China’s New Leaders Face an Economic Turning Point

Nov. 14 (Bloomberg) -- As the U.S. has been consumed by its own political transition (or, more precisely, lack thereof), it has paid scant attention to the one occurring in China.

Yet how the new Chinese leadership navigates its economic challenges may well turn out to be far more important to the global economy than how the fiscal cliff drama plays out in Washington.

The opening of the 18th National Congress of the Communist Party of China this month, which will usher in the presidency of Xi Jinping, has been accompanied by a variety of indicators that the Chinese economy is strengthening a bit. But there’s reason to worry that Xi will not enjoy such good economic news throughout his tenure.

A growing body of academic studies warns that economic growth in China might slow substantially in the years and decades to come. One crucial reason is that, in the past, it has been driven disproportionately by workers moving from farms to factories. That method of raising productivity may now be largely exhausted -- because most of the workers who could successfully make the transition already have.

The point at which moving workers from agriculture to manufacturing no longer leads to economic gains is called, in the literature of economic development, the Lewis turning point -- after the Nobel-winning economist Arthur Lewis. If China is at or near its Lewis turning point, Xi will face an extraordinary economic challenge, with far-reaching geopolitical ramifications.

Shifting Productivity

Estimates by Xiaodong Zhu of the University of Toronto provide some sense of how large the historical gains from shifting workers from agriculture to manufacturing have been. In 1978, agriculture accounted for 69 percent of total employment in China. And because average labor productivity outside agriculture was six times as much as inside it, shifting workers across the sectors generated huge productivity gains. By 2007, however, agriculture accounted for only 26 percent of total employment.

As a result, since 1997, migration rates have risen, on average, less than 5 percent a year -- down from 10 percent between 1985 and 1997.

At the same time, the relative quality of the migrant workers appears to be declining. For example, their average age has been rising -- because most young workers, who presumably are better suited to factory work, have already left.

A slowdown in growth of the pool of productive workers can be expected to generate wage pressures in the coastal manufacturing regions, and that is indeed what Hongbin Li, Lei Li, Binzhen Wu and Yanyan Xiong of Tsinghua University have already found. In 1978, the annual wage of the average Chinese urban worker was $1,004 in 2010 U.S. dollars. By 2010, it had risen to almost $5,500. Wages have grown especially fast for more highly educated workers, but they have risen noticeably for less-educated workers, too. And, somewhat surprisingly, wages are higher at nonexporting companies than at exporting ones.

What’s more, the Tsinghua University researchers say, China is “already experiencing labor shortages.” They point to survey data from China’s Ministry of Human Resources and Social Security suggesting that, in a sample of 117 cities, the number of newly created jobs now exceeds the number of job seekers. In 2001, by contrast, this same survey found that new job seekers exceeded newly created positions by 50 percent.

Not everyone considers this to be evidence that China has reached the Lewis turning point. Jane Golley and Xin Meng of the Australian National University say there is still little to suggest rising wages are the result of a shortage of unskilled labor.

“China still has abundant workers who are underemployed with very low income in the rural sector,” they wrote. “We argue that China’s unique institutional and policy-induced barriers to migration have prevented many rural workers from migrating to cities.” This interpretation is much more encouraging, because it suggests that China could reopen the spigot of migration by making policy changes.

Turning Point

The International Monetary Fund says that reality lies somewhere in the middle -- that the Chinese economy will reach the Lewis turning point sometime between 2020 and 2025 -- about the time when Xi’s term ends.

Even after that point has been reached, high growth is still possible -- it will just be more difficult. Xi will face enormous political and economic difficulties. As my former colleague Larry Summers likes to put it, China represents a greatly leveraged bet on economic growth -- and if growth is much harder to achieve, that bet may turn sour.

So for Xi’s sake, as well as the rest of the world’s, let’s hope the growing evidence of wage pressures, reduced migration and labor shortages reflects obstacles that he can remove, rather than an inherent constraint on Chinese growth.

(Peter Orszag is vice chairman of corporate and investment banking at Citigroup Inc. and a former director of the Office of Management and Budget in the Obama administration. The opinions expressed are his own.)

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