[MUSIC] One of the major challenges currently facing Chinese firms is rapidly rising labor cost. The real wage in the manufacturing sector has more than doubled since 2007. And here you can see that it's gone from something like 20,000 renminbi per year to over 40,00 renminbi per year. At the same time the ratio of the unskilled wage to the skilled wage or former worker wage, has exhibited a U shape pattern. Where since, again, 2007 or so, the growth of the wages of unskilled workers has grown faster than the wages of the more skilled workers leading to this upward slope in this ratio of the two wages. Now, how can firms respond to the challenge of rising labor costs? Obviously it puts pressure on profits and makes it difficult for trading firms to remain internationally competitive if the cost of production are going up very fast. Well we can think of different types of responses. The most negative consequence of rising wages would be if it put the firms out of business so they had to either exit or downsize the scope of their production. This would result in the loss of Chinese jobs. A more neutral response to this rising wage pressure would be to relocate production activity either to another part of China where perhaps the labor cost or other production cost were lower or possibly even to another country such as Vietnam. But if you move the firm outside of the country, of course you'll lose the employment benefits to the domestic labor force. And instead you're going to be employing foreign workers. Now the most positive responses to rising labor costs would be a response to maintain competitiveness by upgrading to higher value added products. To shift to more capital intensive or skill intensive production, this could even mean the use of automated machinery or robots to substitute for labor. Obviously that could reduce the demand for labor and the number of jobs in manufacturing. But it could help firms continue to be profitable in an environment where the relative price of labor has gone up compared to capital. Now in 2015, I was part of a survey called the China Employer-Employee Survey which surveyed over 500 manufacturing firms in Guangdong province, which is the big manufacturing province in China. We had a very high response rate to the survey and in each firm we randomly sampled six to ten workers. So in total we had a sample of nearly 5,000 workers. And this was in collaboration with some other research institutes in China. So what we found when we asked firm managers directly, what are the greatest barriers to your firms development, that the most Popular answer was labor cost. This was the biggest concern, perhaps not surprisingly. In addition they sited low market demand which of course also make sense giving the sluggish recovery of the global economy. And they also sited some other issues. One is taxation, the rest are all related to talent or labor or skill, technical talent, worker skills, managerial talent and innovation ability. Now if we look inside these firms at the structure of employment. What we see is about, two thirds of the employees are front line production workers. And then we have about 7%, who are top or middle level managers, another 10% who are other managers including office workers. 7% technicians, 4% salesman and then another 4.5% of other workers. In the data we were able to ask workers of different types about their wages in the most recent year or two and we found that wages were increasing steadily for all of the groups. But you can see that the wages of the production workers and the other workers were quite high compared to the wages of the skilled workers, the managers, office workers and technicians. The salesmen also increased quite high, but that's a very fairly small group. So that, for the low skill workers, the production workers, the big group, wages were increasing by about 10% a year from 2013 to 2014 which is the years that we asked about our 2015 Survey. Now what about the employment changes within these firms that we surveyed? Well we found that on average, there was a reduction in employment in these firms by about, well more than 3%. And there was an over 5% average reduction in the employment of front-line production workers. So, overall as a group these firms were shrinking and downsizing. Interestingly, the employment of top level managers increased and technicians and other managers was relatively flat. So we do see some evidence that the firms are shifting their skill mix in terms of their workforce, towards more skilled workers and away from less skilled workers. So, what did we find in terms of the different firm responses to this challenge of rising local wages? Well first as just noted, many firms reduced the number of workers, especially front mine production workers. In addition, about 10% of the firms had exited from production, meaning they had shut down from about one and a half year period from January 2013 to mid 2015. The third kind of neutral response, is relocation, but we found that very few firms had actually relocated to other locations. Whether in other provinces in China or to other countries, in fact even among the few firms who did relocate most of them went to other places within Guangdong Province. The next possible response that we looked at was outsourcing, meaning that the firm tried to either invest in another factory in another cheaper place in China or come to an agreement where another factory in a different location would take on a lot of the production activity for them. But this we also did not find to be terribly significant, 10%. Still much more than the relocation, but not a dominant type of response. And finally, we tried to see if firms responded to rising wages by changing the way they produce goods in terms of being more skill intensive or more capital intensive. And we were trying to find a relationship between whether the cities that had very high wage changes, whether we saw more of a response from firms in these dimensions. And we actually couldn't really find very strong evidence that this, in fact, was happening. At the same time it could be that this type of adjustment takes time. We do know from the data that 40% of the firms did have automated equipment, which suggests that a non-trivial share of the manufacturing firms had shifted to fairly capital intensive methods of production. As I said capital responses to wage changes might be relatively slow, so it might take time before we observe them. Now we are going to see in the video of our visit to a couple of firms in Tungua city in Guangzhou province that many firms in southern China are really thinking seriously about buying robots or heavily automated machines to replace workers, in order to be more cost competitive in a context of rapidly rising wages.