Rising labor costs, a slowing recovery in the advanced economies, and expected reductions in China’s dependence on external demand will probably slow China’s growth to 7–8 percent in the years ahead. A significant slowdown, as feared for the United States, is unlikely, however. If domestic economic rebalancing—now recognized by top leaders in Beijing as absolutely necessary—accompanies this slowdown, it will be a good thing for China and for the rest of the world.
Overheating Largely Contained
China’s efforts to reduce overheating and control a potentially dangerous housing bubble have been largely successful so far. Although consumer price index (CPI) inflation, driven by food prices, grew in August, producer price inflation fell. In light of a probable decline in food prices later this year, the government’s 3 percent CPI inflation target for 2010 looks achievable.
The central bank has tightened monetary policy somewhat since the first quarter and the government took tough measures in April to cool speculative housing demand. As a result, market turnover has fallen sharply and average prices in some cities have decreased marginally. There are unconfirmed reports of price increases in some cities in August, but the housing price index for the leading 70 cities continued to moderate.
No serious market disruptions have occurred, and the government appears able to control the bubble without killing the construction industry—as it did in the first half of 2008—at least for now.1 New housing starts and construction activity remain relatively buoyant and housing sales picked up significantly in August. As the government works to keep the bubble under control and improve affordability—a big problem for first-time home buyers in the major cities—it is not likely to relax property lending restrictions anytime soon.
GDP Growth Slowing But Robust
GDP growth will likely fall to 7–8 percent in coming years, but this lower rate will be more sustainable. Investment’s contribution to growth—no less than 90 percent during the first three quarters of 2009—dropped to around 55 percent in the first half of 2010, and will likely fall further as the recovery takes hold. New lending has also continued to moderate since January.2
At the same time, China’s growing urban population—whose share of total population is expected to rise from 46 percent today to 60 percent by 2030—will help keep its growth rate robust. It will keep demand for urban housing strong for years. In this respect, China’s present economic situation differs significantly from Japan’s after its financial and real estate crises of 1990–1991. China’s domestic confidence (consumer and business) also remains strong.
Rebalancing and Domestic Demand Growth
China’s trade surplus reappeared and widened quickly after a rare deficit in March. If this trend is not reversed, China’s external surplus may frustrate global rebalancing efforts and intensify trade friction with other countries. Already, tensions with the United States and the EU over China’s exchange rate and industrial policies are rising.
Though the outlook for 2010 and beyond is uncertain at this time, China’s current account surplus for the year is unlikely to exceed 5.5 percent of GDP—the same balance as 2009. In August, the most recent month for which data is available, imports grew faster than exports, lowering the trade surplus considerably from $28.73 billion in July to $20.03 billion.
Beijing says it is committed to rebalancing its economy—that is, reducing dependence on external demand and increasing reliance on domestic consumption growth—and it has taken some initiatives in the right direction. As part of its stimulus, Beijing introduced a large-scale “affordable housing” program for rentals and ownership, subsidized by the central government. Many details remain unclear, but Singapore’s successful public housing scheme seems to have inspired the program. One of China’s objectives for this program is to create a large source of domestic demand to compensate for the expected slowdown in export growth.
In addition, Beijing hopes to address the social problems that have arisen from reduced housing affordability in tier 1 cities and also to avoid urban slums. Plans to deal with these issues—which target efficient urbanization—are becoming increasingly central in the government’s long-term development and rebalancing program. China realizes that high quality urbanization and adequate infrastructure will lead to greater productivity growth and a higher quality of life for its urban population.
However, the incentive regime—including VAT export rebates, land pricing, the exchange rate, and many other factors—continues to favor exports and import substitution. Nonetheless, domestic consumption growth (both household and government) is very strong and has probably exceeded GDP growth—as is necessary for macroeconomic rebalancing—since the beginning of 2009.3 China’s next five-year plan (for 2011–2016), which will likely be approved next month, will undoubtedly emphasize the need for rebalancing. Even if the incentive framework is modified to be consistent with rebalancing aims, many years will pass before China begins to look like a more “normal” economy.
Demographic Shifts and Labor Markets
As a result of China’s quick and impressive recovery in 2009, labor markets tightened considerably, driving up real wages even faster than in pre-crisis years. The speed surprised most analysts, who—after some 20 million migrant workers were laid off from export manufacturing in eastern China and large-scale lay-offs occurred in construction—had anticipated that high unemployment and stagnating real wages would persist for an extended period.
The exact opposite has happened. Since late 2009, labor shortages—not only in the main manufacturing zones of eastern and southeastern China, but also in interior regions—have driven up real wages. Wages for unskilled labor have increased by 15–20 percent so far this year, and wages for skilled and experienced labor are rising even faster.4 Dozens of local governments have adjusted minimum-wage requirements significantly. Strikes and demands for independent labor unions—both illegal in China—have sharply increased, often in spite of police efforts to suppress them. The only segment of the labor market where supply continues to exceed demand is university graduates.
After aggressive reforms over the past fifteen years, China has perhaps the least restricted labor market of the large economies,5 and it appears to have reached the so-called Lewis turning point sooner than expected. Named after the late Nobel-Prize winning economist Arthur W. Lewis, this theory predicts that unit labor costs in developing countries will rise when surplus rural labor is absorbed.
Since late 2009, labor shortages have driven up real wages.
Two supply-side factors are at work. First, long-predicted demographic shifts have kicked in. Though China’s labor force is forecast to peak around 2015, the supply of 16–35 year olds—and especially of females, who are in high demand in export manufacturing—has already started to decline.
Second, the urge to move to coastal cities for a better life is not as strong as it used to be. Living conditions in rural China have steadily improved and China’s “go-west” policies of recent years have made more jobs available in interior provinces, where the growth rate often exceeds that of coastal areas.
The practical economic implications for China are significant, especially for industries where labor costs represent a relatively large share of production costs. Such industries may have to close, upgrade technology, or relocate to other parts of China (or to other countries) where labor costs are lower. Many of these changes are already occurring. As a result, manufacturing may become more capital-intensive, machine tools more important in industrial output, and interior provinces more industrialized.
Pieter Bottelier, former chief of the World Bank’s resident mission in Beijing, is a nonresident scholar in Carnegie’s International Economics Program and senior adjunct professor of China Studies at the School of Advanced International Studies (SAIS) at Johns Hopkins University.
1. Construction accounts for about one third of total investment and is a major growth driver in China.
2. There is growing concern, however, that some banks are selling securitized debt as trust-style investment products off balance sheet so as to avoid the constraints of low, government-mandated bank deposit rates. No reliable statistics on such transactions are available, but according to some estimates the total could amount to as much as 20 percent of reported lending. CBRC has ordered that all off-balance sheet assets and liabilities be brought on-balance sheet before the end of 2011. CBRC is also requiring some banks to raise more capital and is expected to require additional provisioning on the expectation that NPLs will rise in the wake of excessive lending, sometimes for dubious projects, in 2009 and early 2010.
3. There are no reliable household consumption growth statistics in China.
4. This information is mainly based on media reports; official statistics on wage increases in 2010 are not yet available.
5. Restrictions on labor mobility imposed by China’s household registration (Hukou) system are significantly less than they used to be.
