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Has China reached tipping point?

Karen Maley

Published 7:41 AM, 21 Jul 2010 Last update 10:05 AM, 21 Jul 2010


In recent months, it’s been clear that there have been new forces stirring in China. We’ve witnessed a surge in the number of worker strikes. And instead of being confined to localised disputes in smaller factories, the industrial unrest has erupted in major factories operated by big multinationals, such as Japan’s Honda, and the giant Taiwanese contract electronics assembler, Foxconn.

Chinese workers have become increasingly strident in their demands for bigger pay packets.

The latest research report by Louis Gave, from the highly-regarded research firm, GaveKal, provides a very interesting analysis of the big changes that are now at work in Asia, and what they might mean for investors.

Gave notes that for years, it’s been relatively easy to make money out by investing in Asian stocks, because Asian markets have tended to be undervalued, and because the region has notched up such impressive growth rates. That’s now changed. Most Asian markets are now trading at significant premiums to Western markets. And this means that unless Asian shares are able deliver what investors are hoping for, Asian markets could again face a de-rating.

Gave notes that Asian stocks could face some headwinds because Asian central banks have broken step with their western counterparts. While US and European central banks are still locked into pursuing extremely loose monetary policies, most Asian central banks have started tightening in a bid to keep inflation under control. And Asian currencies are likely to come under some upward pressure as a result.

Not surprisingly, the more hawkish policy stance on the part of the Asian central banks is likely to impact exporters (which typically make up 20-25 per cent of Asian equity indices) and Asian financial stocks (which usually make up between 30-35 per cent of the indices).

Gave argues that it’s important for investors to take heed of the big shifts occurring within Asian markets. He points to the Chinese equity market which peaked almost a year ago, and has since dropped by more than 25 per cent.

But despite the drop in the overall market, stocks linked to local consumption and stocks paying high dividends – such as utility stocks and stocks in the pharmaceutical, consumer staples, software and tech sectors – have held up strongly. On the other hand, Chinese financials, and stocks in the steel and cement, mining, oil and gas, and real estate sectors have underperformed.

Gave argues that this reflects an important structural shift in the Chinese economy. In the first place, Chinese exports to the West are not likely to maintain the same blistering growth rates as they did over the past decade. It’s also likely that Chinese infrastructure spending will lose some steam, mostly because much of the obvious infrastructure build-out (such as highways and high-speed rail lines) is already nearing completion.

But, even more importantly, Gave argues that the Chinese labour market is at a crucial tipping point.

When countries first begin to industrialise, there’s an almost infinite pool of rural workers flocking to urban sectors to work in factories. And because productivity in the industrial sector is higher, factories can hire huge numbers of workers without having to raise real wages.

But there comes a tipping point when the pool of labour available in the rural sector is smaller than the demand for labour in the industrial sector. And that’s the point when real wages start rising. Gave argues that 2010 looks like being the year that China hits its tipping point – and real wages start rising.

According to Gave, as labour becomes more scarce, Chinese wages will be bid up until they match, or even exceed, the rate of productivity growth. And this explains what been witnessing in the industrial disturbances at the Honda and Foxconn factories.

“This is a momentous change: for years, businesses have simply assumed that China has an unlimited supply of young people who can be had for modest wages and replaced at will. Over the next 15 years this will cease to be the case: businesses will have to pay more for entry level workers, and then work harder to retain them for longer, because they will not be so easy to replace.”

One consequence of hitting the tipping point is that China can no longer rely on simply adding more capital and labour to drive economic growth. Instead, economic growth will increasingly depend on using capital and labour more efficiently.

But higher real wages mean that Chinese households will boost their spending. “Once wages grow faster than productivity, the labour income share of GDP will start to grow and household consumption will begin to assume its rightful place as the main motor of the Chinese economy”, he writes.

Gave concludes by saying that these are not easy times for Asian investors. But within Asian equity markets, he recommends high-yield paying stocks, utility stocks, and stable growth stocks, especially those that are linked to the consumer.



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4 Comments


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Alex Ford wrote:

Karen, I think you are reading a mountain into a very slight molehill here (See Has China reached tipping-point?, July 21).

The targeting of foreign business by labour is tacitly encouraged by the authorities when strategically useful. There is plenty more labour in China, still locked up in the interior.

In the last 30 years, since the reform of a wretched system, the percentage of GDP reaching the hands of ordinary workers has shrunk dramatically, although their real income has increased significantly at the same time.

I say good luck to the labouring masses of China and their quest to put a little more meat in their rice bowls.

However, the key driver for change is that fact that the Chinese government has witnessed the fact that there is only so much money they can lend the indolent consumers of the west before the system breaks down.

So there's an economic imperative to develop more domestic consumption in order to develop a strong China.

21 Jul 2010 11:43 AM

Jonathan Urlich wrote:

This may prove to be a much bigger tipping point than most people realise! (See Has China reached tipping-point?, July 21.)

There are also other forces at work that may be a major problem for the Chinese economy.

China is a command economy run by the political masters. They set the exchange rate, bank lending, industrial production and housing development. All of these areas are under stress!

If you look at the baltic dry shipping index you will see rates indicating a double dip recession for the global economy as a whole. Most of Europe is going into contraction with many countries having to make severe cuts in spending.

Europe is the main export market for China, which is a major headache for the Chinese authorities. The USA is heading for contraction because of continued consumer weakness further impacting on the Chinese. The potential property bubble in China is being ramped up by their laying off the middle classes in large numbers.

The outlook for Australia and New Zealand is very grim as commodity exports fall of a cliff. Let's hope we get some political leadership to avert the looming doomsday scenario.

The world can still be saved if the G20 countries have a sensible plan of action to manage through these economic headwinds. The human spirit is resilient and we are capable of finding answers. The past teaches us great lessons in this regard.

21 Jul 2010 12:05 PM

Jason Zhang wrote:

This is an excellent article. However it always fascinates me to see how many researchers are trying to apply past theories or western economic experiences to today's China (See Has China reached tipping point?, July 21).

Today's Chinese economy is unique. In our books, we've never had such a well balanced, fast-growing centralised government controlled market economy before.

Look at all these elements: they set the exchange rate; bank lending, industrial production and housing development has been watched by central banks across the world in an envious way throughout GFC.

The comment that "It's also likely that Chinese infrastructure spending will lose some steam, mostly because much of the obvious infrastructure build-out (such as highways and high-speed rail lines) is already nearing completion" requires a bit more in-depth reality check.

According to the collection of recent general media data, there are already 106 known big construction projects on the way to be completed in the next five years in China, requiring funding of more than $RMB15 trillion ($A2.5 trillion).

I'm not sure when and where the Chinese economy will peak and start to slide. But right now, we – and all investors – need to be positive and be greedy if possible. We will never come across an opportunity like China in our life-time again. Let's make the most of it.

21 Jul 2010 5:32 PM

Brian Crooks wrote:

It's a shame the idiots running the US economy don`t wake up to the fact that decent wages mean a growing domestic economy.

It looks like the Chinese are awake to it. Watch them boom over the next few years – and watch the US slip down the economic scale (See Has China reached tipping point?, July 21).

21 Jul 2010 6:12 PM



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