Finally, China starts to tackle the high cost of hiring

There was a lot of news out of China last week–stock markets tanking, interest rates being cut, etc–so it’s understandable that some other interesting developments slipped through with little notice. This one is worth highlighting as I think it may well mark the beginning of an important longer-term shift in China’s labor market and policies: the State Council lowered employers’ required contributions to two social insurance programs, injury and maternity insurance, a move it said would save firms 27 billion renminbi a year (see the China Labour Bulletin for an English-language summary). Yes, I know this sounds boring and technical, so why is it important? Because it starts to address one of the biggest but least-known issues in China’s job market: the very high costs employers face to hire workers.

It is not a very well-known fact that China has some of the toughest labor regulations in the world, and some of the highest required contribution rates to social insurance programs. As a result, the “labor wedge”–the percentage of the total cost of an employee that comes from things other than wages–in China is around 45%, as high as in a number of European countries (this is according to an estimate by John Giles in a World Bank paper; see chart below).

laborwedge2

This fact does not square with the widespread perception of China as a nation of sweatshops employing hordes of migrant workers, and indeed is a relatively recent development stemming from the 2008 Labor Contract Law. But China’s problem with these generous worker protections is ultimately the same one that many other developing countries have encountered: strong legal protections and generous insurance programs are so expensive that in practice they only become available to part of the workforce. Effectively China has two labor markets: one for urban white-collar jobs with all the legal protections, and one for blue-collar jobs held by rural migrant workers that generally lack the full set of benefits. As John and his co-authors summarize the issue in their 2013 paper:

China’s urban social insurance system carries heavy burdens for both employers and workers, and may carry significant implications for China’s long–run competitiveness. Moreover, this high implied labor tax wedge likely encourages informalization of the labor market: employers under-report wages and game the system in numerous ways, while workers have incentives to opt out of participation in social insurance schemes. As in other developing countries, high mandated contribution rates provide strong incentive for employers to evade compliance through the use of labor dispatch services and under-reporting of employment and wages.

The IMF in its last Article IV report on China also, very correctly in my view, highlighted this issue and urged the government to change:

Social contribution rates, which are high and very regressive, should also be reduced as they distort the labor market, make growth less inclusive, and favor informal over formal employment.

So economists have for years been flagging this issue as an area where “structural reform” is needed. Having a relatively high cost of employment should, other things being equal, discourage employers from hiring. But there’s been little evidence that this was in fact a real problem over the last few years–instead, it was much more common to hear complaints and anecdotes about labor shortages. So the very high rates of social contributions did not seem like they were imposing much of a cost on the economy: the job market stayed tight and wages continued to grow rapidly. While high hiring costs may have lowered employers’ demand for workers relative to what it otherwise would have been, this effect was not big enough to seriously affect the balance of the labor market.

That has all changed in recent months, as the economy has continued to weaken. With employers finding growth in demand for their products continuing to soften, it’s hardly surprising that their demand for additional workers is also softening. Public data on China’s labor market is limited, but there is much labor data that is collected but not published, and this seems to have been enough to get policymakers worried. The State Council has warned of “growing pressure on employment,” and rolled out a whole series of measures designed to assist the unemployed, such as tax breaks for hiring new workers, cheap loans for small businesses, and support for laid-off workers to start their own companies. The most recent of these moves, the small cut in some social insurance costs, may indeed be a needed reform, but, as is so often the case, the timing of reform is being driven by the economic cycle.

We therefore seem to be at a tipping point in the labor market that is causing the government to look again at the cost-benefit analysis of its labor policies. And as China’s economic growth continues to slow in coming years, I expect the costs of its current set of labor policies will become increasingly apparent. So the balance of its policies should shift more toward encouraging employment, and preferring higher rates of enrollment in social insurance programs to higher benefit levels. European countries have often been criticized for preferring labor policies that reward people who already have jobs at the expense of people who want jobs. China’s latest move is a clear if marginal shift in the other direction: it would prefer that 27 billion renminbi not go to improve the welfare of people who already have jobs, but instead be spent on hiring new workers.

The fact that China is moving relatively early to make this adjustment–before there has been a big increase in unemployment–to me is a hopeful sign that it could be more flexible in navigating this transition than some other countries. That may not be the most obvious conclusion, since China is after all a Communist country that one might expect to have a strong ideological commitment to social-welfare institutions. But the “socialist market economy with Chinese characteristics” of the past three decades has in fact never been particularly keen on socialist labor market institutions, as a whole host of workers’ rights groups will tell you.

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