Tuesday, April 22, 2008

The End of Cheap Labor.

There are some, still sketchy, reports that China is running out of cheap labor. For example, this article. This has very big worldwide meaning. Not only China, the whole world is running out of cheap labor. Some companies are moving production from China to India, Indonesia, Bangladesh or Vietnam. But these countries, with exception of India, have much less population combined than China. India has a fast developing economy as well, and, unlike other mentioned countries, some enforced labor laws. The only remaining big source of cheap labor now is Africa, but it has huge problems. Most of Asian labor, when cheap, is also educated (at least literate, quite often has 6-8 years of school education). Not so in Africa. African infrastructure is essentially non-existent compared to Asia. Political situation is just horrible. Even South Africa has a big political risks, other countries have risks not compatible with long term investing. Conclusion: no more reliable sources of cheap labor.

What does it mean for economy, and most importantly, investing?

End of wage stagnation

First of all, wage stagnation of the beginning of 21st century is about to end. China was the main driver of it, now it's wages there are growing fast. The same is going to happen everywhere. It's just demand/supply situation: same demand, less supply, higher prices.

Readjustment of Prices

Higher price of labor will move prices of labor-depended products up. Food is first, not only because of labor costs, but also because developing world is consuming more of higher quality food. Current jump in food prices probably has other causes as well, biofuels being main suspect. But prices of labor intensive foods, first of all vegetables and fruits, is going to grow for some time. Prices of services are going to grow as well. Same goes for labor intensive industries, first of all apparel. I'm sure that this growth will not continue as long as labor cost growth, for reasons outlined below. But big price readjustment is due for several years.

Automation and Robots

Here, I'm saying it. Maybe somebody mentioned it before, let me know. But I haven't seen it yet. Labor intensive industries are labor intensive because it's hard to mechanize/automate them and because cheap labor was available until now. With more expensive labor, it will be profitable to develop expensive equipment, processes and organization to sharply increase productivity. Industries will have no choice. In some cases, low tech machinery might be possible. But in most cases, industries will need high tech solution, most notably, robots. Not the kind Asimov wrote about. And not the kind currently used in auto industry. More likely, the kind currently produced by iRobot. Self-propelled, highly adaptable, with easily modified software. I expect creation of completely new robot-producing industry. Current robot producers probably will be left behind. Industrial robot producers because they are stuck in old way of thinking. iRobot, because this company is chronically incapable of making money from its great products. Doesn't matter, demand will create new companies.
Mechanization/automation will stop price growth in currently labor intensive industries. Always did, always will be.

Structural Crisis

Price readjustment. Birth of new industries. Does it remind us something? Sure, 1920s. Auto industry radically changed transportation and transport costs fell. At the same time, agriculture mostly moved from draft animals to tractors. Many people may point to the fact that auto industry appeared before 1920s and that tractors were used, at least in USA, in the end of 19th century. But mass changes happened in 1920's. We all know how 1920's ended. Most economists, at least contemporary ones, forget that structural crisis was one of the reasons for Great Depression. Can the same thing happen as a result of end of cheap labor? Probably. Maybe it will not happen in the era of fiat money and Central Banks. We'll see. Good thing is that it's not going to happen overnight. First we need at least 10 years of development.

What It Means for Investors?

Short term: Get out of China. No Chinese investment is safe now. Communists at power there just don't understand economy. India, maybe Indonesia, are safer bets, if you want to invest in Asia.

Long term: Look for new robotic companies. Especially for ones creating robots for services and agriculture. We might catch comething big there.

Disclaimer: This article is not intended as an investment advice. Every person should make her/his own investment decisions based on all available information and advice from her/his own financial advisor.

No comments: