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

The Path of Wage Drivers

History, data, and literature suggest that any look at the future wage path in China must include labor productivity and labor force growth, innovation spending, the effects of foreign investment, and the peculiar regional and sectoral imbalances and bottlenecks that are characteristic of the post-reform labor market. Long-run economic conditions also affect the wage path by impacting the strength of labor demand. While insufficient data preclude any type of econometric modeling, the recent history of these variables is very illuminating.

Labor productivity is a key driver in the wage path. In a perfectly competitive labor market, worker pay should be equal to the marginal product of labor. Even in China, where many analysts believe that the wage has been below the marginal product of labor for decades, the literature shows that labor productivity is a key issue for the wage path.

Labor productivity is impacted by many factors, but three are key. The first is the capital-to-worker ratio. A related variable is the advancement of technology, which is thought to be embodied in new capital deployment. The skill composition of the workforce also is a key productivity determinant, as shown by the statistical evidence reviewed in the previous section and by many other studies.

While the literature surveyed in the previous section found that the effect of foreign firms on labor productivity was ambiguous, it seems clear that the negative competitive impacts in the local-owned firms will give way to positive demonstration effects as China develops its technological infrastructure. Thus, a look at some measure of the foreign presence is warranted for insight on wages.

While data are not available to calculate a capital/worker series, there are data on innovation spending, which has both a capital and a research and development (R & D) aspect. Figure 10 shows that the growth rate of innovation spending was on a fairly pronounced downward path through much of the 1990s, both for the total economy and for manufacturing. (6) While the reasons for the slowing growth are unclear, the growth rate did slow from exceedingly high levels in the early 1990s--as high as 50 percent for the total economy and 42 percent for manufacturing. It is conceivable that there was a significant diminishing return to capital in the post-reform Chinese economy. The highly capitalized state sector may have slowed its innovation investment rate as new ownership sectors--which were less capital-intensive--emerged. But in 2000, total innovation expenditures grew at a 14 percent rate, while innovation expenditures in the manufacturing sector grew at an even faster 17 percent. As innovation spending accelerated in 2001, the divergence widened. Total innovation expenditures grew by 16 percent, while innovation expenditures in manufacturing grew by 27 percent.

Education of the workforce appears to be on an upward path. After stagnating through much of the late 1980s and early 1990s, the graduation rate from secondary schools began to climb in 1993 (Figure 11). Graduation from higher education institutions, which also lagged through the late 1980s and early 1990s, saw a modest increase in the 1994-1996 period, was flat until 1999, and then resumed its upward path.