The labor market in post-reform China: history, evidence, and implications; China's labor cost advantages are shifting but will remain formidable

Business Economics, Oct, 2004 by Cliff Waldman

Concern over China's growing economic power has focused attention on its prevailing wage, which--in spite of recent strong growth--remains a fraction of that of the industrialized countries. This paper analyzes the recent history and current structure of China's emerging labor market with the use of published econometric evidence of Chinese wage determination and with recent labor market, macroeconomic, and demographic data. The results indicate that wages of skilled Chinese workers will accelerate enough for the skilled wage gap with the industrialized world to narrow appreciably over the coming years. China's advantage in semi-skilled and unskilled labor costs, however, will continue for an indefinite period.

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The emergence of China as a global economic power has garnered increasing attention in news analysis and political dialogue. As shown in Figure 1, China's economic growth compared to global growth has been extraordinary, even considering the well-known flaws in Chinese gross domestic product (GDP) data. China's rise is all the more remarkable for its speed. It was not until 1978 that China began to lift the burdens of communist economic control by initiating an experiment with private ownership and markets.

Of great interest to the United States is the growing importance of China in the U.S. trade picture. U.S. imports from and exports to China have accounted for increasing shares of total U.S. imports and exports of goods and services (Figure 2). In 2003, China's rapidly growing bilateral trade surplus with the United States reached nearly $124 billion.

Two factors have combined with this remarkable growth performance to transform the Chinese economy into a magnet for foreign direct investment (FDI), which exceeded $53 billion in 2003. First, with a population of 1.3 billion and with the promise of economic reforms, China has enormous potential as a consumer market. (1) Secondly, wage costs in China are a fraction of those in the industrialized world. China's average annual wages in 2001 for both the economy as a whole and in manufacturing were under $1,400 at the current (fixed) exchange rate, even with wage growth above nominal GDP growth in the 1998-2001 period, and even with wages more than doubling between 1993 and 2001 (Figures 3 and 4). (2)

The consequence for the U.S. manufacturing sector of growing import competition from China and other low-wage giants has been a topic of considerable debate. On the one hand, Bernard, Jensen, and Schott (2003) found that plant survival, along with output and employment growth, is negatively correlated with the share of industry imports sourced from the world's lowest-wage countries. The unique finding of that paper is that it is the origin of imports rather than their overall level that is related to industry and plant reallocations over time. The authors find "statistically significant and economically meaningful links" between low-wage imports and plant outcomes. They estimate that a 10 percentage point increase in the share of low-wage country imports is associated with a 3.3 percentage point increase in the probability of plant death and a 1.3 percentage point decline in year-over-year plant employment growth rates.

On a somewhat contrary note, Kristin Forbes (2004) questioned the link between Chinese imports and the plight of American manufacturing workers. She acknowledges that Chinese imports affect the prospects for domestic firms with which they compete, particularly those firms that are relatively intensive in the use of less-skilled labor, as these are goods in which China has a comparative advantage. She offers, however, a number of reasons why imports from China were not a significant factor in the sharp employment decline that the U.S. manufacturing sector experienced between mid-2000 and early 2004. In addition to the fairly recent nature of the surge in Chinese imports and exports, sectoral data indicate that the largest employment declines occurred in export-intensive industries. She notes that "Job losses in U.S. manufacturing have been mainly in industries in which imports from China are small" (Forbes, 2004, p. 33.) Finally, she argues that because a large share of U.S. imports from China once came from other countries, the resulting job losses were most likely felt outside of U.S. borders. She concludes that long-term manufacturing productivity gains and recession, particularly in business investment and exports, were largely responsible for the severe manufacturing jobs losses of the 2000-2003 period.

Regardless of the argument over import competition, wage levels in China will undoubtedly have some impact on the future of production outsourcing from the United States and other industrialized nations, as well as the development of new Chinese consumer markets. Wage growth is fundamentally important to the future of China as a global economic force. Thus, the purpose of this paper is to explain the origin of China's large pool of inexpensive labor and to consider the future path of wages. The analysis is based on scholarly articles taken from the growing literature on the Chinese economy, a wide variety of economic and demographic data series, and conversations with a number of respected experts. Data constraints and a high degree of structural instability in the Chinese labor market preclude a quantitative prediction of near-term wage growth. But the literature and data upon which this paper is based have allowed for the development of a qualitative analysis of the continuing evolution of the Chinese labor market and consideration of the implications for the United States and global economies.