By Alexander Chipman Koty

The relentless momentum of investors turning their sights toward China has softened as slowing growth and stock market volatility cause alarm among observers. In 2015, foreign direct investment (FDI) into China’s manufacturing sector came in at $39.54 billion, a slight drop from 2014. While some of these fears are grounded in reality, others are overblown. This is particularly true in relation to the manufacturing sector — China’s principal driver of growth during its boom years — which made the country known as “the factory of the world.”

After decades of rapid growth and development, China’s manufacturing sector is inevitably changing. Shifts in demographics, hiring practices, technology, and markets are  changing the Chinese manufacturing sector. These transformations are not unconditionally negative for the country’s competitiveness. China’s evolving manufacturing sector will change the way investors operate their factories, and it presents new opportunities for growth in the country’s increasingly multifaceted economy.

Demographics

During the years of double-digit growth, the manufacturing sector capitalized on China’s large supply of young, able-bodied workers. High birthrates during the 1960s and 1970s flooded the labor market with cheap, young, strong workers prime for the physical demands of manufacturing during the 1980s and 1990s as the government shifted from a planned economy to a market-based one. This fortuitous combination contributed to China’s historic growth and industrialization.

These same workers are aging and beginning to retire from labor-intensive manufacturing jobs. The number of people aged 60 and older  is projected to grow from 200 million in 2015 to more than 300 million by 2030. In contrast, the amount of young workers is falling due to urbanization, rising living standards, and the infamous one-child policy. While China’s elderly population is ballooning, the amount of youth aged 20-24 is expected to decline from 125 million to 68 million over the next decade. Further, this generation is better educated than previous ones, and has less interest in poorly paid, physically demanding manufacturing jobs.

Hiring practices

Factories are changing their hiring practices as the domestic service industry emerges, China’s western regions grow, and labor protection laws strengthen. Chinese employers traditionally prefer to hire women for labor-intensive industries. At its peak, women comprised about 80 percent of the workforce for occupations such as toy and electronic assembly. Men are now more prominent in these positions, as many women previously working in manufacturing opt to join the service sector. In 2013, services surpassed manufacturing as the largest contributor to China’s GDP. The proliferation of service industries catering to domestic consumers has attracted many unskilled female workers who enjoy better conditions.

Workers now have greater choice over their industry and location.Traditionally, this has not been the case, leading to a large group of migrant workers who flocked to cities and were vulnerable to exploitation by employers. . Because of the prohibitive hukou housing registration system, employers regularly exploited migrant workers by withholding payment, not contributing to employee benefits, and forcing massive amounts of unpaid overtime.As manufacturing relocates from China’s wealthy coastal regions to the less developed interior, workers have fewer incentives to travel far from home for employment and are consequently less vulnerable to exploitation.

The labor dispatch, or temporary worker, loophole is another method employers have used to reduce labor costs. In response to rising wages and 2008 laws requiring companies to more diligently pay worker benefits, employers took advantage of the loophole to avoid additional expenses. The loophole was meant to be used for temporary, auxiliary, or substitute jobs, but companies often employed dispatched workers for years at a time. In some cases, factories would directly hire workers and force them to sign with a dispatch agency. Because dispatched workers are technically employed by their agencies, companies could avoid responsibility for payment of benefits and the risk of labor disputes. Similar practices have been used when hiring “student interns,” who are sometimes intimidated into accepting lower wages and worse conditions than regular employees. However, recent regulations curb these practices, forcing companies to be more responsible and meet their obligations to their employees.

As the workforce keeps diminishing and diffusing across the country, workers are empowered to make demands and seek greater protection of their rights. Protests have increased in recent years as workers object to unpaid employer tax contributions, underpaid wages, and poor work conditions. Such demonstrations are also sparked by aging workers who have greater awareness of the importance of retirement, housing, and insurance contributions. To maintain social stability, Beijing is taking steps to ensure greater company compliance with written laws as workers become more vocal and the overall economy slows.

Prospects for the future

To remain competitive despite a  diminishing workforce and government regulations increasing  the costs of labor, China is boosting productivity and producing higher value goods. For example, as labor-intensive industries, such as apparel, shift to lower cost locations, Beijing is encouraging manufacturers to move up the value chain and produce more innovative products. The “Made in China 2025” campaign hopes to turn China into a global power in manufacturing advanced technology rather than cheap, and often imitated, merchandise. This process requires significant financing to develop innovative R&D, train skilled workers, and upgrade factories to include more automation and robotics.

The expiration of China’s demographic dividend, growth of the service sector, and westward diffusion of factories has shrunk and diffused the labor pool. However, China remains an attractive destination for manufacturing and holds advantages over its competitors. While wages have risen, so too has worker productivity. China also has a developed shipping and logistics infrastructure, and is increasingly a market for manufactured goods rather than just a producer, letting businesses take advantage of the proximity for reduced shipping costs.

Although the country has not yet fully transitioned from low-cost to high-value manufacturing, capitalizing on government incentives can potentially pay dividends. Investors can also take solace in the fact that the factories they contract are gradually providing their employees better conditions and benefits. Though the manufacturing sector risks being caught in the middle income trap, China’s vast financial resources and significant domestic market present lucrative opportunities during the industry’s transition phase.

 

About the author: This article originally appeared in China Briefing, a subsidiary of Dezan Shira & Associates. Dezan Shira is a specialist foreign direct investment practice, providing corporate establishment, business advisory, tax advisory and compliance, accounting, payroll, due diligence and financial review services to multinationals investing in China, Hong Kong, India, Vietnam, Singapore and the rest of ASEAN. For further information, please [email protected] or visit www.dezshira.com.

Posted by Alexander Chipman Koty