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Solution In The Offing For China's Rising Labor Costs

Citing a recent cabinet report, Xinhua, the Chinese state-run news agency, called for 7.6 percent growth for the Chinese economy in 2013. While actual figures will be officially released late January, various reputable research firms have placed their growth estimates within the same range.

If China has grown 7.6 percent in 2013, this will be the worst growth since the Asian financial crisis of 1997-1999. Interestingly, however, there is no call for panic. If anything, China is on the right track. A 2013 growth rate of 7.6 percent surpasses the government's target of 7.5 percent. It has also been iterated by top Chinese officials, as well as analysts, that the Chinese economy must grow at least 7.2 percent annually to create 10 million new jobs.

However, while China's economy continues to move in the desired direction, one perennial sticking point remains; rising labor costs.

Increasing Labor Costs Drag Economy

Increasing labor costs in China remain a thorn in the flesh of policy makers. As we have reported extensively, several analysts, including Nomura's renowned Richard Koo, have cautioned against increased labor costs in China. According to the National Bureau of Statistics of China, the working age population started declining in 2012. Inevitably, this has reduced the pool of labor, leading to higher wage demands, and in effect, higher labor costs for producers. The effect is that other countries, like Myanmar and Bangladesh, are slowly replacing China as the prime destination for cheap labor, leading to an investor exodus in China.

Xu Shaoshoi, who leads China's National Development and Reform Commission, has in previous statements told Chinese lawmakers to present solutions that address the rising labor costs in the country.

Eased One Child Policy Signals Solution in the Offing

China dominated headlines toward the end of 2013 when it formally eased its controversial decade-long one child policy. Under the eased laws, couples are now allowed to have two children provided one of the parents is an only child. Before, a couple could only have a second child if both parents were the only children.

This eased policy presents a long-term solution for the rising labor costs in China. It will increase the pool of youthful citizens and in effect, increase the working-age population. This will cap labor costs in two key ways.

First, a larger labor force will increase the government's tax base, allowing it to reduce tax per head while still collecting desired levels of revenue. Reduced tax per head will reduce workers' propensity to demand higher wages, keeping companies' labor costs low.

Second, a youthful labor force will increase competition for jobs. Increased competition will mean that lower wage rates will be more acceptable, allowing firms operating in China to lower their labor costs.

Although it may be a while before the dividends of the eased one child policy are seen, the new policy will certainly rein in China's increasing labor costs.