Category / Economics

by Andrew

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.

by Andrew

One book, twenty views about China

The universe of independent research on China has grown much larger in recent years, as can be seen from the contents of this new e-book. John Mauldin and Worth Wray have pulled together a good number of commentators and China watchers, among whom are some friends and partners in crime in Beijing and Hong Kong. My employer Gavekal is also well represented, with a piece by our CEO Louis and one by my colleague Ernan Cui. My own piece is on China’s exports and its New Silk Road ambitions. There’s a wide range of views about China represented in the book, including some I disagree with, so it should make for a good and varied read.

 

mauldin_book_small

by Andrew

Risks and politics in capital account liberalization

Various talking heads, including yours truly, are quoted in this Bloomberg piece about the risks to China’s decision to step up the pace of capital-account liberalization in recent months. Here are some indicative comments:

“History shows that if China prematurely opens the capital account before properly sequencing in other reforms the results could be disastrous for financial stability and longer-run growth prospects,” said Kevin Gallagher, an associate professor of international relations at Boston University who co-wrote a paper on China’s cross-border capital deregulation. “I worry that they are forgetting the past.”

The best sequencing would have China first free up its domestic financial sector and shift to using interest rates as the major tool to affect credit, according to Louis Kuijs, Royal Bank of Scotland Group Plc’s chief China economist. Next, policy makers should allow greater currency flexibility, and then open the borders to capital flows, said Kuijs, who previously served as the World Bank’s senior economist in Beijing.

Why all the hand-wringing? In April, central bank governor Zhou Xiaochuan made a surprisingly public and specific pledge to complete some additional opening of the capital account during 2015–a timetable explicitly driven by the goal having the renminbi blessed by inclusion in the IMF’s currency basket for the SDR, whose quinquennial review begins in November. The IMF has made very positive noises in response, so it is looking like a done deal. The symbolism of having the renminbi recognized as a reserve currency is obviously very important to China. Or, what I think is more likely, the symbolism is politically useful for Zhou. An issue of national prestige is a much better way to convince the rest of the government of the merits of additional capital account opening than a technical economic argument. In any case, it seems pretty clear that the decision to open up more to capital flows (through measures like the trading link between the Shanghai and Hong Kong stock markets) is not being driven by technocratic concerns about sequencing, but by political opportunity.

It’s reasonable to worry about the potential consequences of this opportunistic strategy. I have a lot of respect for Louis Kuijs and do not quibble with his preferred sequencing. And there are definitely a number of Chinese economists who think opening the capital account should be a relatively low priority, undertaken only after more liberalization of the domestic economy. However if we are describing what is actually going on in China, rather than prescribing what it should be doing, I think it is pretty clear that the proper sequencing of reforms is not the big priority.

Does this make sense? If you think about how governments actually work, it does. Policy changes tend not to happen at the exact moment that the eggheads think is optimal, but when there is a political opportunity to get agreement on them. Proposals can sit on the shelf for years until the right political moment arrives. It looks like Zhou has decided to seize the moment to push through some additional opening of the capital account, without worrying too much about whether it is exactly the right time to do so. Sure, some people may quibble about the sequencing of reforms, and there may be some messes to clean up later. But getting the sequence wrong may be less of a risk than missing a political window of opportunity that may re-open for years. At least, that is the apparent calculation.

The politics of capital-account liberalization are a useful reminder that China’s economic reforms do not, despite how it may sometimes seem to outsiders, proceed according to a detailed top-down plan made long in advance.

by Andrew

Does this plan for tackling China’s excess capacity have a chance?

What is to be done about the excess capacity in China’s heavy industry? As the decade-long housing boom has topped out in recent years, companies that had bet on ever-rising demand for construction and building materials are finding themselves with idle factory capacity. The excess is probably most serious in steel, but is also evident in related sectors like coal mining (the fuel for the power plants that drive steel smelters). This idle capacity weighs on the economy by depressing prices and margins in the affected industries, and holding back corporate investment and hiring plans. The debate over how to respond to this issue pits those who advocate letting the troubled companies collapse and markets right themselves, against those who fear too much dislocation and argue for extending more subsidies and bank credit to help troubled companies through a rough patch.

