cost.  But as the recent debacle over the pricing of iron ore indicates,  control of the price of commodities lies outside of China’s hands, and this would be the case no matter what the value of the yuan.

Summing up, the evils and maladies of a large yuan appreciation outweigh the benefits, and gradual appreciation is still the best strategy.’

Professor Guo is not adverse to the use of loaded rhetoric (references to the ‘luxurious consumption’ of the USA) or examples (the iron ore price negotiation - which has little to do with the subject at hand but is an emotive point for Chinese nationalists). 

But he is an influential economist within China, and it is interesting to see how points which  in the US and elsewhere would help make the case for rapid appreciation are here used to make the case for a more gradual approach. 

Secretary Geithner might argue that appreciation of the yuan is part of the adjustment of the Chinese economy.  Prof Guo argues that because China is adjusting the structure of its economy it cannot be expected also to rapidly appreciate the value of the yuan.

You can see the original blog posting here.

Exchange rate, Industry, Trade, US-China Relations, Uncategorized

China and US leaders are about to kick off this year’s meeting of the Strategic & Economic Dialogue with opening remarks.  I have an op ed on the talks in today’s South China Morning Post.

SCMP subscribers can read the article here, or I’ve pasted it below:

Don’t Mention the Currency

A sunk ship in South Korea and a sinking economy in Greece may be enough to scupper hopes of movement on the exchange rate at the US China Strategic & Economic Dialogue

China is a currency manipulator and unless they change their wicked ways we will take them to task: that was the message from Senator Barack Obama on the 2008 Presidential campaign trail.  Back then, the exchange rate was 6.83 yuan to the dollar.  Almost two years and one global financial crisis later, the exchange rate is still 6.83 yuan to the dollar, and President Barack Obama and his team have fallen strangely silent.

One reason for that silence might be that an informal understanding between Beijing and Washington has been reached.  Back in April, the US Treasury decided to delay publication of a report to Congress on international exchange rates - a report which might have officially designated China as a currency manipulator.  That decision came shortly after a visit to the US capital of one Zhong Shan, China’s vice Commerce Minister.  Whispers from Washington suggest that, though no concrete assurances were given, Zhong’s visit did at least result in a meeting of minds.  The US would dial down the rhetoric on the exchange rate and China would proceed with appreciation, at its own pace, but within a reasonable time frame.

For many in Washington, a reasonable time frame meant before the next meeting of the Strategic & Economic Dialogue - the annual US China talk fest which is set to take place in Beijing on the 24th and 25th May.  But with the talks about to commence, expectations of an early resumption of appreciation appear increasingly misplaced. 

Why the delay? Look no further than the European sovereign debt crisis.  The EU might have belatedly mounted its white horse to ride to the rescue of the Greek damsel in distress.  But the episode has rung alarm bells in Beijing, suggesting that the global financial crisis has yet to run its course and the time for the resumption of yuan appreciation is not yet right.

If a resumption of appreciation in advance of the meeting was too much to hope for, maybe a little table thumping in the meeting itself will do the trick? 

Probably not.  On the US side it is the State Department that’s calling the shots, and that means a focus on the strategic, not the economic, half of the Dialogue.  The sinking of a South Korean navy ship, with the deaths of 46 sailors on board, has raised the temperature on North Korea.  With an official investigation placing the blame squarely at the door of Pyongyang, shaping a response has risen to the top of the agenda for the Dialogue.  And with the focus of attention elsewhere, there is little hope of progress on the exchange rate.  Officials on both sides have already begun to talk the issue down.

A sinking economy in Greece and a sunk ship in South Korea might be enough to scupper hopes of a move on the exchange rate at this week’s Dialogue.  But excuses will do little to appease an increasingly vocal domestic lobby in the US.  Trade unions, industrial interests, and a Congress spoiling for a fight might have bought into the Treasury’s softly softly approach in the run up to the Dialogue.  But continued inaction may well use up scarce supplies of patience. 

The Treasury has signaled that it wants to see a multilateral solution to the problem - hinting at a resumption of appreciation ahead of the meeting of the G20 in Canada in June.  But if no action is forthcoming by then, domestic interest groups might start to ask what President Obama has done to make good on his campaign trail promises.

