ASEAN Minimum Wages Surging…

In the May monthly note covering the need to address income inequality and weak domestic demand across Asia, I noted that: ‘To absorb surplus export capacity as DM demand growth remains depressed, Asia will be forced to broaden domestic consumption patterns via accelerating minimum wage levels…with the added benefit of strengthening social cohesion and sustaining political legitimacy for local elites.’ That process is well underway, but isn’t without risks. Following protests last month, the governor of Jakarta agreed to raise the city’s monthly minimum wage for 2013 by 44% to $230. This comes on the heels of similar moves earlier by six other provincial governments who approved a hike in minimum wages of up to 26% for next year (compared to the 10% average seen this year)  and other provinces are expected to follow.

While higher wages will narrow Indonesia’s cost advantage over its Asian peers (the monthly minimum wage in Bangkok is $195, for example), it’s unlikely to reverse the recent FDI surge, a large part of which is directed toward domestic consumers in any case – FDI in Indonesia jumped 22% in Q3 y/y to a record $5.9bn. However, while I’ve been happy to overweight Indonesian equities this year, the implications of a further consumption surge for the IDR, inflation and trade account in 2013 are ominous unless the country’s commodity export prices rally soon and/or fuel subsidies are cut.

Indonesian consumption has already been growing at above trend so far this year, and accelerating wage hikes next year will drive an even faster rise. Which is all great for the domestic demand theme, but you can have too much of a good thing, and certainly too soon. Brazil for instance offers a cautionary tale of excessive domestic consumption growth gone horribly wrong, in the absence of structural reform and infrastructure investment, with a crashing currency as the solution. YTD at end October, Indonesia’s trade balance was in deficit by $561m, compared with a surplus of $23.6bn in the same period last year. In 2013, there is a growing risk that either inflation lets rip, or the trade deficit turns ugly. In either case, BI would be forced to hike rates to defend the IDR.

The rapid wage hikes are a shock for local low margin local manufacturing, but as in China, there is still a wide minimum wage discrepancy between regions which allows room to relocate within the country. For capital intensive industries such as metals, autos and chemicals, average labour costs are a small percentage of input costs. The consumption boost will be inevitable in coming quarters; Thailand, which lifted wages across the country by up to 40% in April this year, saw private consumption rise 2.2% in Q3, accelerating from 0.9% in Q2.  Across ASEAN, Malaysia is set to introduce minimum wages for the first time in 2013, while Vietnam is set to increase its minimum wage by 25-30% for the private sector next year.

In China, average salaries in USD terms in the coastal regions are still 50-60% higher than those in Jakarta and ‘Pull Through’ wage inflation across ASEAN from the demographic shift in China underpins the domestic demand investment theme, but ultimately remains dependent on faster local productivity growth as China’s accelerates back to double digits if it reforms SOEs decisively. It also requires higher investment to remove growth bottlenecks and avoid a destabilising deterioration in inflation and trade balances, the latter already evident in Indonesia, only partly because its terms of trade have reversed with weak commodity export prices. October exports plunged 7.6% y/y, following a 9% y/y slide in September. Imports surged nearly 11% y/y, led by oil and gas purchases, boosting the deficit to a new record monthly peak. Subsidized energy comprises about 55% of the trade deficit, and all those new motorcycles on the road next year as a result of these wage rises won’t help.

‘If Australia is on the wrong side of China’s medium term structural growth shift, Mexico rather than any Asian country will probably be the biggest winner from rising Chinese wage costs. The all-in cost for an average factory worker in the Chinese coastal industrial zones is now only 10-20% cheaper than for a Mexican and that gap will be eliminated in the next 18mths. Low wage growth owing to strong labour force growth (the product of favourable demographic trends and migration back from the US of illegals), and an undervalued currency despite this year’s rally have boosted Mexico’s attractions as a competitive hub for US manufacturing, as evidenced by the country’s rising share of US merchandise imports, now at 13% or just behind China, and a 10-year high trade balance.

The country’s new President has long campaigned for structural reform of the country’s labour laws, tax code, and liberalisation of the state owned PEMEX dominated energy sector, which would boost FDI and other capital inflows medium-term. This is exactly the reform path which ASEAN countries will have to take to keep pace if they are to benefit from low margin, labour intensive manufacturing migrating from China, after a very lacklustre productivity performance in recent years, largely a function of the sustained underinvestment post the late 1990s crisis, with investment/GDP ratios still well below levels seen 15 years ago from Thailand to Malaysia.

Over the rest of this decade, it’s not in China’s interest to remain as the low-cost and low economic-value-added manufacturing hub for global OEMs. To advance decisively into middle- income status before demographic decline hits hard, it clearly needs to derive a greater portion of its economic output from the high-value-added manufacturing and service sectors, which is the hugely challenging task occupying the new leadership. As that process unrolls, it will have disruptive impacts across the region on relative terms of trade and potentially exacerbate structural weaknesses e.g. for Indonesia, with weaker commodity export prices, higher domestic wage inflation and over time a weaker currency pushing up import prices and widening balance of payment deficits. While mass consumer plays will get a further boost from a region wide leap in mandated incomes for the bottom 25% of households (even Singapore will eventually succumb), in terms of relative valuation and the unmet investment needs to sustain high trend growth rates and higher wages, ASEAN infrastructure and construction exposure looks a better medium term bet.

