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Is China Pumping the Brakes on its Transition to a Services-Based Economy?

by James Lord

August 13, 2018

China's labor market

China’s labor market is transforming as automation leads to factory layoffs and workers find new jobs in the growing services sector. But this transition is not taking relace quite as smoothly as some make out.

There is a standard narrative about China’s labor market. Wages are rising rapidly as migrant workers become scarcer and manufacturers, losing their competitive advantage, are turning to automation to save costs. This is driving massive factory layoffs with displaced workers finding employment in China’s fast-growing services sector.

This version of a large-scale transition of the labor force from industry to services is constantly repeated by economists, government leaders and state media combing through official data releases.

“There have been continuous announcements and plans released about cuts and shifting workers to new industries,” Shehzad Qazi, Managing Director of research firm China Beige Book International, tells CKGSB Knowledge. “Beijing keeps releasing these headline-grabbing announcements with big numbers.”

It’s a simple story, and it makes sense. But is it true? Not completely and certainly not yet.

Beijing is definitely sincere in its support for automation. The government has set an ambitious target of tripling the number of industrial robots per 10,000 workers deployed in the manufacturing sector to 150 by 2020. This would bring China in line with developed economies, which Beijing hopes will allow it to maintain its status as the “world’s factory.”

The pressure on manufacturers from rising labor costs is also genuine. Wages increased 6.8% in 2017 alone. The average factory worker in China now makes more than their counterparts in almost every Latin American country.

Many local authorities and large employers in China are also doing their best to promote automation and reduce production costs. Dongguan, a southern manufacturing hub, launched its bluntly titled “Replace Workers with Robots” campaign four years ago. Terry Gou, CEO of manufacturing giant Foxconn, has set his company the target of deploying more robots than its 1 million human workers in the near future.

But the reality is more complex than the headlines make it appear. While it is true that some manufacturers are embracing automation, many are reluctant to invest in expensive equipment. And though the workforce is shifting from industry to services, this transition is taking place much more slowly than many believe.

Pressing Pause

There is no doubt that some rebalancing of China’s labor market is happening. Employment data from the National Bureau of Statistics show a steady shift from secondary to tertiary industries in the years up to 2016, the last year for which figures are available.

China Beige Book, which collects its own independent economic data, has also noted this trend. “Hiring has been more widespread in services than in manufacturing since 2015,” the company told CKGSB Knowledge.

But the rebalancing does not appear to be the result of the services sector absorbing workers that have been laid off by manufacturers. In fact, China Beige Book has not noticed a trend toward layoffs among manufacturers at all.

“We haven’t picked up any large-scale slowdown in manufacturing hiring growth,” says Qazi. “As a matter of fact, manufacturing hiring growth remains far above the levels seen two years ago.”

The reason for this is partly a cyclical upturn in the global economy since the start of 2017, which has benefited Chinese exporters. But it is also due to an intentional decision by the government to stimulate the economy, especially during the run-up to the 19th Party Congress last October. “Manufacturers were being allowed to access credit at a cheaper rate,” explains Qazi.

According to China Beige Book, hiring rates in manufacturing continued to accelerate throughout 2017 even as growth in the services sector fluctuated. “This raises serious questions about how much of this uptick was market-driven,” the company added.

These trends suggest two things about the current labor market. First, it is manufacturing, not services, that has been driving employment in recent months. And second, the government lacks confidence in the services sector’s ability to do so.

“There is definitely a reluctance to move away from the old growth model as rapidly as China probably needs to,” agrees Qazi.

A Slow Revolution

In this kind of policy environment, manufacturers have little incentive to invest in expensive new machinery. And there are signs that other factors are holding back Beijing’s automation drive too.

The headline figures suggest that China is making progress on automation. The country has already become the world’s largest purchaser of industrial robots. By 2020, China is predicted to spend $60 billion annually on robots, accounting for half of all spending in Asia-Pacific, according to researchers International Data Corp.

Several local governments have followed Dongguan’s lead by launching policies to help manufacturers automate production, including Kunshan in eastern China and Shunde in the south, according to Jenny Chan, an assistant professor at Hong Kong Polytechnic University (HKPU) whose research focuses on China’s labor market. But these cities are still a minority.

What’s more, some initial champions of automation appear to be losing enthusiasm. Dongguan was the first city to offer subsidies to manufacturers purchasing industrial robots. Its location in the Pearl River Delta, one of the wealthiest regions in China, meant that it felt the impact of rising wages earlier than other cities.

But after years of loudly promoting its pro-robotics incentives, the city seems to have quietly dropped the campaign. “The new mayor of Dongguan never mentions the automation policy,” says Lin Jiang, Professor of Economics at Sun Yat-sen University, which is located in Guangdong—the traditional hub for export-led production.

