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| The Effects of Labor Costs on the Scale and Upgrading of China's Processing Trade |
| MAO Qilin, SHENG Bin
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| Center for Transnationals' Studies, Nankai University |
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Abstract In 2004, China's Ministry of Labor and Social Security implemented minimum wage regulations that extended the minimum wage system to all parts of the country. This significantly has increased the labor costs of firms and gradually removed the low-cost dividends that processing trade firms have traditionally enjoyed. In recent years, the transformation and upgrading of processing trade has become a focus issue, and the report of the 17th National Congress of the Communist Party of China clearly states that the transformation of the growth mode of foreign trade must be accelerated based on quality, the import and export structure must be adjusted, and the transformation and upgrading of processing trade must be increased. Therefore, it is theoretically and practically valuable to study the scale change, transformation, and upgrading of China's processing trade from the perspective of increases in minimum wage and labor costs.
To this end, this paper performs a difference-in-differences analysis of the effects of labor cost or minimum wage increases on the scale and upgrading of processing trade based on the micro data of Chinese firms from 2000 to 2013 and by treating the promulgation of China's minimum wage regulation as a quasi-natural experiment. This leads to three main findings. First, although labor cost increases significantly reduce the scale of processing trade, they promote the transformation and upgrading of processing trade firms via a backpressure mechanism. Second, mechanism tests show that labor cost increases encourage processing firms to increase their fixed investments, increase on-the-job training and research and development expenditures, and improve production efficiency, which collectively promote the development of processing firms. Third, a study of the relationship between labor cost, resource allocation, and the upgrading of processing trade at the urban level reveals that improvements in the efficiency of export market-share allocation is a key channel via which labor cost increases stimulate increases in urban processing trade.
This study has important policy implications. For a long time, cheap labor costs have underpinned the rapid development of China's processing trade. However, China's processing trade is typically characterized by large quantity and low quality, and it often lacks its own brand and core technology. In addition, most companies involved in processing trade are original equipment manufacturers rather than finished item manufacturers, and export expansion is mainly supported by a large number of low value-added primary processing products. This paper finds that although labor cost increases do not contribute to the expansion of processing trade scale, the backward force mechanism significantly promotes the upgrading of firm processing trade and improves the efficiency of resource reallocation, which promotes the upgrading of urban processing trade. This shows that China may slightly increase the minimum wage standard and improve the wage security system to encourage processing trade firms to reduce or abandon their excessive dependence on low-cost labor strategies, and to strengthen research and development innovation and improve efficiency to avoid the low technology trap. These measures will promote the transformation and upgrading of processing trade firms and ultimately enhance their position in the global value chain and capture value-added export opportunities.
The main contributions of this paper are as follows. First, this paper may be the first to systematically and comprehensively examine the effect of the minimum wage system and labor cost increases on China's processing trade. The findings of this paper therefore enrich the literature on the economic effects of minimum wage law. Second, in the context of the open economy and the global value chain, this paper devises a comprehensive index and evaluation system for studying the transformation and upgrading of processing trade, and thoroughly probes the transmission mechanism underlying the transformation and upgrading of processing trade driven by labor-cost increases. Third, this paper investigates the micro-level effects of labor cost increases on the upgrading of firms' processing trade and the macro-level effects of these increases on the transformation and upgrading of urban processing trade. It thus enriches the literature on the reallocation of resources that occurs in response to increases in the minimum wage or labor costs.
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Published: 12 November 2021
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