Unit 4 Macro: Perspectives on Chinese Wage Inflation

My students have been researching and writing about the rapid growth of wages in the Chinese economy. Here are some of their perspectives with each author appearing at the top of the relevant section.

George Clay

China is a country whose economy is undergoing a prolonged period of economic change. In the present circumstances many aspects of the internal price mechanism, supply side and population demographics are changing rapidly, leading to rising new demands by firms and individuals alike. Among the most noticeable of these fluctuations is the problem of wage inflation. Over the six year period from 2002 to 2008 this was roughly five times that of the United States, and exceeded that of India by at least 10% over the same years.

These new pressures may be arising from several sources. Primarily the increasing switch in employment from agriculture to secondary and tertiary industries needs to be considered. This on-going process is exemplified by increasing rates of urbanisation; internal population migration in China is already estimated to be the largest in history. As these new industries produce higher value goods and productivity is thus boosted, so the value of the labour involved rises, and with it wages. This is especially true given the increased levels of skill and human capital required for such new industries, which when gained themselves add to the value of the labour involved. This boost in productivity and movement “up the value chain” can be seen not only in the switch from agriculture to manufacturing and services, but also in developments and innovations within the latter industries, something that has been happening across China since the late 1990s.

Changes in population patterns also mean that Chinese demand for labour is in surplus for the first time in the modern era. Urbanisation means that the portion of the labour force which is not accessible to the market has dwindled to almost nothing. This is in stark contrast to the situation in the 1970s where well over half the population was still living in rural communities, cut off from the world by appalling infrastructure. Changes in demographics (a legacy of the one-child policy’s introduction) are contributing to this; although the largest generation on record is currently of working age, it will be the last of its kind due to a combination of ageing and state-imposed birth control. Within a decade the working population will begin to shrink dramatically. These factors combine to produce demand for labour which exceeds supply, and which is therefore driving up wages.

Initial evaluations of this trend were pessimistic; analysts stressed the additional and imminent costs which these new rises would impose on firms. They also pointed to a rise in unit cost and thus a progressive fall in the international price competitiveness on which China has so long relied. This trend, to their minds, was only underlined by the new signs of equally price competitive industries (the main example is textiles) emerging in South-East Asian competitors, primarily Vietnam and Thailand. This view is however easy to attack. When put in the context of a rise in the production of high value products (which is the primary reason for increases in wage rates in the first place) such rises in unit cost are to be expected, even welcomed as a sign that Chinese industry continues to develop, avoiding the “middle income trap” to which conventional wisdom so long consigned it. Any rise in unit cost can thus be viewed as a sign not of a loss of competitiveness in old markets but of entry into new ones. If the increased profitability which ought to accompany such a trend does in fact appear among Chinese firms, then this should more than counter-balance any rise in total costs arising from a larger wage bill.

There are arguments that rising wages could prove beneficial in a far more direct fashion. China’s industry is consistently suffering from a lack of domestic consumption, leading to an export over-reliance and potentially greater vulnerability to external shock. It also leads to an overly strong currency, which, while currently suppressed by a zealous central reserve which buys dollars to counter the unfavourable rates, is a long term disadvantage which China would do well to address. A boost to domestic consumption would be an important step towards correcting such an imbalance.