Out Of The "Hard Landing" Pan And Into The "Crash" Fire - Are Things About To Get Even Worse For China?
Over the past week one of the more hotly debated and market moving topics was the resurgence of speculation that China may be on the verge of a "hard landing." To a large extent this was driven by renewed concerns that the country's debt load, especially at the local government level, will be a substantially greater hindrance to growth and hence, concern than previously thought. This was paralleled by concerns that Chinese growth will likely slow down substantially more than previously expected, even as inflation remains stubbornly high. The result: a move wider in Chinese CDS in the past week whose severity was matched only by a similar move around the time of Lehman, when the world was widely seen as ending. Concerns that delusions about decoupling are precisely that (courtesy of 3 out of 4 BRICs printing a contractionary sub-50 ISM also led to the biggest drop in the Hang Seng index since 2001, after it tumbled 22% in Q3 as fears that a Chinese slow down would impact all developing economies with an emphasis on East Asia. Yet if a Hard Landing is all it took to disturb the precarious balance in which China always somehow always ride off into the sunset having rescued the entire world, we wonder what would happen if the market started expressing concerns that a Hard Landing is the optimistic case, and nothing short of a Crash Landing may be the baseline. Because according to the Economist, which informs us of a very troubling development out of China in which foreigners may be about to face a new entitlement funding tax for all domestic workers beginning October 15, and hence a surge in overall labor costs, then a "Crash Landing" may well be in the cards for the world's biggest marginal economy.
In "The Coming Squeeze", the Economist writes that the "cost of expatriate labor in China may be about to soar." The reason - a new tax levied on foreigners to fund the perpetually weakest link of Chinese society: its entitlement programs. "Officials have now unveiled some detailed rules which seem to require foreigners as of October 15th, to pay into China's public scheme that provides pensions, health care and unemployment benefits. The likely costs of the new measures are unknown. It is possible, but not certain, that foreigners will face stiffer taxes than locals. All that is clear, says KPMG, a tax consultancy, is that the law will squeeze both expats and their employers."
By this point a major red flag should have gone off: with international employers sourcing a key portion of the labor demand pool in China, a tax provision such as the one envisioned, which sees both foreign workers and foreign multinationals, would result in a surge in labor equivalent costs for what was once the cheapest labor market in the world (yet one which as Zero Hedge discussed several months ago may be poised to hit parity with the US in a few short years). Yet while natural labor supply/demand imbalances would have taken a long time to fully materialize, a government tax levy would have an immediate impact, and hit MNC bottom lines very hard. The net result would be a crunch in corporate bottom lines. The logical consequences would be scaled layoffs to preserve profitability, and a shift to a US-style labor relationship in which corporations extract a pound of productive efficiency flesh from their workers in exchange for the "privilege' of having a job. It is only logical that employees of domestic companies will demand comparable treatment and a prefunding of their own social safety net as the push for another Welfare State goes into high gear. One need only look what happened to Chinese auto companies two years ago when the domino effect of rising salaries forced most to increase their employee wages substantially or else face a disruptive (to put it mildly) work climate.
Needless to say, foreign workers met with a much more restrictive tax regime will also flee the country in droves, relocating to more tax-friendly havens, especially since as The Economist writes, "foreigners are unlikely to benefit from unemployment insurance, because it fhtey lose their jobs they typically lose the right to live in China. The rules suggest that pensions may be portable, but do not say how exactly this will work - and it is difficult for retired foreigners to obtain permanent residency in China.
Two other big red flags result from the implications of this move, which fundamentally is nothing short of a government-induced push to stick foreigners with the check for the country's non existent safety net:
1). China is very actively starting to consider having a safety net, which implies that even the government no longer has much faith in the export-driven mercantilist model (aka the symbiotic, or stated-better, Mutual Assured Destruction with the US model). Whether this is due to ongoing economic turbulence in which China can no longer rely as much on the US and global consumer is unclear, but we are fairly confident it is a significant factor.
2). China is now taking a much more hardline approach vis-a-vis international corporations, and foreign labor in general. Without doubt this is driven by the push to promote domestic corporate interests which China is seeing as not benefiting proportionately. The Economist agrees with this:
The climate for foreign firms in China is starting to feel frosty. Costs are rising, regulations are growing more burdensome. Local competitors are playing rough. Some, like Cosco, a shipping giant, have brazenly tried to renege on contracts. Others have used their political allies to squeeze out foreign partners. One Westerner reveals that two foreign firms on whose boards he serves have recently been forced to leave the country shedding their assets in fire sales. China is much too big and booming for foreign firms to ignore, and plenty of multinationals are doing splendidly there. But this latest turn of the screw may not be the last.
Some would say that it would be economic and political suicide for China to proceed with this plan. But when things start to turn ugly, as they have in the past several months, centrally-planned (not to mention hard line communist) economies have been known to make less than rational decisions. China would not be the first, nor, judging by rising expectations that our own Fed Chairman may soon resume exporting outright inflation to China yet again via yet another monetary stimulus, last.