US Productivity Growth a Double Edged Sword for Labour Market…

In this US recovery, total payroll employment has only risen by 1.9%, versus over 8% on average in recoveries since 1961. Productivity has rebounded above its 2% LT trend, while real median income has been negative since the recession. That more than any Fed action explains why equities have performed so well in such a lackluster macro environment, as margins have swiftly rebounded on technology enabled cost-cutting, but that is also driving extreme income inequality and weak aggregate demand. The non-farm payrolls report on Friday showed unemployment declining to 7.8% in September after holding between 8.1% and 8.3% during the first eight months of the year. This is the lowest unemployment rate in more than four years. Employers added a seasonally adjusted 114k jobs, accompanied by upward data revisions indicating that 181k jobs were added in July and 142k in August, and Q3 job growth was far higher than in the spring, amid yet another US growth panic.

Despite gasoline prices flirting with $4/gallon and the pervasive uncertainty over 2013 tax levels, the jobs market has returned to its recent trend. Since the start of 2011, payrolls have grown by a pretty consistent average of 169k jobs a month. Payrolls have risen by more than 250k only three times since the start of 2011, and by less than 50k only once. The labour force rose by 418k in September and the participation rate rose, although it remains historically low (see chart below). In addition, the long term unemployment level has moved down to 40.1% from 41.9% in June. Naturally, the surprisingly low unemployment rate and large upward revisions to prior months drove Republican conspiracy theorists needlessly into overdrive.

Large revisions are a long-standing pattern, whether there’s an election looming or not. Almost all the revisions, however, came from an upward revision of 101,000 to local government education in August before seasonal adjustment – a repeated anomaly at this time of year. It’s likely something is wrong in the BLS collection process as there shouldn’t be a recurrent pattern of error like this. The real issue is less the quantity than quality of the jobs being created; the vast majority were part-time, continuing the general trend since 2009. After accounting for population growth the economy is on balance shedding full-time positions with benefits, offset by part-time positions at lower pay and no benefits. We need to see median real household income rising on a consistent basis to drive a stronger and less volatile recovery, rather than simply cheaper consumer financing as prescribed by the Fed.

The  gain  in  hourly  earnings  was  solid  in  September  at  1.8%  y/y  and  suggests  a corresponding increase in personal income, which would imply support for consumer spending, and further employment gains (the relationship as shown in the chart is that personal income/consumption leads employment by about 3 months). The minutes of the September FOMC meeting released last week point to a vigorous discussion about employment conditions. Those wondering when the Fed’s QE measures might end did not get the definitive decision rule they were hoping for, as the current US recovery is historically well past middle age, at 13 quarters, but has been a very weak one on almost every metric, making traditional policy short hand rules such as the capacity utilization rate dubious.

Stepping back from the data noise, the proportion of 16 to 64-year-olds who are employed fell sharply in the recession and has barely recovered since; while the unemployment rate has steadily fallen back towards its historic levels, labour force participation has fallen, keeping the employment-population ratio constant. One hypothesis is that the recovery has been so weak because of underlying adverse trends in the US labour market. In an academic paper entitled “Manufacturing Busts, Housing Booms, and Declining Employment: A Structural Explanation”, the authors show how the ongoing decline in the demand for men with no more than a high school education in increasingly IT intensive manufacturing has generated an increasingly negative employment trend for these workers for three decades.

This trend continued unabated during the years after the 2001 recession but was masked by the housing boom, which lifted employment for less-skilled workers for another five years. If we view the housing boom (when residential investment doubled from its long-term average at about 3% of GDP) as an aberration that is unlikely to resume, it is misleading to compare the current labour market with that just preceding the onset of the 2008 crash, just as output gap analysis is similarly misleading. In both cases, the starting level of activity was artificially boosted by an historic credit boom, flattering the apparent strength of the US economy at every level back in 2007. The decline in the employment to population and male workforce participation ratios has been a long-term structural trend, pre-dating the 2008/9 recession but accelerated by it.


The recent auto sales data, alongside the ISM surveys (particularly on services) suggest that we’re still stuck in that 2% or so growth zone. Whether the recent mediocre but steady performance of the jobs market and overall economy can be sustained into Q1 or even accelerate, depends increasingly on political events in Washington. As both the Presidential election and ‘fiscal cliff’ loom, there seems to be bipartisan agreement emerging in a couple of areas. Defense spending is slated to come in for $600 billion in cuts over nine years, which might compromise national security and would certainly eliminate thousands of jobs. It seems likely that at least some of that will be restored. In addition, there is bipartisan support for allowing the temporary payroll tax reduction to expire; this will help restore cash flow into Social Security and Medicare, but will cost the average household about $1,000 annually. The uncertainty has been a deterrent to economic activity, as reflected in weakening corporate investment trends, for example.

The  two  sides  have  been  in  meaningful  discussions,  which  are  encouraging;  Treasury Secretary Tim Geithner recently met with Congressional leadership and the Congressional Ways and Means Committee has stepped up its deliberations, but there remains fundamental ideological disagreement on the future course of tax policy and entitlement spending. Without a compromise in these two areas, a long-term budget agreement will remain difficult to achieve. Some observers suggest that a deal will be reached that postpones the crunch point on the debt ceiling, deferring hard discussions until later in 2013, or even that we will go over the cliff to avoid the Republicans breaking their bizarre but sacred principle of no tax rises, and then some taxes get cut again in January.