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May 31, 2011

Is China Running Out of Surplus Labor?

Economists have been warning of a looming labor shortage in China, raising concerns that wages will rise and China's growth will slow. That could stall economic recovery around the world. Xin Meng, a recent visiting scholar at The Chazen Institute, weighs in.

Rebecca McReynolds

The last two decades have seen extraordinary economic growth in China, accompanied, and often driven, by large-scale rural-to-urban migration. Between 1997 and 2009 rural-to-urban migration increased from 39 million annually to 150 million annually, creating a low-cost labor supply that fueled the country’s export growth. However, since 2004, economists and academics have been warning of a looming labor shortage in China, raising global concerns that the shrinking labor pool and commensurate rise in wages will slow China’s growth, stalling economic recovery around the world. Most of those warnings, though, are based on research that misses the essential features of the Chinese labor market, argues Xin Meng, a professor in the College of Business and Economics at Australian National University and a recent Lulu Chow Wang Visiting Scholar at the Chazen Institute of International Business.

Meng argues that China is far from a normal market economy and that China’s rural-to-urban migration — the primary source of the unskilled labor pool — is very different from that typically seen in a developing economy. As a result, China’s unskilled labor pool is limited more by institutional factors than by demographics, says Meng, so even a minor change in government policy could easily fill any labor gap for the foreseeable future.

What’s Normal — and What’s Not

One major departure from a normal market economy is that China’s rural unskilled workers do not stay permanently in cities, due to regulations that discourage permanent relocation. For example, there are restrictions on the types of jobs migrants can hold when they come to urban centers. They have no access to key social services, such as unemployment insurance and health care, and their children cannot attend local schools. As a result, migrants tend to stay only a few years, sending money to their families, and then move back to their rural homes.

Given these conditions, Meng argues that China’s potential labor pool is deep enough to sustain the current unskilled labor market for years before pressure begins to build on wages. In fact, China could double its stock of unskilled labor just by changing some of the institutional policies that promote churning. “Right now there are 150 million migrants working in the city, and they stay an average of six years,” she says. “If migrants increased their average stay by only one year, the stock of migrant labor would increase 18 percent, increasing the labor pool by 25 million. Doubling the length of stay, to 12 years, would double the number of migrant labor supply to 300 million.”

Where Government Fits In

China has made attempts to change some of its restrictive policies that encourage churning. For example, a national law was passed requiring employers to pay unemployment and health insurance for all of their migrant workers. But local governments have little incentive to enforce such laws because their performance measures are based on local economic output; insurance increases labor costs and may dampen local growth. In addition, the issue of insurance portability has yet to be resolved.

Meng thinks that any real change will have to be driven — and paid for — by the central government. And that would require a significant structural change in China’s economic development strategy. Local governments wield substantial control over local social and economic decisions, and there is no incentive for them to help workers coming from other regions of the country

That leaves the world’s fastest growing economy with two choices, Meng says. Either the central government radically changes current policies governing migration, or it shifts its economic growth model away from low-cost manufacturing dependent on unskilled labor to a high-skill, capital-intensive economy. The latter option would force international companies to look elsewhere for cheaper production options, such as India or Vietnam. “The international business community is already closely watching this,” Meng says. In the end, though, it is an internal issue that China needs to solve, and solve quickly, she adds.

“If low-skilled jobs increasingly go elsewhere, the future employment of the hundreds of millions of workers in rural areas will become an important economic and social issue,” she says. “And if the growth strategy shifts to the adoption of high skill-intensive technologies, then it is essential that increasing the quality of rural education becomes a major policy priority.”

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