平和
和平
평화
CHINA
22 March 2014
Woman on street, Xiaoyi County, Guangxi

China's disappearing cheap labor

For the past three decades, the Chinese economy has relied on a vast supply of cheap labor, moving from the rural country to the industralizing cities. All the signs point to this is coming to an end

For much of the past three decades, the Chinese economy has relied on a seemingly unlimited supply of cheap labor, moving from the rural country to the industrializing cities. China has thus been following the model of Nobel-prize winning economist, Sir Arthur Lewis.

Lewis argued that developing countries have a dualistic structure, with a capitalist sector and a non-capitalist ‘subsistence’ sector. The capitalist sector attracts the migration of workers from the subsistence sector, which is characterized by surplus labor and which can earn more wages in the capitalist sector than in the subsistence sector.

Even though the capitalist sector might develop quickly, wages do not increase because of the continued flow of surplus labor into the capitalist sector. While this means that capitalists make high profits, it also helps fuel development as profits are reinvested. And in the initial stages of this process, output does not decline in the subsistence sector, because the marginal productivity of its labor is negligible.

Eventually, the reservoir of surplus labor in the subsistence sector is exhausted. This is known as "Lewis turning point". Wages then begin to rise in the subsistence sector, as well as in the capitalist sector, which reduces profit levels. The process of capital accumulation slows down. At this point, we no longer have a dualistic economy. The capitalist and subsistence labor markets are now integrated.

China seems to be following the pattern of the Lewis model. Labor disputes have been gradually increasing over the past decade, and labor shortages and wage inflation have intensified in recent years -- particularly since 2008 when several Chinese labor laws were issued or updated, spurring workers to voice their various demands in the labor markets. Indeed, 2010 witnessed a marked increase in strikes, labor disputes and even suicides in the workplace. Regions with higher GDP per capita have had a higher labor dispute incidence.

Surplus labor supply has dwindled reflecting the effects of the one-child policy, as well the rapid economic growth which has been drawing migrants to the industrial centers. The year 2012 also saw the beginnings of the fall in China's overall working age population (aged 15 to 59), by 3.5 million to 937 million. This marks the turning point from the growing workforce that buoyed China's growth throughout past decades to a shrinking pool of workers which will tighten labor markets over the medium term.

Labor shortages first emerged in the Pearl River Delta in 2003, and then expanded to the Yangtze River Delta and to inland provinces to become a national phenomenon. In response to higher wages, foreign investors and even Chinese companies have been shifting production to lower wage countries like Vietnam and Bangladesh.

To what extent is the arrival of the Lewis Turning Point a problem for China? And how should the Chinese government and businesses respond?

The Lewis Turning Point is a positive development in terms of income equality. The economic development described by Lewis, with surplus labor moving to the capitalist sector, is also associated with a rise in income inequality.

This was first described by Simon Kuznets in his famous Kuznets' curve which identified an increase in income inequality in the initial stages of development, as capitalists keep earning more profits, while surplus labor do not benefit from growing wages. Thus, the arrival of the Lewis Turning Point also coincides with the Kuznets' Turning Point, the point where income inequality reaches its peak, and starts to decline again. Workers can thus begin to enjoy a larger share of the benefits of economic growth.

Another effect of the arrival of the Lewis Turning point is the rise in strikes and other industrial unrest. Non-democratic governments like that of China are always tempted to respond through repressive measures. Given that this reflects the reality of labor market conditions, it is more sensible to develop labor market institutions (including trade unions) which can facilitate dialogue and negotiation for solving disputes. The Chinese government's initiatives in this area remain insufficient to date.

More fundamentally, the arrival of Lewis Turning Point signals the moment where the cheap labor development model is no longer tenable and industrial upgrading is necessary. A country like China thus needs to invest in education and technology to graduate from low-cost labor-intensive production, and to avoid the risk of falling into a “middle income trap”. Rising labor costs also makes management of inflation more challenging.

China is very conscious of these challenges, and is working hard to upgrade its economy. But the upgrading and innovation potential of the economy is held back by the dominance of state-owned enterprises and repressive politics.

Author

John West
Executive Director
Asian Century Institute
www.asiancenturyinstitute.com
Tags: china, cheap labor, Lewis Model, Lewis Turning Point, Kuznets' curve, OECD, middle income trap

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