I caught this at the bottom of Andy Lees’ morning note:
China – To limit inflation China will impose price controls on food according to the NDRC, and will severely punish anyone found speculating on corn or cotton. “The policies that are being considered aim to contain the momentum and will be delivered in combination as a one-two punch”. The Chinese Daily says that one of the measures being considered is to give mayors the responsibility for a basket of food items, but it does not elaborate whether this means setting the price on a basket of goods or whether it means a kind of rationing. I think realistically, given the Lewis Point this is something we have to get used to as it is clearly going to be harder to maintain economic growth without inflationary pressures.
It was interesting he mentioned the Lewis Turning point when talking about inflation in China because I have been assuming this would be a big issue as well. Most economists have focused on the currency peg and China’s low real rates of interest as the fuel to the inflation fire. On this issue of labour costs , I wrote "Labour shortage could spell inflation and trade deficits for China" in April:
Informed researchers are asking what happens to China based on the recent demographic shift from rural labour surplus to rural labour deficit. The answer may be slower growth and higher inflation, according to a paper released last month by China’s Center for Economic Research at Peking University. But other impacts may also be increased consumption and a deteriorating external balance.
The paper by Huang Yiping and Jiang Tingsong is a very technical and dense work based on macroeconomic modelling. But the results are clear: If China’s rural labour surplus evaporates (as seems to already have occurred), we are going to see savings drop and productivity collapse.
The paper is based on the work of Sir Arthur Lewis, an economist from St. Lucia.
Lewis published in 1954 what was to be the most influential development economics article, “Economic Development with Unlimited Supplies of Labour” (Manchester School). In this work Lewis combined an analysis of the historical experience of developed countries with the central ideas of the classical economists to produce a broad picture of the development process. In his story a “capitalist” sector develops by taking labour from a non-capitalist backward “subsistence” sector. At an early stage of development, there would be “unlimited” supplies of labour from the subsistence economy which means that the capitalist sector can expand without the need to raise wages.
-Entry for Sir Thomas Arthur Lewis, Wikipedia
What Lewis found is that industrial wages rise very quickly when the supply of excess rural labour is exhausted. This is called the Lewis Turning Point and is where China is right now.
Could it be that the Lewis Turning Point is behind both the rises in labour wages in China and the general rise in inflation? China’s official inflation rate has reached a two-year high on the back of food price inflation, that’s one reason the Chinese are looking to suppress food prices. Is this the way to fight inflation? It is what the Argentines and Mexicans tried in 2008. But, of course controls of this sort don’t work. Think back to the Nixon wage and price controls after the U.S. went off gold. We know these controls were ineffective. More likely, controls will lead to food shortages as they did in Argentina.
Here’s the global connection: The supply of excess rural labour is now exhausted. That has caused wage price inflation. Combined with global issues creating commodity price inflation, you see serious cost stress on Chinese exporters. I think the cost pass-through will happen if only because these manufacturers are operating in a less cushioned environment with reserve requirements increasing, interest rates rising, and credit growth slowing. Manufacturers in basic industries like clothing have shoestring margins. So with commodity prices like cotton rising and labour costs rising and access to credit reduced, it is only a matter of time before prices go up irrespective of the value of the Chinese currency.
As for the currency issue, this confluence of events will make it harder for the Chinese to revalue the currency. If officials revalued too much in this environment, it would spell disaster for many exporters. Michael Pettis believes the Chinese would need to backpedal on their incipient monetary tightening if they did, which could induce a Japan-style bubble and crash. This is going to be a very tricky environment. I say, watch Chinese price inflation. How the Chinese policymakers react will have global implications.