Averting a Labor Crunch
Is China reaching a demographic threshold known as the Lewis Turning Point (LTP)? If so, it could have far-reaching implications for both China and the rest of the world. A common rite of passage as economies move from developing to developed market status, the LTP is the point at which the flow of surplus workers from the countryside begins to dry up. This process gradually robs a country's manufacturers of the cheap labor that drives their international competitiveness. The economist Sir William Arthur Lewis introduced the concept in 1954 in his famous Dual-Sector Model, which consists of both subsistence and capitalist sectors. The model holds that countries in the early stages of industrialization have an almost unlimited supply of labor from the subsistence sector. As a result, businesses can expand for some time without increasing wages by drawing labor from this parallel sector. However, once businesses fully absorb the excess labor, further growth causes wages to rise and the economy reaches its LTP.
Evidence that China is closing in on its own LTP abounds. On December 10, 2004, the Xinhua News Agency reported on its website about the rising wages of migrant workers in coastal regions, caused by the country's strong export activities. In July 2010, the China Economic Journal published a special issue debating the country's LTP, and in 2013, the International Monetary Fund published a paper that predicted China's LTP would emerge between 2020 and 2025. Historical data show that from 1995 to 2011, the average annual growth rate of real wages was 13.1 percent, exceeding the real GDP growth rate of 9.8 percent. Consequently, the gap between China's labor costs and those of other developing countries has progressively widened.
China's countryside has been the principal source of the labor bonanza enjoyed by the manufacturing sector, as low-income rural workers abandoned farms to seek employment in cities. However, the supply of rural workers who could potentially migrate is now dwindling for several reasons.
The rural total fertility rate has steadily dropped over the past 30 years due to both policy and development reasons. Although authorities have applied the one-child policy less stringently in rural areas, they do enforce an upper limit of two children for rural families. Urbanization itself has further reduced the rural birth-rate as women become better educated, marry later and seek employment in urban areas. Over time this results in fewer people of working age in rural areas and higher old-age dependency ratios. In fact, the World Bank estimates that the gap in old-age dependency ratios between urban and rural China will widen further, from 4.5 percentage points in 2008 to 13 percentage points in 2030.
The rural labor pool is also growing older, which can potentially limit workers' willingness and/or capacity to migrate to urban areas. Some economists have suggested that the marginal cost of migrant labor has risen in recent years, particularly because the older migrant workers become, the less willing they are to travel long distances. They usually have more family-related costs than younger workers, which can make uprooting to move to the city unfeasible.
The spread of rural entrepreneurship and new non-farm work opportunities in rural areas has soaked up much of the rural surplus labor pool. In 1995, just under one-quarter of rural workers between the ages of 16 and 20 worked outside of farms, but by 2007 this figure had rocketed to over 97 percent.
Institutional restrictions such as the "hukou" household registration system may further restrict the flow of migrant labor. In the wake of the third plenum of the Communist Party's 18th Central Committee in 2013, the country has signaled its intention to relax hukou restrictions on migrants seeking to settle in small and midsized cities, although they will remain in place for large cities. This is a good first step, but more action is necessary.
Because of these trends, analysts expect the size of the rural labor surplus to plunge and severely curtail the migration from country to city. Once it passes the LTP, China will move from an economy with a vast supply of cheap workers to one characterized by labor shortages and rising wages. This shift could cause dramatic disruptions in China and across the rest of the world, forcing multinational players to rethink their global strategies.
These changes in rural-urban migration flows are taking place in tandem with an overall plateauing of China's working-age population, the latter reflecting the demographic trends set in motion by the one-child policy instituted in the 1970s. In December 2012, China's population between the ages of 15 and 59 was 937.3 million, a decrease of 3.5 million from 2011. Based on UN labor force projections, the total population will continue to grow, but the working-age segment will expand more slowly and ultimately begin to shrink.
Growing Older, Faster
The workforce is not just getting smaller; it's also growing older. What's more, the country is aging at a faster rate and on a larger scale than most now-developed economies have experienced. As of September 5, 2012, data from the China National Old-Age Council Office shows that the country's population of people aged 60 over was 200 million people at end of 2013 and will reach 300 million by 2025. UN population projections reveal that the share of the population in this age bracket will rise rapidly, from about 12 percent of the population today to 20 percent around 2025, and that this ratio will peak at 30 percent in 2050. This means that China will become an aged society in only 25 years, instead of taking the 100 years typically required by advanced economies. For instance, as of September 24, 2013, China Economic Times reported on its website that in 1901 the share of France's population in the 60-and-overcategory was 12.7 percent – less than a point higher than China's today – and took until 2000 to pass 20 percent. This accelerating pace of aging will add to the severity of future labor shortages, increase old-age dependency ratios and raise the cost of financing social protection systems such as health care and pensions.
Demographics, by their nature, tend to unwind slowly; the population dynamics we see today reflect forces set in motion several decades ago. Likewise, demographic policy shifts instituted now may take a long time to take hold. In the near term, the burning demographic platform China finds itself on requires a more pragmatic approach that has four elements.
Although China has experienced strong productivity growth over the past few decades, progress comes from a low baseline. Consequently, the country still trails many developed economies in term of absolute productivity levels. In 2012, for example, China's labor productivity was only 22.3 percent of the United States'.
