China’s Economy Labors Under Its Demographic Pressures

It is tempting to gloss over the conclusion of the newly published report of the International Monetary Fund’s most recent annual Article IV consultations with China’s economic policy makers. That the managed slowdown of China’s economy to more sustainable long-term growth rates has run into stronger than expected headwinds from the euro crisis and that China remains too dependent on unsustainable investment for growth is now conventional wisdom.

This Bystander’s eye was caught by a short note in the report about labor supply and the extent to which fast intensifying demographic pressures are squeezing out the supply of cheap rural labor available to transfer to the urban industrializing economy that has underpinned China’s three decades of rapid growth. The point at which the excess subsistence labor in the countryside is fully absorbed into the modern sector is known as the Lewis Turning Point (LTP).

It is a critical point along the path of a developing nation. Once the pool of low-cost labour runs dry, employers and the state have to raise wages and benefits, and the country loses its low-cost competitive advantage. Made in China will be replaced by Made in Myanmar as the label of cheap everything, just as Made in China replaced Made in Japan decades back. The subsistence and industrializing parts of the economy merge. Overall growth is driven increasingly by the marginal productivity of labour. Increased purchasing power in workers’ pockets means that consumption increases. The country transforms itself from a producer to a consumer, while services become a larger part of the economy as the industrial sector diminishes relatively. This is a point China wants to get to. The IMF asks if when it will do so.

Source: IMF Country Report No. 12/195, PRC 2012 Article IV Consultation

In short, its answer is that China will be approaching it by the end of this decade, and hit it sometime between then and 2025 (see chart, left). Despite labour being in short supply in some regions and wages being pushed up for reasons of social stability, the IMF reckons the country’s surplus labour to be in excess of 150 million at present. But it says it will fall to 30 million by 2020.

As a result there will be pressure to unlock surplus labour between now and then. An easing of the one-child policy, further reform of the hukou system of residency rights and with it easier access to social benefits such as subsidized housing, schooling and healthcare, and an end to informal but widespread discrimination in job recruiting based on gender and looks are likely. All will delay the onset of the LTP, just as liberalizing financial services and improving productivity could advance it as it would raise net household wealth. But wherever the LTP lies, it is an unescapable point in China’s future, just as the country will have to navigate another tipping point, when per capita income reaches $10,000-12,000 a year, the level at which developing economies tend to stop developing without institutional change.

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4 Comments

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4 responses to “China’s Economy Labors Under Its Demographic Pressures

  1. I am a bit confused. Could you confirm what I think I understand — China wishes to reach LTP, but because of the euro crisis, its calculation is off-balanced? Thanks!

    • China Bystander

      Sorry to have confused you. China wants to reach the LTP because that will be confirmation that it has rebalanced its economy towards being driven more by consumer spending. However, in the short-term, because growth has been slowing more than expected because of the euro-crisis, the government has had to use traditional credit expansion as a stop-gap measure to prevent the deacceleration from being too rapid. That means that the progress in the structural reform of the economy that was slowly but steadily being made in the direction of rebalancing has also slowed. So it is a case of one step forward, two steps back, for this year at least. –CB

  2. Interesting that financial reform is really the key factor in the long term. This gives them an incentive against reform, IMO. They may say they want to reach the LTP, but when they do, wages will rise and it will be more difficult for them to appear to be an industrial powerhouse from the outside, while holding back from that $10,000 to $12,000 reform point.

    Also, the effect of the 2nd scenario, liberalizing hukou laws, is interesting. It makes me wonder what benefit they get from those laws.

  3. China Bystander

    There has to be financial reform to make capital allocation more efficient and thus the economy more productive to off set rising labour costs. Liberalizing hukou laws puts non-wage compensation into the hands of workers so easing the wage pressure a bit. The current purpose of the law is to act as a labour supply regulator. That won’t be needed in the future. –CB

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