How Did Rising Labor Costs Erode China's Global Competitiveness?

Labor costs in China have been increasing dramatically in recent years, spurring worries that the country may lose its comparative advantage in manufacturing and its role as the “World’s Factory”. This paper aims to evaluate the effects of rising labor costs on China’s attractiveness to multinationals and its competitiveness in exports, by using regional variations in minimum wage distortion as possibly exogenous shocks to unskilled-labor costs. We first develop a two-sector model by introducing the minimum wage into a general equilibrium model which integrates production and trade in a multi-regional setting. Consistent with model predictions, we find that rising minimum wage distortion reduces more of the exports in unskilled-labor intensive industries. Moreover, exports by foreign invested firms are more sensitive to changes in minimum wage distortion than exports by domestic firms, and both intensive and extensive margins matter for this distinction