Rising factory Automation Boost the Long-term Outlook for China
By Stephen Green
Capital Group Economist
China’s surprise currency devaluation and the decline in its stock market have underscored the challenges facing the world’s second-largest economy. After years of powerful economic expansion, the increased volatility is largely a result of uncertainty about what will propel growth as China transitions from an investment-led economy to one that’s consumer-driven. One concern has centered on Chinese productivity and a fear that rising wages could weigh on economic efficiency and hold back growth. I believe these worries are not only unfounded but overlook some of the encouraging trends in productivity and the labor market that bode well for China in the long run.
A key positive is rapidly accelerating factory automation. The use of advanced technologies such as robots and other complex machinery is just beginning to take off in China, and it’s expected to grow considerably in the next few years. China is now the biggest market in the world for so-called industrial robots, and the number of these machines in Chinese factories is expected to increase by an average of 25% each year between 2015 and 2017, according to the International Federation of Robotics. Increased automation will bring many benefits, including allowing the Chinese manufacturing industry to progress from low-end commodity products such as apparel to higher-value areas such as electronics and other forms of technology.
Aside from the benefits for Chinese manufacturers, this process is likely to spur demand for foreign-made automation equipment. Though China is working hard to expand its domestic robotics industry, much of its automation equipment, especially high-end components, comes from leading foreign companies. For example, Japanese-based corporations are among the top robotics suppliers to China.
The opportunity for such companies is strong in part because of the relatively low number of robots in China. Despite growth in recent years, the installed base of robots in the country is modest compared with the enormous size of China’s manufacturing base and the number of workers it employs. Germany, for example, has a far greater “density” of robots. The Chinese government is determined to change that, as demonstrated by President Xi Jinping’s pledge last year to pursue an “industrial robot revolution.” But although the domestic robotics industry will no doubt make progress, Chinese companies will not become technological peers with the Japanese and other outside suppliers in the next decade, meaning there should continue to be strong demand for foreign-made robots.
Despite rising wages, the outlook for productivity is encouraging.
The growth of automation is only one of several reasons for optimism about productivity in China. Gains in productivity have, of course, been central to China’s growth story for much of the past four decades. Since the government began implementing genuine economic reforms in the late 1970s, productivity growth has been nothing short of spectacular. Better education, the importation of foreign technology and massive infrastructure development have all helped feed productivity growth. Mass migration has also been a huge factor, as millions of people from rural areas have streamed into cities in search of better jobs. That has provided manufacturers with a plentiful and inexpensive source of labor.
Not surprisingly, wages have risen as the economy has matured. In the last few years, wage growth has outpaced productivity growth. That has stoked concern that escalating labor costs could eventually undermine productivity and eat into economic growth. The fear is that China could become less competitive if emerging-market rivals are able to undercut it in manufacturing and production costs. However, I have studied this issue closely and the evidence simply doesn’t back up this scenario. On the contrary, I am very impressed with the dynamics in China’s labor market and believe the country is well positioned in terms of productivity.
To put China’s outlook into perspective, consider how other fast-growing Asian nations — specifically, Japan, South Korea and Taiwan — fared at similar points in their own economic development. These countries all went through multi-year spans in which wages surged faster than productivity. Rather than receding, growth in each of those nations remained strong during and after these periods. In fact, the clear lesson is that such fast wage growth is entirely normal and to be expected.
As its economy matures, China is moving toward higher-end exports.
Labor productivity in China has been expanding at a faster pace than it did in the other three countries at comparable points. This is quite an impressive feat. Even with higher worker salaries, China’s manufacturing wages remain extremely competitive. For instance, average Chinese salaries are only one-tenth the level of those in the U.S., but China’s economy operates at 40% of U.S. productivity.
Beyond that, China is doing well in the high-value export industries that are most important to its future. It’s certainly true that production costs have risen for labor-intensive manufactured goods, especially those where increased automation is too costly or logistically infeasible. That’s the case, for example, in the footwear industry. But no one in Beijing is losing sleep at the thought of the nation becoming less competitive as a shoe or sock exporter. Instead, thanks partly to greater automation, China is gradually shifting the mix of its exports to higher-value goods.
In a larger sense, it’s important to realize that rising wages are critical to the development of China’s consumer class. The country is slowly making the transition from an economy dependent on heavy industry and infrastructure spending to one powered by consumer spending. Higher wages will boost consumption as Chinese citizens move up the income ladder. The growing middle class will become a natural market for the goods produced by Chinese factories that were previously oriented toward overseas markets.
There is no doubt that China faces significant near-term challenges as the government addresses its slowing economic growth. The transformation to a consumer-led economy will be inherently bumpy, with bouts of heightened market volatility. However, this is part of the process by which emerging economies modernize. Put another way, this is how sustainable middle classes are formed and how advanced economies evolve. The fundamental building blocks are in place for the long run, and I believe the current changes will help pave the way for a new phase in China’s development. There are certainly challenges, but I believe the country is well poised to meet them.
Stephen Green is an economist who covers China. Based in Hong Kong, he has nine years of experience and joined Capital Group in 2014.