EU-China Relations, Exchange rate, Financial Crisis, International Relations, US-China Relations

China’s growth in the last 30 years has been impressive.  But perhaps the last 30 years have been the easy part.  Anyone can build factories to copy goods designed elsewhere in the world.  The difficult part starts when an economy has caught up to the global technology frontier, and has to start thinking for itself.

That is when the education system starts to be really important.  A bad education system is not going to produce good innovators.  I don’t think there is any question that the Chinese education system is good at instilling basic skills, and there has also been a massive increase in those attending university.

But what is less clear is whether the Chinese education system teaches the kind of critical thinking and problem solving skills that underpin an innovative economy.

The author of this recent article, which I have translated from the China Youth Daily, thinks not:

‘There was a story recently about a child taking an exam who said that ‘flat’ was the opposite of ’round’, only to be marked wrong because the standard answer was ’square’.  Leading scholars have remarked that they would not score well in today’s examination system because the important thing is not to know the right answer, but to know the standard answer.

I’d even venture to suggest that if Deng Xiaoping himself took an exam in today’s education system on Deng Xiaoping theory, he’d be hard pressed to get full marks.  Let’s have a look at the reality

A self study guide to exams on Deng Xiaoping theory has the following sample question: use the theory of ‘one country two systems’ to reflect on Hong Kong’s reunification with the motherland.’

It seems like many people could have different responses to that question.  One person might respond that the return of Hong Kong to the motherland was a sign of increasing national strength.  Another might say that the ‘one country two systems’ approach had allowed Hong Kong to continue to flourish after reunification.  A third might add that the ‘one country two systems’ approach could also be used in respect of Taiwan.

From the point of view of common sense, we couldn’t say that any of these answers were wrong.

But according to the the standard answer, there is only one correct response, and none of the reflections on Hong Kong’s flourishing, applications to Taiwan, or anything else that did not fit would have scored full points.

If Comrade Deng was still alive and someone asked him that question, how would he respond?  Comrade Deng was a man of lively mind, he would have modulated his response according to the situation, according to with whom he was speaking, or just to have a different turn of phrase.  In a test on his own theory, Comrade Deng would be hard pressed to score full marks.

These days, lots of people ask why China has not produced any great thinkers.  Do the great problems of today have standard answers?  So will an education system based on repeating standard answers produce great thinkers?’

You can see the original article in Chinese here.

Culture, Social Policy

Carnage on the mainland’s stock markets yesterday, with the Shanghai Composite Index falling more than 5% to close to 2500.  You can take your pick of possible explanations, with fears of tighter economic policy, concern about the outlook for the real estate sector, and uncertainty about the global outlook in the wake of the European sovereign debt crisis the favourites.

One intriguing alternative which has been doing the rounds in the Chinese press, is the idea that the introduction of index futures has created an incentive for big investment funds to push the index down.

The idea is that if you have a significant enough share of the market, you can short sell futures contracts at a value for the index of say 3000, then start selling your equity holdings to drive the level of the index below 3000, exercise your futures contract, and buy back your holdings at the lower price point - making a tidy profit in the process.  Liaowang has a lengthy article explaining how it all works here.

Deliberately manipulating the market to increase profits for your firm is obviously pretty dodgy.  But it gets even worse. This article suggests that some fund managers are actually short selling futures on their own account, then using the fund they manage to drive down the value of the index - profiting themselves at the expense of their customers.

Investment, Stocks

Regular readers might remember that a few weeks ago I posted a translation of the opening pages of ‘Brothers’, Yu Hua’s riotous epic of life in cultural revolution and reform era China.

The plot has now moved on from an adolescent Li Guangtou caught peeping in the public latrine.  Li Guangtou’s business instincts were evident when he demanded, and received payment of seafood noodles for relaying a description of the ladies’ bottoms he saw that day to Liu Town’s curious menfolk.  In reform era China, those instincts have made him a rich man.

Li Guangtou likes to joke that ‘in the day he collects profit, in the night he collects women.’  He hopes to be able to collect both together when he organises China’s first beauty pageant for virgins.

