And Wages Increased so Fast ?

China’s industrial sector has faced large increases in raw material prices, and wages have also risen significantly. This paper aims at analyzing and quantifying the impact of the cost pressures on the profitability of industry, as well as the way that China’s industry has responded to the pressures. By combining information from the input output table and time series from the enterprise survey and on prices, wages, and employment, we estimate what has happened to the “technical efficiency” of the usage of intermediate inputs: the amount of intermediary inputs adjusted for price changes. We find that it has improved significantly since 2002 in most sectors in core manufacturing, although not for all. The second factor that has offset increases in input prices and wages is labor productivity growth, measured here as value added per worker. Our results suggest that sectors that faced higher cost pressures have made larger efforts to offset the cost pressures. The gap between output price rises and input price rises increased from 4 percentage points in 2005 to 4.3 percentage points in 2006 for core manufacturing. That this was possible while at the same time increasing the average profit margin shows that the ability of China’s industry to offset rising raw material prices by increasing efficiency has so far remained undiminished.