Labour Pains

The Chinese New Year began,  with a jolt for some mainland  migrant workers. News  reports said hundreds returned from  their holiday to discover their overseas  bosses had absconded, leaving behind  abandoned factories and unpaid wages.

More workers are expected to face  a similar plight in the coming months  because manufacturers are complaining  that a controversial labour contract law  that took effect in January is pushing up  production costs and adversely affecting  their businesses.     

Several South Korean and Taiwanese  businesses are already relocating factories  from to countries with lower  labour costs like , according to  published news reports.

One such firm is Compal Electronics,  the world's second biggest maker of  contract laptops. The company plans  to open a new production base in  in 2009, a year ahead of  schedule. The move led to speculation  that the company is deserting   because of rising costs resulting from  the new labour law and a decrease in tax  incentives for foreign investors on the  mainland, according to a report carried  in ’s Commercial Times. The  company, however, says it will maintain  its factory near Shanghai .

Hard-hit manufacturing

The tougher law, passed in June last  year, brought sweeping ch ange s to work  contracts, making it more expensive to  dismiss long-term workers, limiting the  flexibility of fixed-term contracts and  empowering unions. The moves aim to  enhance labour rights protection and  minimize disputes.

Although the law applies to all  mainland companies, the manufacturing  sector is expected to be hardest-hit,  says Jack Chow, partner of IPO and  capital markets at KPMG China and  Hong Kong .

“Historically, because of the  short-term nature of employment  with manufacturers in , many  previously under-reported their number  of labourers with various authorities,   and it makes the new employment law  an issue with them,” he says.

 Employers blame the new law  for damaging ’s status as the  world’s workshop and affecting  Hong Kong investors in Chinese  enterprises and listed companies.  “In the past, there was not enough  protection of workers. But now, the  law is too radical,” says Kaiser Tang,  vice general manager of Best Cheer  Stone Group, China’s biggest stone  manufacturer, which employs about  1,000 people.

Tang says he expects the labour rule  ch ange s will increase costs by around  20 percent and the effects will begin  to show in March or April. What is  also worrying Tang is that company  management now faces tougher  penalties, including jail terms, in case  of accidents. 

“As a middle manager, I am  worried about the extra responsibility,”  he says.

A toy manufacturing company in Dongguan, which employs 800 staff   and has an annual turnover of US$13.5  million, agrees that the new law will  raise costs by around 20 percent. 

The owner, who asked not to be  identified, says he had to convert all of  his employees previously on fixed-term  contracts into permanent staff after the  Chinese New Year, in addition to giving  them non-employment, retirement,  medical, and accident insurance. “We  have to increase everyone’s salary and  buy four insurances for them,” he says.  He plans to pass on the extra costs to  his customers. 

Implications of the new rules 

The fact that the new law makes it more  difficult to sack workers will add to  costs, says Jungle Wong, practice leader  of the human capital advisory services  in Deloitte for and Hong Kong .

“It will be more difficult to ask an   employee to go without paying severance.   In addition, the implementation of the  labour law will be stricter than before,  and some of the grey areas will be  eliminated,” Wong says.  Analysts say the increased costs of  the controversial law and the impact of  a new corporate tax law that eliminates  tax incentives for foreign enterprises may  discourage foreign direct investment into  . FDI stood at a record US$74.7  billion last year, Ministry of Commerce  figures show.

The law comes in addition to growing  competition from other developing  countries. Labour costs in had  already been rising before the new law  was introduced due to staff shortages  and rising salaries.

However, labour-cost increases will be less significant in a wider picture of  rising costs, says Jack Chow of KPMG.

“I think manufacturers were  suggesting a 20 percent increase in their  labour costs. But when it’s factored  into the total manufacturing costs, I  would say it would boil down to one  or two percent because labour costs  would not be a significant component in  manufacturing costs,” he says. “So when  comparing against the increase in raw  materials or the fuel costs, I don’t think  

the increases in labour costs will be a real  concern to the manufacturers.”

Not all of the law’s requirements are  new, but many have been strengthened  or clarified. For example, it was unclear  whether employers had to contribute to  the social benefits of workers on fixed  contracts. Now, it is clear that they do.  The new law also emphasizes the need  for employers to put written contracts  in place. 

“That’s not new but the penalties  have increased so there is a much  greater need for full compliance,” says  Fiona Loughrey, partner and head of  China employment group at law firm  Simmons & Simmons. “So that is an  administrative burden.”

“There is at least one provision in  the new labour law which is actively of  benefit to employers and that’s the cap  on severance pay,” she added.

Severance pay is now payable if a  fixed-term contract expires and is not  renewed, unless the employee rejects a  proposed renewal on the same or better  terms. The amount payable depends  

on the length of employment and the  average salary paid during the 12 months  prior to the termination or expiry of the  contract. However, it is capped at 12  months salary.