With CNY1m available to the lucky winner, virgins from all over China have descended on Li’s home town.  It’s a carnival atmosphere, with local hospitals doing a lively trade in replacement hymens for would be contestants (CNY3000 the going rate), a con-artist offering a do-it-yourself option (price CNY100), contestants offering favours to judges in return for preferential treatment and struggling to avoid the groping embrace of the local male population, and Li Guangtou - armed with a pocket sized mirror - inspecting the veracity of the most comely contestants claims to innocence.

With the contest about to start, a political dignitary is called upon to address the assembled crowd.  This is my translation of the relevant section:

‘Grabbing the microphone, he addressed the crowd in a voice of authority, speaking of all the benefits that have come to mother China as a result of the reform process, from the economic development of the entire country to the economic development of the province, the county, and our own Liu Town.

Changing direction, he swung from Liu Town’s GDP back to that of the entire country, before rambling back again to Liu Town, and the virgin beauty contest that was about to start.  He said that the virgin beauty pageant showed how the lives of the Chinese people were getting better every day, that the virgin beauty pageant would provide a major boost for China’s traditional culture, and help integrate the town with the wave of globalisation.

His spit had been flying over the crowd for half an hour when he finally concluded, shouting: ‘I hereby proclaim, the first national virgin beauty pageant open!’

Two days later, the air of the town is grimy with the exhaust fumes of the tractors which pull the contestants floats, the judges have been so assaulted by the attentions of virgins eager to win their vote that some of them are unable to walk, the con-artist has made CNY100,000 in sales of replacement hymens, and the second place virgin has been exposed as the mother of a two year old child.

Li Guangtou’s virgin pageant is riotous fun, an extravagant metaphor for a country whose rapid development has resulted in an equally rapid lose of innocence, but whose new wealth has enabled a masquerade of traditional values.  Replace the term ‘virgin beauty pageant’ with ‘Olympics’ or ‘Shanghai Expo’ and I think you get an idea of the target of Yu Hua’s satire.

Culture

I have an op ed in today’s South China Morning Post on the impact of the latest trade data and the European sovereign debt crisis on the outlook for China’s exchange rate.

SCMP readers can see the text here.  Or I’ve pasted it below:

Even the tea leaves some questions unanswered
 
 
When will Beijing loose its iron grip on the value of the yuan and allow its appreciation to resume? No one has a definitive answer to that question. But, until quite recently, the signs in the tea leaves suggested a resumption of appreciation was imminent and that a first move might even be on the agenda for this month or next.
Why so confident? Three factors seemed to suggest Beijing was gearing up for a policy shift. First, China’s exports are moving back onto an even keel. The factories of the Pearl and Yangtze river deltas are shifting up to full capacity, and exports for March and April have returned to pre-crisis levels.
 
Second, inflation has returned to the mainland’s economy. Increases in consumer prices might be contained but prices at the factory gate are way up, and one of the main reasons is higher costs for imported crude oil and iron ore. The appreciation of the yuan would help keep a lid on imported price rises.
Third, China’s trade partners are ratcheting up the pressure. A meeting of the US-China strategic and economic dialogue at the end of this month and a G20 summit at the end of next month will increase the volume of calls for appreciation. Beijing faces its own domestic pressures and nationalist sentiment might make it difficult to kowtow to the United States. But with the European Union and other emerging market economies like Brazil and India also calling for appreciation, China’s leaders might find themselves with few friends and many enemies round the G20 table.

