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China & Ford Motor – What do they have in common? Implications –The X Factor

Excerpt from “Waves of 2008″ written by our Chief Research Strategist Anthony Tsung.

The X factor, is the rising cost of inflation and the over aggressive stance by the communist party to impose regulations on their own labor market and to increase tariffs on trade in their efforts to curb potentially devastating growth. [This portion of the report will expense with the agriculture inflation that the world is experiencing for the time being]. The most recent law comes into affect January 1st, 2008, of next year. This news, in my observation goes largely unnoticed by the market [perhaps due to the heft of the news from the credit crunch that has dwarfed most events else where in the markets.]

It was reported on June 29th that China’s legislature passed a sweeping new labor law today that strengthens protections for workers across its booming economy. This comes in the face of pleas from investors who argued that he measure would reduce the competitive appeal of China’s low-wage business-friendly industrial base. The implication of this ruling, which comes into effect in 2008 enhances the role of the Communist Party’s monopoly union and allows collective bargaining for wages and benefits. While this, in effect, may not cause much instant change to the underlying structures that has fueled a low cost of labor in China, it imposes the risk the sound idea of Asian-outsourcing; that China is moving towards to increase the cost of doing business, and potentially harming what has fueled the bright prospects in China initially. In the Asian psyche—this is also a show of hand by the government that they believe they can sustain themselves and are beginning to wean themselves away from trade and adopting, perhaps, a more isolationist’s point of view. It would seem that politically and economically, they intend to shift the status quo to place them as the next global driver of the global economy. This has future implications that pose a risk not only to the U.S. but all of Europe as well.

The new legislation imposes that employees will have to have written employment contracts that comply with minimum wage and safely regulations. It also moves China closer to the EU style labor regulations that emphasis fixed- and open- term employment contracts enforceable by law. It requires that employees with short- term contracts become full time employees with lifetime benefits after a short-term contract is renewed twice. Perhaps most significantly, it gives the state run union and other employee representative groups the power to bargain with employers. While this is a stark mark down of the original draft which virtually prevents any lay offs of any workers employed by multi national companies in China, it marks the first of many steps by the government to curb many of the outsourcing benefits China did have. The new plan also outlined that companies must “consult” with the state- backed union if it plans workforce reductions, suggesting a softening from earlier drafts that gave unions the right to approve or reject layoffs before they could take place. This new plan has also sated that severance pay will be required for many of its workers, and tightens the conditions under which an employee can be fired.

The Ford Motor Factor-but what does this have to do with Ford Motor Co.?

On November 17th, 2007, Ford said its new contract with the UAW comes “very close” to eliminating its labor cost gap with Asian rivals and gives Dearborn automaker a clear advantage over the other Detroit car companies. Ford entered this year’s labor negations saying it needed the UAW to agree to a trimming of hourly labor costs by $30 an hour in order to close the competitive gap with foreign automakers operating in the southern United States.

The automaker announced that its deal with the UAW allows it to employ a significantly higher percentage of lower-paid workers under a two-tier wage system than the union allowed with Chrysler LLC and GM. Ford said it will also save about $2 billion in heath care costs annually as a result of the agreement. While the intricacies of the negotiations are much, what investors should note here is the flexibility of the UAW and with labor costs there. This may infer that domestically, should Unions be flexible, and it would seem with recent developments that they are—corporations may insist on negotiating with manufacturers domestically to cut costs if China is to increase wages and diminish the opportunistic benefits of outsourcing there, and to also focus on operational cost reductions than the easy “outsource” route to cut costs.

While these moves will not spur over night decisions and changes drastically—it would seem with recent economic and political developments that there is a shift in the dynamics that have been fueling this outsourcing phenomenon in China. With the unexpected showing of leniency by the UAW, there may be better deals for Detroit auto makers and other unionized work forces in the near future. Investors should be wary of current emphasis of overseas Asian growth and its low cost of capital that has fueled foreign investments as well as infrastructure plays.