Is Low-Wage China Disappearing?

Fan Gang

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2010-08-30

BEIJING – Reports about labor shortages, wage disputes, and wage increases for
migrant workers in China have abounded of late. They naturally raised concerns, or
expectations, that China’s labor-cost advantages may be disappearing.

It is my hope that China’s comparative advantage as a low-wage producer does

disappear – the sooner the better. But why should I, a Chinese economist, wish to see
China’s competitiveness reduced through rising labor costs? After all, when a country
still lacks real advantages, such as higher education, efficient markets and enterprises,
and a capacity for innovation, it needs something like low wages to maintain growth.

While cheap labor has been a key factor in generating high growth over the past three
decades, it has also contributed to profound income disparities, especially in recent
years. And persistent, widening inequality might cause social crises that could interrupt
growth and damage competitiveness. China must avoid such a scenario, and if wages
could increase in some meaningful way, it would indicate that the economy might
finally reach the next stage of development, during which income disparities would be
narrowed.

Unfortunately, China has not yet reached that point – and will not any time soon.
Agriculture remains the main source of income for more than 30% of China’s labor
force, compared to less than 2% in the United States or 6% in South Korea. Another
30% of the labor force comprises migrant workers, who have doubled their incomes by
moving from agriculture to the industrial and service sectors.

Although migrant workers earn only about $1,500 per year on average, the income gap
between them and agricultural laborers provides a powerful incentive for the latter to try
to find better-paid non-farm jobs. Naturally, this competition in the labor market

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suppresses non-farm wages: whereas labor productivity in non-farm sectors increased
by 10-12% annually in the past 15 years, migrant workers’ real wages have increased by
only 4-6% per year. As a result, income disparity between low-end labor, on the one
hand, and professionals and investors, on the other, has also increased.

All this means that the process of industrialization in China still has a long way to go.
To reduce farm labor to 10% of the labor force (the point at which, judging by historical
experience elsewhere, China may achieve worker-farmer wage equilibrium), the
economy needs to create about 150 million new non-farm jobs.

Even if the economy continues to grow at 8% per year, China might need 20-30 years to
reallocate agricultural laborers and reach “full employment.” But this requires
generating eight million new jobs every year, including five million for farmers leaving
the countryside.

During this long process of industrialization, wages will increase gradually, but it is
very unlikely that they will grow at the same rate as labor productivity. This is bad news
for reducing income inequality, as capital gains and high-end wages may grow much
faster. But it should be the good news for competitiveness, because Chinese wages will
remain relatively low in terms of “wage efficiency.”

Indeed, the wage increases of recent years have not changed the basic cost structure of
Chinese companies. An analysis by Goldman Sachs shows that, despite real wage gains,
the share of labor costs in total manufacturing costs is lower than it was in 2001 – a
trend that continued in the first half of 2010.

To prevent serious social tension, China’s government (at various levels) has begun to
intervene by enforcing higher minimum wages, in addition to investing in a social
safety net for the poor. In some provinces, minimum wages have increased by more
than 30%. But the minimum wage is normally much lower than the effective wage, and
thus has not changed the fundamental relationship between wages and labor
productivity.

Nevertheless, artificial wage increases enforced by government policies could slow

down the process of labor reallocation and make some “surplus labor” permanent.
Income disparities will not be fundamentally altered until the market equilibrium wage
inches upwards sufficiently to create labor demand at decent wage levels.

So will companies, both multinationals and Chinese, leave for Vietnam, Bangladesh, or
Mozambique? Perhaps. But that will happen only if the other countries’ wages are
relatively more efficient (i.e., productivity there is ultimately higher than in China), and
not just because Chinese nominal wages go up. For now, however, this does not seem to
be the case in general.

Evidence that China’s wage efficiency remains high relative to other developing
countries comes in the form of continued growth in inflows of foreign direct investment
over the past 12 months, despite wage increases. In July, for example, FDI increased by
29.2% year on year, much higher than the global average. There may be many factors
behind China’s strong FDI performance, but it does mean that the nominal wage
increase itself may not lower the capital gains that concern investors most.

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In any case, the Chinese wage story is much more complicated than it might seem.
Nominal wages may increase, while real wages stagnate, owing to higher inflation.
Even if real wages increase in some coastal cities, “surplus labor” could keep the
national average flat. And even a real wage increase on the national level will not
undermine competitiveness if labor productivity grows still faster.

So the conclusion seems to be that wage growth will not threaten China’s
competitiveness in the next 10 or even 20 years. As China will not complete the process
of reallocating workers from agriculture to more modern economic sectors any time
soon, it should remain a cost-competitive economy for the foreseeable future.

Fan Gang is Professor of Economics at Beijing University and the Chinese Academy
of Social Sciences, Director of China’s National Economic Research Institute,
Secretary-General of the China Reform Foundation, and a former member of the
Monetary Policy Committee of the People’s Bank of China.

Copyright: Project Syndicate, 2010.

www.project-syndicate.org
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