The signs in the trade, inflation and political tea leaves seemed to point towards an imminent resumption of appreciation. But a vanishing trade surplus in March and April and the European sovereign debt crisis have thrown the tea leaves into a new configuration.
Central to the case for China’s trade partners is the idea that the appreciation of the yuan will help bring China’s trade account, and so also the world economy, back into balance. An undervalued yuan, the argument goes, gives China’s exporters an unfair advantage and cripples the competitiveness of exporters in the EU and US. The result is bumper trade surpluses in China and corresponding deficits elsewhere in the world.
But a deficit in China’s trade account in March and a tiny surplus in April have called this argument into question. If China’s trade account is moving back into balance at the current exchange rate, what is the urgency in resuming the yuan’s stalled appreciation?
The European sovereign debt crisis has also changed the calculation. For China’s leaders, the Greek drama signals that the international outlook remains uncertain. If the path to recovery is rockier than was previously thought or, even worse, might lead off another cliff, that is bad news for China’s exporters.
The EU seems to have moved decisively, if belatedly, to restore confidence and stability. But with the outlook uncertain, China’s leaders are hardly likely to kick away the main support for the most important sector of the economy.
The Greek crisis also affects the way the European side views the exchange rate. A silver lining to the Greek cloud has been a fall in the value of the euro against the yuan - strengthening the competitiveness of European exporters. With plenty to worry about at home and the exchange rate moving in their favour in any case, Brussels is likely to dial down the volume of complaints on China’s exchange rate regime.
All this changes the calculation on China’s exchange rate regime. The signs in the tea leaves are no longer as clear as they were. If the Greek drama develops into a European tragedy, or China’s trade account stays close to balance this month, it might even be time to brew a fresh pot.

EU-China Relations, Exchange rate, International Relations, Monetary Policy, Trade, US-China Relations

When will China raise interest rates?  That, alongside the question of the exchange rate, is the key focus for market attention.  In the view of Fudan University economics professor Sun Lijian, now is not the time.  This is my translation of the main points from his recent blog posting:

‘Today, China is faced with the problems of imported inflation from high commodity prices and a bubble in the property sector.  That is a similar situation to the one we faced in the second half of 2007 and first half of 2008.  Back then, academic and government economists were united in calling for higher interest rates.  What is the difference now?

First, the real economy is growing fast, but it’s a feverish, not a healthy growth.  With the real economy still in recovery phase, using the blunt instrument of interest rates to raise the cost of capital might actually have the impact of forcing capital out of the real economy and into the capital markets - making the property bubble worse.  Quantitative measures - like the reserve requirement ratio - are the best way to clamp down on asset price bubbles without impacting the recovery in the real economy.

Secondly, raising interest rates would not be interpreted by the markets simply as a tightening of monetary policy, but rather be seen as a withdrawal of the stimulus.  If panic gripped the markets, the good work of the twin fiscal and monetary stimulus might be undone.  At the same time, by increasing the interest rate differential with the USA, raising rates might attract hot money inflows, putting more pressure on the currency to appreciate.

Third, for Asian countries - Thailand, Korea, Indonesia - the problem is containing property bubbles caused by rapid inflows of capital.  Containing inflationary pressure and asset bubbles resulting from capital inflows is the most important economic problem facing Asian governments, including China.  Raising rates would attract more capital inflows and make that job more difficult.

Summing up, the risks to the real economy, worsening asset price bubbles, putting more pressure on the exchange rate, and attracting capital inflows suggest that the government should focus first on the use of quantitative tools (the reserve requirement ratio, lending guidance to banks), and that the time for raising interest rates is not yet right.’

You can see the original here.

Exchange rate, Financial Crisis, Monetary Policy, Property

In my last post on pig production and inflation I argued that though pork prices do have a big effect on China’s consumer price index, the underlying cause of inflation is not too few pigs but rather too much money.  But that does not mean that food prices are not important.

I think this extract from a story called ‘Pounds, Ounces, Meat’ by Zhu Wen, is an interesting illustration of the importance of food prices in Chinese life.  I read the story in translation and I believe the original was written in the mid 1990s, but having visited a few Chinese vegetable markets, I can attest that Zhu’s account still rings true today.

The story takes place in a vegetable market.  An old lady whose newly purchased tomato has just been crushed by another shopper is demanding compensation:

‘The old lady said she had bought 6 tomatoes, costing 2.5 yuan altogether, making each tomato 0.41666 yuan on average.  Rounding it up, he owed her 0.42 yuan.  After a brief stunned pause, the man demanded to see the other 5.  The old lady brought over the basket from the ground and, one by one, rummaged out the tomatoes from in amongst the potatoes, cauliflower, asparagus, lettuce, ginger, onions, long chillies, and pickled garlic.  I disagree, the man pronounced after thorough investigation, these 5 are all quite big, but the one I squashed was obviously much smaller.