China can achieve large labor productivity improvements by boosting capital investments, especially in new technology areas, by matching worker skills and job requirements more accurately, and by improving the quality of the human capital it has under development. As China moves to reform its education system, it should make better planning and forecasting strategic priorities. To rebalance the economy and encourage enterprises to move up the value chain, the country needs people with a broader practical set of capabilities, including "soft skills" such as effective communication and presentation capabilities, and strong IT technology expertise. It has to engineer a major culture shift at its universities so that they focus not only on teaching science, technology, engineering and mathematics, but also on teaching students how to learn, as well as business-focused skills such as communicating effectively, thinking critically and being more adaptable in the face of a changing business environment.
Also, institutional barriers associated with China's household registration system stop the country from making full use of its labor reserves. The hukou system prevents labor from moving freely around the country because it does not give migrant workers full access to local health care or schooling for their children. As a result, most migrant workers choose to leave their employers in large cities and return to smaller cities nearer their hometowns, creating labor shortages in key sectors. What's more, many migrant workers have limited educational backgrounds. With China moving from a manufacturing-led to a service-led economic footing, this unequal distribution of education resources will create significant problems for employers seeking qualified workers in the future.
Third, while laborers often lack the skills employers want, China also faces a severe labor market mismatch at the top end of the educational spectrum. Surveys report that many graduates with advanced degrees face increasing difficulties in securing satisfying jobs. China produces the largest number of PhD degrees in the world, a number that has increased 9 percent annually for the last decade. Recent research done by Recruitment and Consulting Service Association shows that nearly 85 percent of employees in China think they are overqualified for their jobs, a level much higher than the global average rate of 47 percent. Employers, on the other hand, say their difficulty in recruiting general workers increased by nearly 50 percent in 2010 compared to 2008, Ernst & Young reported in 2012. This conflict between having too many overqualified graduate students and too few skilled workers is reflected in the fact that college graduate students between the ages of 19 and 25 have the country's highest unemployment rate, at around 13 percent as shown in the China Urban Unemployment report.
China should rethink its vocational schools and private education programs, putting a greater emphasis on turning out employable graduates. A good way to align work needs with education offerings is the establishment of enterprise/government/university collaborations. One possibility involves the creation of dual-track apprenticeships as an alternative for both enterprises and their employees. The apprenticeship's work-based training periods allow employers to assess and recruit future skilled employees, enabling them to understand the capabilities of potential employees in real life situations. Simultaneously, apprentices receive an education that aligns with the enterprise's needs, values and culture. Apprenticeships also help trainees develop key soft skills such as effective communication and presentation abilities, and ground them in areas such as entrepreneurship, problem solving and teamwork. This type of program has a successful track record: in 2009, the European Commission had an estimated 3.7 million students involved in apprenticeship studies in the European Union area.
Finally, on March 27, 2010, China Daily posted an article on its website that suggests that the labor pool, shorn of inefficiencies, could actually be large enough to serve the country's needs for at least the next 40 years. In fact, the IMF estimates that the country's potential excess supply of labor – the reserve of unemployed and underemployed workers – is in the range of 150 million people.
New technologies offer many possibilities for re-integrating marginalized groups back into the workforce, including mothers with children, older people, unemployed people and discouraged workers. The greater coverage provided by mobile networks, cloud-based technologies and new applications can help educators and employers engage inactive workers such as the rural unemployed and mothers with children. Through distance-learning and more flexible working styles, employers can address changes in employees' physical strength and stamina at different life stages, and equip them with advanced skills. A work-from-home experiment conducted by professors at Stanford and Peking University that focused on the 242 workers at a large Chinese travel agency found that employees randomly assigned to work at home for 9 months increased their output by 13.5 percent versus the office-based control group. The study also established that at-home workers reported significantly higher job-satisfaction scores, and that their quit rates fell by almost half.
New technology also brings new business models that can increase overall employment growth. Alibaba, China's biggest e-commerce company, directly or indirectly employs some 12 million workers, for example. Research done jointly by Ali Research and Tsinghua University shows that the company's Taobao portal, the country's biggest consumer-focused website, has provided around 600,000 work opportunities for 80 thousand housewives, 170,000 unemployed, 2,300 retired people and 310,000 students. These retail shops cost very little but offer entrepreneurial opportunities and employment at the grassroots level. Regardless of gender, educational level or registered residence, the Taobao platform offers non-discriminatory opportunities, including equal technical support and free online space, for all online shopkeepers. What's more, emerging service sector industries such as online retail and logistics businesses offer strong prospects for luring discouraged workers back into the labor pool.
Staying on Track
While China could be on the verge of reaching its LTP, the country can do much to avert the threat to its continued economic growth. Collaborative efforts involving businesses, universities and government agencies and the introduction of new technologies offer pragmatic ways to match skills better and thus utilize the existing labor force more efficiently. By successfully employing these approaches to resolve its labor shortages, China can safely negotiate the LTP bottleneck and stay on a path of longer-term economic growth.
Mark J. Purdy is a managing director and chief economist at the Accenture Institute for High Performance. Mickey Fang Xu and Jing Yu are researchers at the institute
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