Unit 4 Macro: Productivity Improvements in China

Productivity is a measure of the efficiency with which a country combines capital and labour to produce more with the same level of factor inputs. We commonly focus on labour productivity measured by output per person employed or output per person hour.

A better measure of underlying productivity growth is total factor productivity which takes into account changes in the amount of capital available for each worker to use and also changes in the size of the labour force.

To give a simple numerical example, if the size of the capital stock grows by 3% and the employed workforce expands by 2% and output (GDP) increases by 8%, then total factor productivity has increased by 3%.

China has achieved impressive gains in productivity in recent years. Some of this is undoubtedly the huge spending on capital investment which has grown to nearly 50% of China’s GDP. The labour force has also grown although this is scheduled to level off and then decline in the years ahead.

What has driven improvements in Chinese total factor productivity?

GDP per person employed in China

Data from Timetric.

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China from Timetric

Comparing productivity in China with Hong Kong

Data from Timetric.

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China from Timetric

1. Resource shifts: There has been a huge shift of resources out of relatively low productivity agriculture into more productive work in manufacturing industry and construction. Over half of the Chinese population now live in urban areas.

2. New technology and innovation: The willingness of Chinese businesses to adopt and exploit new production technologies and process innovations. Mobile telephony has expanded at a rapid rate

3. FDI effects: High levels of foreign direct investment into China has also boosted productivity – new manufacturing capacity and technology has lifted efficiency and may well have led to productivity spill-over effects among supply-chain businesses. For example, in April 2012, Samsung Electronics, the world’s biggest memory chip maker, unveiled plans to invest $7bn (£4.4bn) to build its first chip factory in China.

4. Openness and global competition: The Chinese economy has become more open – trade is accounting for a rising share of national income – global competition is a stimulus for efficiency improvements

5. Better infrastructure: Heavy state spending on critical infrastructure has improved the overall efficiency of the economy for example in reducing transport delays and increasing communication speeds

6. Management: Restructuring of state-owned businesses has been a factor behind better productivity. The Economist magazine reported recently that “sophisticated methods of control, more productive use of assets and rapid globalisation have boosted productivity”

7. Improved wages: There is strong pressure for mean wages to rise in China especially as the latest Five Year Plan emphasises the need to boost domestic demand. Will a number of years of rapid wage acceleration provide a boost to worker productivity?

Although China’s productivity improvements are impressive, the process of productivity catch-up with advanced nations still has a long way to go. China’s labour productivity is about 12 per cent of that of the USA. The two charts below taken from data produced by the International Labour Office show relative labour productivity levels for different regions of the world.

For China to make the leap from being a middle-income to a high-income country it will have to achieve further big strides in lifting productivity. Capital investment and the size of the labour force is set to have less impact on output per person; attention is focusing on improving the stock of human capital, competition and managerial standards in raising factor efficiency.

Further reading:

Business week: Can the US compete with Chinese manufacturing?
Economist: The end of cheap China