China in Transition

China Heading from Labor Surplus to Shortage

Chi Hung KWAN
Consulting Fellow, RIETI

(Published in the September 28, 2011 edition of the Allatanys Newspaper Guide)

As symbolized by the tight supply of migrant workers in the coastal regions in recent years, China is rapidly heading from a period of labor surplus to a phase of labor shortage. With China approaching the stage of full employment in the process of economic development and the aging of its population gathering pace, labor supply could become a constraint on economic growth.

Declining working-age population

Since the launch of its reform and open-door policies, the Chinese economy has been growing at a rate of nearly 10% annually. One of the factors that have enabled China to achieve this impressive growth is its enormous labor force, which has seemed virtually unlimited. Not only does the working-age population account for a high percentage of the total population, but also its rate of increase was high. Since the 1980s, however, the population has been aging, and growth in the working-age population has been gradually slowing, following the effect of the one-child policy adopted to control the population. The United Nations estimates that the working-age population as a percentage of China's total population has begun to decline after peaking around 2010 and that the working-age population will begin to contract before 2015.

These changes in the population structure are likely to constrain economic growth in two ways. First, a decline in the working-age population means a fall in the labor force and, in turn, a decrease in the labor input. In addition, the aging of the population is likely to be translated into a fall in the savings rate. As a fall in the savings rate means a decline in funds for investment, this will indirectly push down the rate of economic growth. China also has an urgent need to develop a pension system in preparation for the advent of the aging society. Aging is a phenomenon generally found in developed countries, but China has to face this challenge before it achieves affluence.

Arrival of the Lewisian Turning Point

With the movement of the labor force from rural to urban areas rapidly underway, in addition to changes in the population age structure, China is approaching the Lewisian Turning Point, which heralds the achievement of the full employment stage of economic growth (Cai Fang, Director of the Chinese Academy of Social Sciences, the Institute of Population and Labor Economics: "China Facing a Declining Labor Force: Needs to Focus on Market to Improve Productivity," the Asahi Shimbun GLOBE (Sep.4-17, 2011), Page G-5 on September 4, 2011). This recognition is widely shared among economists, and the following changes in the labor market are cited as the factors.

First, the shortage of migrant workers has been protracted, and the labor shortage, which was initially limited to eastern China, is showing a tendency to spread into midwestern China. In addition, the shortage is no longer concentrated on engineers and skilled workers, but is evident in unskilled labor as well.

Second, growth in real wages had been consistently below real GDP growth until 1998, but the relationship between the two has since reversed.

Third, a 2005 survey conducted on 2,749 villages in 17 provinces by a research team to promote the construction of a new socialist countryside under the aegis of the Development Research Center of the State Council shows that although surplus labor of approximately 100 million people remains in rural areas nationwide, many of these workers are middle-aged and unsuited to any industry other than agriculture. In this survey, roughly three-fourths of villages responded that "all young workers in the village that are capable of working away from home have already gone."

To date, China's abundant labor force has supported its economic growth through the following channels. First, on the supply side, the fact that redundant labor in the agricultural sector has been absorbed by the industrial sector has contributed directly to the expansion of GDP. Also, in terms of income distribution, keeping wages low has worked in favor of the high-income group with capital income, and this, in turn, has led to higher savings and higher investment. On the demand side, low wages have enabled China to enjoy export-driven growth based on low costs. However, once full employment has been achieved, employment will be limited by the growth in the working-age population, and wages will rise in step with productivity gains. The savings rate and export competitiveness of labor-intensive products will consequently decline, and as a result, the economic growth rate will inevitably fall.

Structural adjustment urged by rising wages

Meanwhile, the rising upward pressure on wages associated with the achievement of full employment will prompt China to make structural changes needed to transform itself from a developing economy to a developed one.

First, labor's share of the national income will rise with the increase in wages, and disparities in income distribution will narrow. In addition, changes in the supply-demand relationship in the labor market have already been improving workers' rights, such as shorter working hours and the easing of the family register system. These will contribute to social stability, together with the falling unemployment rate.

Also, higher wages associated with productivity gains will lead to a rise in the real exchange rate through a rise in prices (with a fixed exchange rate) or an increase in the nominal exchange rate (in the case of a floating exchange rate) (the Balassa-Samuelson hypothesis). Like the strong yen once experienced by Japan, the strong yuan will increase the purchasing power of the Chinese people through improved terms of trade (relative prices of exports to imports) and, in turn, will contribute to the expansion of domestic demand and the correction of external imbalances.

In addition, the Chinese government has been careful about revaluing the yuan, worrying about the negative effects on employment associated with decelerating exports, but it will not need to take such considerations into account once full employment has been achieved. Rather, to control the inflationary pressure associated with higher wages, the government will become more proactive about revaluing the yuan as it will lower import prices.

Finally, in the wake of the achievement of full employment, the policy priority of the government will also change from an emphasis on employment to an emphasis on productivity growth. If relieved from the constraint that millions of jobs must be created every year, China will "graduate" from labor-intensive industries, and industrial advances will accelerate in the form of shifting resources to higher value-added areas. To that end, companies are undertaking restructuring by investing in labor-saving equipment, developing new business areas, and making foreign direct investments.

The original text in Japanese was posted on September 29, 2011.

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September 29, 2011