The odd combination of a slowdown in the economic growth rate and a tightening labor market is the result of the structural change the economy is going through. Meanwhile, the situation for low-skilled labor, specifically, is being driven by upgrades in the manufacturing sector, and is not the source of the middle-income trap that the country seems to be facing.
Many academics and government officials have expressed concerns that demand for low-skilled labor in China has exceeded supply since the 2008 global financial crisis even though the economy has slowed. Some of them have even argued that the shortfall may cause China to fall into the middle-income trap. But if you look at all the fully-fledged middle-income countries, none of their predicaments can be explained by the problem of labor shortages. There is no clear evidence that the two are even related.
Some sociologists have blamed the labor shortage in China on family planning policies which they say led to the shrinkage of the available work force. But such a demographic impact usually takes more than 10 years to fully emerge, and is more likely to occur when the economy is growing at a rapid rate. Why do labor force declines seem to have worsened in recent years when the economy slowed? If you look at the data of new urban jobs created over the past few years, the numbers were all more than 13 million which were much higher than expected. Hence, it can be inferred that it was a surge in demand rather than a fall in supply that caused the labor shortage. This is a reflection of the economic structural transformation that China is pushing through. The question is, how much longer will the imbalance last, and is the era of labor surplus gone forever?
The rising cost of labor has compelled the manufacturing sector to control costs by stepping up consolidation and increasingly replace human workers with robots. Many small, inefficient factories were bought out or shut down as a result, and many blue-collar workers lost jobs and turned to other industries. The combined effects of these two factors are pushing the manufacturing sector to focus more on quality and branding, and the sector has seen rapid efficiency gains.
Meanwhile, the service sector has expanded. Consolidated manufacturing enterprises are often larger, and managing them is more complicated. They require more advanced technologies and better, diversified services, which has spurred the development of many small- and medium-sized enterprises. Demand for white-collar workers skilled in manufacturing processes has increased to the point of exceeding supply. As incomes for low-skilled labor moved upwards, so did domestic consumption. With these developments in the labor market, the overall cost of labor is now determined by the service sector. The manufacturing sector’s demand for labor is continues to diminish and blue-collar workers are not in a position to negotiate.
The market for services catering to consumption needs has expanded rapidly, primarily because the consumption model of many people has changed. Previously, they spent to regain strength and energy to work better and earn more. At that stage, their spending on services was kept to a minimum. Now they spend to entertain themselves, improve their social status or for the pure pleasure of spending. This means they are much more willing to pay for services.
These changes are expected to increase domestic consumption on a nationwide basis and enhance the quality of consumer-related services. Of course, consumers are sometimes service providers themselves. This means an increase of consumption reduces the availability of labor. In other words, there must be more workers to provide the same amount of services. This is the most important factor in why low-skilled workers have been in short supply these days.
So this is what happened: with higher labor costs, factories replaced workers with machines to improve productivity. Meanwhile, household consumption increased while each person now provides fewer services. The resulting inefficient supply of services has raised labor costs and factories must keep up by making further efficiency improvements.
This clearly indicates that a shortage of low-skilled labor has driven manufacturing industries to improve productivity, but it is not what endangers the economy with the risk of the middle-income trap.
The process will come to an end when two conditions are met. First, when robotized systems are fully integrated into the manufacturing sector and second, when the service sector enters a stage of consolidation to increase productivity. Then, we will see once again the supply of labor exceed demand and unemployment increase, like what many developed economies are experiencing nowadays.
*Ye Xiang is the managing director of VisionGain Capital Ltd. and chief economist at Guoyuan Securities (HK) Co., Ltd.