The old lady glared upon her adversary, suddenly realizing he was not yet a spent force.  Well, what do you say?  The man pulled out from his bicycle trailer a carrot and laid it in front of the old lady: Look, I bought 4 carrots, 625 grams altogether.  At 2.4 yuan a kilo, they cost me 1.5 yuan which makes each carrot 0.375 yuan on average, but because this one is the thickest and the longest, it’s bound to be worth more than 0.42 yuan.  Take this and we are even.

The old lady closed her eyes a while, out of habit, then grabbed the hostage carrot and tucked it into her own basket.  But take it from me, she added as an afterword, though the current official price for carrots is 2.4 yuan, you can sometimes get them down to 2.3.  As I’m running late and I’ve got to get home to cook for my children, I’ll leave it here for today.’

Zhu’s underlying point is that reform era China is obsessed with money and material things.  In one of his other short stories, entitled ‘I love dollars’, a young man bargains his father out of a good time by refusing to pay the going rate for a prostitute.  But even though Zhu is using the old woman’s haggling to illustrate a wider point, a visit to any food market in Beijing would be enough to indicate that his fictional account is not too far from reality.

Food makes up around a third of the average Chinese person’s consumption basket, and with incomes low, even small changes in food prices can mean the difference between keeping your head above water, or going under.

Agriculture, Culture, Monetary Policy, Retail

How much for a pork chop?  In China, that’s an important question.  With the money supply exploding last year, and growth accelerating this, all eyes are on consumer prices, to see if the unwanted side effect of last year’s stimulus is a nasty bout of inflation.

About a third of the consumer price basket is food, about a third of the food basket is meat, and pork is the most popular meat.  Add all that up and it turns out that the price of pork accounts for a fair few percent of the CPI basket.  And with the price of that pork chop pretty volatile, it is often the price of pork that is the determining factor in movements in the CPI.

That means that the Chinese inflation numbers are vulnerable to shocks in the pig supply chain.  Back in 2008, a disease in the pig population pushed pork prices sky high and the CPI touched 8%. 

High pig prices, and some hefty government subsidies, encouraged farmers to start piping Marvin Gaye tunes into the sty, nature took its course and a few months later a glut of piglets hit the market and prices started to fall. 

But maybe they fell too far.  At least, that is the view of Xu Qiyuan of the Chinese Academy of Social Sciences.  Xu is evidently a man who has spent some time on the farm, and in a recent paper he gives us chapter and verse on the pig production cycle and the potential impact on the CPI in the year ahead.

This is my translation of the main points from his paper:

‘The pig sector is dominated by small producers.  According to Ministry of Agriculture figures, less than 1% of China’s pigs are produced by farms with more than 5,000 hogs.  Small producers are more vulnerable to changes in the market, and ramp up or down production in response to small changes in prices.

China’s pork reserves are just 300,000 tons, compared to annual consumption of 50m tons.  So the pork reserves do not provide a real cushion against sudden changes in production.

China accounts for 50% of global pig production, and so if domestic demand outstrips supply there is little possibility of raising imports to fill the gap.

It takes 8 months to get a pig to market - four months of gestation and four months of fattening.

Pork prices hit a low in the first quarter of this year.  The response from pig producers will naturally be to slow production. 

The result will be a dearth of pigs from around August onward.  With less pigs available, the price of pork will rise, and this will also push up the cost of other meat products. 

The combined effect could add 1-1.5% to the CPI from August on, and take the total past 4%.’

The counter argument is that it is too much money, not too few pigs, that is the cause of inflation. 

The vagaries of supply and demand in particular markets might mean that inflation is seen first in higher pork prices, rather than higher costs for electrical goods, train tickets, or some other good. 

But if the government was able to rationalise the pig production chain to prevent fluctuations in supply, the result would not be no inflation anywhere, it would be inflation in the prices of some other product.  Better animal husbandry will not solve China’s monetary policy problem.

Agriculture, Monetary Policy