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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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