China's enormous pool of cheap labor has been a critical fuel of the country's economy. But that's changing, as labor throughout much of China is no longer cheap. And that shift has enormous implications for China, Asia and the rest of the world.
Around the middle of the last century, the U.S. and Europe were the manufacturing and production centers of the world. Over time, production of things like electronics, clothes, and toys shifted to Japan, and then to South Korea, Taiwan, and Hong Kong -- as companies tried to keep costs down by making products in countries with cheaper labor.
But labor costs started rising in these countries as well, eventually leading to China stepping in and using cheap labor to supply more and more of what the world wants to buy. This strategy helped China become the world's second largest economy. Even though its economic growth has slowed recently, since 1990 China's economy has grown an average of 10% a year.
In recent years, though, China's labor costs have been catching up to those of more developed countries. The chart below shows labor costs per hour by country.
These numbers are adjusted to account for the productivity of workers in different countries. So although it looks like workers in, say, Brazil earn more than those in the U.S., this isn't the case. It means they aren't as productive as U.S. workers, so they're paid more for what they produce. In this example, U.S. workers produce more per hour than workers in Brazil.
As the chart shows, compared to other Asian countries, China is no longer a very cheap place for manufacturing. After adjusting for productivity, for every dollar a Chinese worker makes, a Thai worker makes 40 cents, and an Indonesian worker makes 8 cents.
Of course, manufacturing companies look at other factors besides labor costs. For example, workers in the Chinese Yangtze River Delta area (near Shanghai) earn about two-thirds of what American workers make, after productivity adjustments. But after factoring in costs to transport the product across the ocean, and the trouble and expense to manage people on the other side of the world, labor costs that are lower -- but not enormously lower -- may no longer be worth it.
The gap in labor costs between China and other Asian countries presents a big opportunity for countries like Thailand, Bangladesh, Indonesia and Vietnam. To move a plant from China to another country costs a lot of money and is a hassle. But as labor costs continue to rise in China, the difference in labor rates will increasingly push manufacturers in China to look elsewhere.
This will have -- and is already having -- an enormous impact on the Chinese economy, as it seeks to move up the value chain to create higher value-added products. Chinese economic growth has dropped below 7% and is at its lowest level in 25 years, in no small part due to a slowdown in manufacturing.
The Chinese government is moving this process along by trying to diversify its economy. Their goal is for manufacturing to play a smaller role in the Chinese economy and for services and consumer spending to have larger roles.
Already last year, the services sector (health care, financial and information services, professionals, etc.) accounted for more than half of China's economy. The manufacturing sector's portion of economic output fell two percentage points to 40.5%.
As this trend continues, expect other less-developed Asian countries to pick up the manufacturing slack. Like it did for China, more manufacturing in these countries will spur more economic growth.
Kim Iskyan is the founder of Truewealth Publishing, an independent investment research company based in Singapore. Click here to sign up to receive the Truewealth Asian Investment Daily in your inbox every day, for free.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.