2005-07-19

Why RMB revaluation is good for China

Apart from the fact that Chinese workers deserve a long-dued raise and all those reasons widely discussed, another real benefit is the ability to prepare its industries to better compete in a global economy. Let me elaborate below.

By now the leaders in Beijing have already learned that a level playing field is the best way to ensure competitiveness of its industries. Any artificial distortion is going to change the boundary conditions that an enterprise compete in China, and hence also its ability to compete globally.

Today, china has been able to optimize manufacturing cost by de-automation in some areas.
  • "Chinese factories reverse this [automation] process by taking capital out of the production process and reintroducing a greater role for labor. Parts are designed to be made, handled, and assembled manually. This reduces the total capital required by as much as one-third. So output per worker is lower in Chinese factories, but the combination of lower wages and less capital typically raises the return on capital above U.S. factory levels. "

However, this de-automation is done under a distorted labor cost structure. Revaluating RMB will adjust the relative cost of labor and machine to the proper level, hence helping Chinese manufacturers to become more competitive in the long run.

If Chinese enterprises continue to compete under such distorted environment, they will expect the same when they expand abroad and pay heavy price for the lessons. A couple years ago I had the privilege to a casual chat with a senior Chinese official. He expressed that they need to help and direct the value migration of Chinese industry. They were very proud that finally they were able to successfully build the auto industry (and consequently the whole family of support industries such as parts manufacturing, etc.). Meanwhile, they were also concerned about the traffic condition as they obviously could not maintain the same pace of growth in road construction. In the discussion I brought up 2 points to consider:

  • Let's try to quantify the loss in productivity due to extra traffic jam. Workers in Los Angeles loss 30-90 minute per day in traffic compared to other areas in US. Include the impact to environment and energy cost, see if the growth in the auto industry is justified
  • If we allow the auto industry in China to compete on a distorted market environment (e.g. road condition, operating cost structure such as emission standard, etc.). China will eventually find its niche as defined by its own auto market, but such niche would not be the same as in a different market environment such as US or Europe.

Tough choice. But the best option is to evaluate the options objectively with a big picture in mind, try not to discard any seemingly minor detail. Then follow the best strategy as your full analysis recommends.

2 comments:

Navin said...

Sun bin,

Do you think, the chinese factory workers will get a raise once it alters teh peg ?

Won't workers lose their jobs because of exports declines to US ?

Sun Bin said...

No, i don't think they will get a raise in RMB. But the appreciation in RMB is making (imported) oil and steel cheap and ease inflation pressure in China. Their wages, in the same amount in RMB terms, will buy them more -- an effective raise.

Maybe some workers will lose their jobs. My guess is that the impact will be minimum. I hypotheize this because there has been a labor shortage and some factories have hard time recruiting already (since last year). If such labor shortage is no longer observed, China should not reval RMB.