It is not clear how successful Dongguan’s pro-automation policies have been. The city’s population, which is overwhelmingly made up of workers who have migrated from rural areas, has fallen from 12 million to 8 million in the past four years. But it is impossible to know how many workers left directly as a result of the campaign. Chan’s research suggests that around 87,000 workers in the city were replaced by robots between 2014 and 2016, but the Dongguan government has never published its own data on this.

In reality, most workers probably left because their companies relocated to the interior, where wages are lower. For many manufacturers, particularly in industries where margins are tight, moving inland is more attractive than automating.

“For lower-end products, factories may prefer to use a lower-tech production style to save costs,” explains Lin. “Despite the fact that China’s labor costs are six times higher than 10 years ago, workers are often still cheaper than robots.”

Even Foxconn, which has trumpeted its automation ambitions more loudly than anyone else, has taken this option. The company’s workers used to be concentrated in coastal provinces like Zhejiang and Guangdong, where Dongguan is located, but in recent years it has opened enormous new facilities in interior cities, including Zhengzhou, the capital of Henan, a province in central China, and Hengyang, the second largest city of Hunan Province.

This does not mean that Foxconn has completely abandoned attempts to move to high-tech manufacturing. The company made headlines in 2016 when it announced that it had replaced 60,000 workers at its plant in Kunshan with robots. But its overall business in China is still heavily dependent on massive numbers of human workers, according to Chan.

“The changes have turned out to be much slower than what Terry Gou, the CEO, must have been hoping for,” says Chan.

This was underlined in June when workers’ rights group China Labor Watch published an expose on conditions at Foxconn’s factory in Hengyang, one of the company’s newer facilities, which produces electronic devices for Amazon. According to the report, large numbers of workers are still used on production lines, where they carry out repetitive tasks such as scrubbing speaker systems with toothbrushes.

Factory workers in China. Will they be replaced by industrial robots?

Finding Cheaper Humans

Many manufacturers are also choosing not to invest in automation because they are able to reduce costs by using alternative labor sources. According to Chan, there is a risk that students in particular may become an enormous reserve labor force. “There is a government target that by 2020 we will have 50% of young people in vocational schools: that is 23.5 million people,” says Chan.

Beijing is promoting vocational education because policymakers see it as an important tool for providing people with the skills they will need to thrive in the new economy. But in practice students are often being used as a way of propping up the old economy.

“Some leaders of companies in industries with tight margins don’t see things in a long-term way,” says Chan. “They just use student interns in 12-hour shifts on the assembly line.”

Vocational students are particularly vulnerable to exploitation because they have to complete a mandatory six-month work placement to graduate. Foxconn was among the companies found to be using thousands of student interns on production lines by a Financial Times investigation in 2017. Chan believes that the use of student labor may partly explain the recent fall in the company’s workforce, although she adds that Foxconn usually only uses students during peak times for production, like the run-up to the launch of the iPhone X last year.

The company has also been accused of reducing costs by hiring large numbers of staff on temporary contracts from agencies. These workers, often called dispatch workers, have fewer protections and entitlements than full-time employees. According to China Labor Watch, up to 40% of staff at Foxconn’s Hengyang plant were dispatch workers, far above the permitted level of 10%.

Beijing is trying to stamp out the use of students and dispatch workers as auxiliary labor, but local governments often feel pressure to look the other way because they worry employers will move to markets with cheaper labor, such as Southeast Asia.

Phony War

Beijing is probably right that automation offers the only sustainable, long-term way for manufacturers to cut costs without offshoring production. But Lin worries that macroeconomic conditions mean that the government will continue to struggle to convince companies to make the required investment.

“It depends how confident the factory owners are looking into the future,” says Lin. “Some owners are cautious about their future in Guangdong, or even China as a whole.”

According to Lin, manufacturers in Guangdong are particularly concerned about the potential impact of a trade war between China and the US. If trade tensions continue to rise, the government may feel even greater pressure to pump money into the economy to support manufacturers, further reducing companies’ incentives to invest long-term.

“The reality is that if the economy were to take a hit, domestic consumption is not strong enough to supplant the reliance on exports and manufacturing,” says Qazi. “As a matter of fact, they may be forced to rely more on the traditional, older sectors of the economy.”

Automation is sure to play an important role in China’s economic future. The World Bank estimates that up to 77% of jobs in the Chinese economy could be made redundant by machines in the long term. Investing in robots will also become more attractive as labor costs continue to rise.

But replacing humans with machines does not look to be a short-term solution to the erosion of Chinese competitiveness in certain industries. The timeframe for this transition will be decades, not years.

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