China Confronts Its Google Problem


15 June 2010

What a difference six months make. In the first half of this year, Honda has been forced by a strike to raise wages at a parts factory in China and electronics-maker Foxconn is doing the same to avert more worker suicides. Some 88% of American companies operating there in a recent survey complain of labor shortages. “Moving up the value chain” is becoming all the rage. So we now begin to see an answer to a question posed in this column in January: “Can China develop into a mature economy if the Googles . . . of the world can’t rise or fall there solely on their commercial merits?”

It can’t, and here’s why:

Rising wages threaten China’s basic economic model. Counting on an endless supply of cheap labor to produce schlock for American McMansions turns out to be unsustainable as the labor grows more expensive and ornery. Beijing will try to tamp down such protests before they grow too assertive, and in the near term cheap replacement workers are on hand to break strikes. But the writing clearly is on the wall.

This matches the experience of other economies like Europe or the United States, where the Industrial Revolution eventually spurred greater union militancy and rising wages. The most commonly cited solution to this “problem” (which is only a problem if you prefer to keep Chinese workers poor and chained to their sewing machines) is to move up the value chain. Think Henry Ford’s 1913 assembly line and many other productivity-boosting responses to rising labor costs. This process is well underway in China now, too.

But that won’t be enough. Rising industrial wages and productivity in the West were also met by the rise of services. Emphasis on capital-intensive manufacturing reduces opportunities for industrial employment. And higher prices for manufactured goods mean more people need to find their way into even-higher-paying jobs. Note the explosion of services such as retail, banking, insurance, travel and tourism and the like throughout the 19th century.

China has a service economy, but it’s small compared to other large developing countries. Value added in services equalled about 40% of China’s GDP in 2009, little changed from a decade earlier. In India over the same span the figure has increased to nearly 50% from 46%. In Russia, it has floated around 50%, and in Brazil it is now 55%, down from 57% a decade ago. Only Indonesia has a service sector proportionately similar to China’s. But Indonesia is also poorer, with per-capital GDP about two-thirds the size of China’s. In fully developed economies, value added by services typically is equal to between 65% and 70% of GDP.

Some hurdles to boosting services are common across many developing countries. People require more and better education to become productive service workers. And there are social factors, such as trust. In a manufacturing economy you hand over your cash and receive a product you can see and touch immediately. In a service economy, you hand over your cash in the expectation that your insurance company or travel agent will deliver a service at some time in the future.

But China adds another, potentially crippling, barrier: politics. The services part of the economy is by far the greatest threat to any authoritarian regime. In forging commercial connections between people and companies, it creates pathways for other types of contact. Google’s business of building a conduit for finely tailored ads to reach computer users didn’t threaten Beijing. The fact that information about Tiananmen Square and emails between dissidents could flow through the same pipeline did, which is why Google kept running up against the censors. Similar worries appear to have prompted authorities to block the iPhone’s signature wireless Internet connectivity, that wondrous vector of modern service provision, and even then the iPhone hit China two years after its roll-out elsewhere.

Thus the service industries—whether banking or travel or communications or legal services—are among the most heavily regulated in China, especially for foreign investors. While this doesn’t exactly add up to an economy with no services, it does mean an economy with inefficient services. For instance, Beijing grants national champion UnionPay a domestic monopoly on processing credit- and debit-card transactions, much to the irritation of Visa and MasterCard. This is vital to allowing authorities to keep tabs on cash flows to maintain capital controls. But it also means less competition and, as a result, a more expensive system for handling cases like transactions where the consumer and merchant use different banks. This adds up to a hidden cost.

Beijing must sooner or later confront its Google Problem: The economy can’t “move up the value chain” if a service behemoth like Google can’t find a hospitable home there. So China has to either open up to services or accept its lot as the low-wage factory to the world. In the short term the government may hope that a still-large supply of cheap labor will delay the moment of decision. But recent labor unrest suggests that moment may be nearer than expected.

Mr. Sternberg edits the Business Asia column.

Source taken from:


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