A year of critical and fundamental change for China

Workers soldering components at Hilight Solar Co Ltd, Zouping county, Shandong province. The private sector has become the driver of job creation in China. [Photo/China Daily]

China will be the focus of many boardroom discussions around the world next year. What will be at the center of these conversations? I believe that it will be a debate about Chinese consumers and how they will behave in a slowing economy and, ultimately, the extent to which they will be the driver of economic growth over the next few years. Let me elaborate.

Wages

This year will likely see the lowest annual income growth in China for at least a decade, with knock-on implications across the economy. Early signs are already there. Government data show urban disposable income rose in single digits year-on-year in the first nine months of 2014, a hint at the big shift that is under way.

The vast majority of the economy has seen double-digit wage growth for the past decade, with the minimum wage in many cities doubling in less than five years. This has created an expectation that this is simply the new normal for income growth. It is not.

As a result, workers are pricing themselves out of the market. For example, International Monetary Fund research in China suggests that a 10 percent increase in the minimum wage leads to a 1 percent fall in employment.

The manufacturing sector provides a telling example. Manufacturing wages are up fourfold in dollar terms over the past decade. In recent years, private-sector enterprises have had to agree to annual wage increases three to four percentage points higher than State-owned enterprises in order to narrow the significant pay differential that had developed by 2010.

The challenges for low-skill assemblers in Guangdong and Zhejiang provinces have been well-documented. They are downsizing, as countries from Bangladesh to Kenya gain share. The cost of technology that substitutes for labor in factories has plummeted, displacing more workers.

Chinese assembly lines now bear no resemblance to those of a decade ago. Employers are under enormous short-term pressure to reduce wage costs amid ongoing weakness in the Purchasing Managers Indexes and persistent deflation in producer prices.

Jobs

Job seekers are realizing that the long-standing attractions of working in SOEs and government departments are not coming back. The job for life, opportunities for status, high pay, and other perks are gone for good.

Smaller SOEs are, in many cases, destined for the more commercially demanding world of private ownership. Many larger SOEs are recruiting fewer people and encouraging the departures of others to improve efficiency. Lower growth means fewer promotion opportunities, and the upcoming regulatory limitations on the multiple of highest and lowest compensation in SOEs will increase wage compression.

The private sector has become the driver of job creation in China, with official statistics (likely understated) showing an increase of 50 percent or more in private-sector jobs over the past five years. However, many of these jobs are relatively low-skill, low-pay positions.

In 2015, the service sector's critical role in job creation will be called upon even more by the government, with expanded policies to encourage service-sector hiring and an additional focus on the quality of jobs created.

In the government sector, the official salaries of teachers, doctors and civil servants remain low, and opportunities for side arrangements are shrinking. Eventually, the government is going to have to pay its employees more－but I do not see that happening on a wide scale in 2015, despite the growing number of cases of teachers striking for better pay.

The number of students taking the central-government entry exam is down despite an increase in open positions. There has to be a connection.

At the city level, we will start to see signs of the "Detroit-ization" (post-auto) or "Glasgow-ization" (post-shipbuilding) of some Chinese cities. Many cities are heavily dependent on a single industry, not just mining or steel but often a specific single manufactured good－lamps, socks or vehicle tires. While great in times of fast growth, the reverse is also true.

Consumer confidence

As a result of all these trends, Chinese consumers will feel less financially secure in 2015. Fewer will feel they have a job for life, most will see wages rise more slowly, many of their real estate investments will decline in value, and lower interest rates will make other investment products look less attractive.

Overall, the momentum of their wealth generation will slow dramatically after a decade of remarkable acceleration.

Lower consumer confidence may translate into lower growth in spending. Fortunately for many in the middle class, they have already bought their apartments, cars and other core trappings of middle-class life. Many Chinese consumers could easily postpone further big-ticket consumption and, at the same time, cut back on daily consumption spending.

Price deflation reduces the perceived opportunity cost of waiting to spend. Already, there are signs of this. Recent Nielsen numbers showed only a 3 percent increase in annual purchases of fast-moving consumer goods.

More specifically, food and beverage company Tingyi (Cayman Islands) Holding Corp reported a 13 percent decline in turnover in the third quarter of 2014, while beer volume sold by brewing and beverage group SABMiller fell in its most recent reporting period.

And remember: very few in the current Chinese middle class were in the middle class the last time there was an economic slowdown. They could well overreact to a small slowdown and turn it into a larger one as a result.