No actual evidence China losing competitiveness, says RBS

KUALA LUMPUR: Despite the rapid increase in unit labour costs in recent years, China has remained very competitive in its exports, especially in light manufacturing, according to the Royal Bank of Scotland strategists.

In a report entitled “Will China lose its competitiveness?” released on Wednesday, Sept 7, RBS said that product upgrades and productivity gains in China had countered the rise in the unit labour cost.

“There are regional competitors in these markets, but evidence of China losing out is still absent,” said the report.

RBS said that in capital intensive industries, China was increasing its specialisation in relatively low-tech sectors and not yet competing directly with more high-tech neighbours such as Korea.

The development bodes well for China to maintain its competitiveness through continued adjustments, it said.

The report said that to many, China's competitive advantage stemmed mostly from its vast labour supply and low labour cost, and the rise in labour prices should see the start of an end of Chinese exports.

Exporters will either have to cut their margins to keep prices steady and to maintain market shares; or, at some stage they will have to pass on the higher costs to selling prices, thereby losing market share to lower-cost competitors, it said.

RBS said that a look at the conventional price based indicators did point to a deterioration in external competitiveness in recent years, adding that unit labour costs (measured in dollar per unit of output), or ULCs, rose 50% between 2004 and 2009, a significant acceleration from the 12% during the previous five years.

ULCs of other low-cost producers such as Vietnam and Thailand also increased, while Taiwan and Korea experienced a drop, it said, adding that that ULCs of India, Indonesia, and Sri Lanka were much lower.

“But actual evidence of China losing competitiveness is still largely absent. In fact rising labour costs have gone hand-in-hand with China's rapid growth in global market share (from 7%% in 2005 to 11% in 2010).

“The rise in capital intensive exports has been a big part of the change. Machinery and transportation is now the largest category of exports, accounting for 53% of the total Chinese exports, up from 39% in 2001. In these sectors increases in labour costs have relatively minor effects,” said the report.

RBS said China had also not lost out in labour intensive light industries (such as textile and clothing, shoes, leather products, and furniture) either.

It said China's exports of light manufacturing products had risen to about one-third of the world markets (from 22% in 2005), dominating other regional competitors.

China's exports are also more diversified than other countries in these sectors, and the margins of the respective industries have held up despite the rising costs, it said.

RBS said China continued to dominate light industry products due to product upgrades and a move up the value chain; productivity gains through the rapid expansion of markets in the last five years; and ability of Chinese producers to pass some of the cost pressures to overseas markets.

The report said past experience suggested that China had responded to rising unit labor cost through capital investment and product upgrades, which bodes well for continued adjustments in the future.

“The fast expanding domestic market gives producers an extra competitive edge to absorb the further rise in labor costs.

“Jury is still out though on whether, if exporters continue to raise prices as in recent months, market shares will eventually suffer,” it said.