For employees with high salaries,  the result will be a reduction on   the amount of severance pay due,  which may counterbalance the extra  costs employers face for severance  payments now required for fixed-term contracts that are not renewed,  Loughrey explains.

The size of the burden for employers will depend on how diligently they  adhered to previous legislation. A lack  of compliance in the past, however,  

naturally leads to speculation about  adherence to the new legislation. 

Foreign observers say past  experience shows that even effective  legislation is often meaningless   because of the lack of proper systems   to ensure compliance. Chow of KPMG,  however, thinks authorities will likely  crack down on irregularities under the   new law. “For those companies that  previously underreported the number of  labourers employed, they will be under  the spotlight and they may expose  themselves to investigation under the  new employment law and be subject to  penalties,” he says. 

The impact on investors

Successive fixed-term contracts will  become a thing of the past because the  new law states that they are limited to  two consecutive terms, although some  provisions of the law in this regard  are somewhat unclear, according to  Simmons & Simmons. Employees who have been working  for a company for 10 consecutive years  and those who complete their second  fixed-term contract are entitled to open-ended contracts.

“The ultimate consequence of the  new labour law will be the effective  abolition of fixed-term contracts,”  says China business consulting firm,  

The impact on investors

uccessive fixed-term contracts will  become a thing of the past because the  new law states that they are limited to  two consecutive terms, although some  provisions of the law in this regard  are somewhat unclear, according to  Simmons & Simmons. Employees who have been working  for a company for 10 consecutive years  and those who complete their second  fixed-term contract are entitled to open-ended contracts.

“The ultimate consequence of the  new labour law will be the effective  abolition of fixed-term contracts,”  says China business consulting firm,  

Dezan Shira & Associates. “Every  fixed-term contract that expires creates  a severance obligation. Without paying  compensation, a problem employee  cannot be dismissed. Business costs will  rise due to the higher expenses for hiring  and terminating staff.”

The effective elimination of fixed- term contracts means foreign invested  companies that widely make use of them  will have less flexibility in employment,  according to Dezan Shira.

“They should check in time whether  their budgeting has to take the payment  of severance into account and to what  extent. As termination against the  law triggers a right of the employee to  

be re-employed [or to be paid] twice  the stipulated severance amount, the  employer has to be very careful,” the  consulting firm says.

But Loughrey of Simmons & Simmons points to a different possible  outcome. She says some employers may  renew a fixed-term contract twice with  a particular employee and then replace  him or her because of the restrictions  placed by the new law.

“Instead of keeping persons on as  long as they wanted to remain with  that employer on a renew, renew basis,  they would renew, renew and then let  go. So they would pay the severance  pay as a sort of an extra tax in doing  business,” she says. “Now this would  be unfortunate for the employee,  particularly if there’s a slowdown in  the economy.”

Dezan Shira says another cost implication for investors is the issue of  underpayment of wages or social welfare,  which is rampant in the mainland. 

“This can be especially d ange rous  when acquiring companies or parts of  companies as one may acquire all the  liabilities as well,” it says.

Chow of KPMG says such   practices will have to stop and it is up   to auditors to ensure that companies   are complying.

“Historically, as accountants, when  we audited mainland manufacturers,  we adapted the practices of the local  authorities [on] short term employment,  or there were local notices issued by the  local authorities who accepted bases  of contributions below the national  standards,” he explains. “But all these  practices will have to be eliminated  going forward.”

He urges accountants involved in auditing mainland companies to watch  out for non-compliance problems.

“When they audit or review  a set of financial statements, they  should question whether there is  any misinterpretation of the new  

employment law and whether there  is any under provision of either social  security contributions or payments of  overtime to workers,” he says.

A step forward for   labour rights

Despite the cost issues, labour rights  activists welcome the new law as a step  in the right direction. Han Dongfang,  founder and director of activist group  China Labour Bulletin, says the  legislation will likely improve ’s  collective bargaining system because  until now, workers can only turn to the  state-controlled All China Federation of  Trade Unions when disputes arise.

“The ACFTU sees itself as a ‘bridge’  between labour and management,  not merely as an advocate for labour,”  Han recently wrote in China Brief, a  newsletter published by the Jamestown  Foundation in the United States.

“As such, it does not actively  defend workers’ interests in  negotiations with management,  but seeks to facilitate a compromise  between the two sides,” he says. The new law requires employers to  sign a collective labour contract with  staff representatives and consult with  them on issues affecting staff welfare.  While the extent of consultation  has yet to be clarified, Han says the  move may help resolve increasingly  bitter and costly disputes about  underpayment and overtime.

Stella Hou, general manager  of human resources firm Hewitt  Associates, noticed that in recent years,  mainland workers have become more  vociferous in demanding redress due  to a tighter labour market and greater  access to information.

“You do see blue-collar workers stand  up and file a case, whether they win or  not,” she says. “I clearly see very, very high  awareness, and increasingly so, among the  employees of how to protect themselves,  around what they deserve.”