Neither of these options is particularly attractive, and the choice to some extent is a false one. Yet discussion of the excess capacity problem seems to mostly swing between an extreme Andrew Mellon-style “liquidationist” position, and the “extend and pretend” school of hoping the problem will go away eventually if troubled enterprises get enough support. The government of late has seemed to lean toward the latter position: the central bank’s lowering of interest rates makes it easier for indebted companies to stay current on their interest payments. A May decision to lower industrial electricity rates and give iron ore mines a tax break was also clearly aimed at reducing operating costs for excess-capacity sectors. Recently Liu Shijin, an economist and senior official at the Development Research Center, a government think tank, stepped in with a proposal cleverly designed to appeal to both sides.

Because I think his proposal is both interesting and realistic in the Chinese context, I have translated here the relevant section of interview in which it appears. The key point is that he proposes using government debt to fund a restructuring plan to shut down excess capacity–which, because it will have real money behind it, will be more effective than previous such plans. I think he is right that direct government funding will be more effective than indirect measures like subsidies, and that there is a public interest in getting the market to clear sooner rather than later. But his plan does require the government to accept a higher level of official debt–something it has historically been reluctant to do, though recent plans for restructuring local-government debt have shown some acceptance of the principle. On the other hand, the sum of 300 billion renminbi that he quotes is hardly a prohibitive figure, given the size of China’s economy and government revenues. Overall this proposal seems like an advance on the current confused strategy, but I do not know how to handicap its chances of actually becoming policy.

China Economic Times: In recent years, China has been restructuring industries with serious excess capacity, but the speed of adjustment is not satisfactory. What are the underlying causes, and how can the situation be improved?

Liu Shijin: I think that the slow pace of restructuring in industries with serious excess capacity in recent years is due to two reasons. First is the effect of the “acceleration principle” that is inherent to the heavy and chemical industries. Due to the increasing specialization of the modern market economy, the production chain for final goods including infrastructure and real estate has lengthened. When demand for these final goods enters into a long-term phase of rapid growth, intermediate inputs will experience a self-reinforcing “acceleration effect.” So the extent of excess capacity in these industries, and the scale of the required reduction, could be greater than originally expected.

Second is the fact that local governments’ attitude toward industrial restructuring is not very proactive, or even passive. Although everyone has recognized that overcapacity is serious and that restructuring is inevitable, often they hope that others will restructure first so they do not have to. In addition to trying to avoid the conflicts caused by shuttering businesses and dealing with debts and re-employment, there is also a lot of selfish thinking by local governments: maintaining the existing businesses means you have a chunk of GDP, from which you can also get tax revenue. The result of these actions is that businesses are losing lots of money; bad companies want to exit the market but cannot, and good companies are also worn down. This is not sustainable.

To cope with this difficult situation, we must have determination to make progress, within a specific time period, in the exit and restructuring of this serious excess capacity. We can consider implementing an action plan for reducing capacity and raising efficiency in industries with serious excess capacity.

China Economic Times: Can you tell us about the specific ideas and measures you envision being part of this action plan?

Liu Shijin: I think this plan should include the following six parts:

First, select the industries to be included in the scope of the action plan, such as steel, coal, petroleum, petrochemicals, iron ore and other industries.

Second, draft a capacity reduction plan. As a preliminary calculation, the plan can be drafted to cover 10% of nationwide production in 2015, with the affected provinces’ plans made according to their share. State macro management departments can sign capacity reduction commitments or agreements with the affected provinces.

Third, establish a “capacity reduction and restructuring fund,” funded largely through the issuance of long-term (10 years or more) dedicated bonds. The amount of the bond issue will be determined by the scale of the capacity reduction in each province. The bonds will be issued and repaid by provincial governments, but the central government will subsidize the interest. The fund will be mainly used to subsidize corporate closures, restructuring and capacity reduction, as well as the placement and re-employment of affected workers. The size of the fund will be approved on the basis of these costs.

Fourth, the affected provinces will use this fund as a lever to promote implementation of the capacity reduction and restructuring plan. When designating production capacity for exit, we should not use the phrase “backward production capacity,” as this terminology is very characteristic of the planned economy. In practice it often means using the size or age of the equipment as a benchmark, rather than its efficiency or compliance with regulations. We recommend using the categories of “illegal capacity” and “inefficient capacity;” the former meaning that which does not national regulations on environmental, energy saving, safety, etc., and the latter meaning capacity with low efficiency that does not have a strong position in market competition. Local governments should follow open and transparent criteria to make a list of companies with “illegal capacity” and “inefficient capacity,” and guide these companies to take the initiative to participate in the capacity reduction and restructuring action plan. Companies that go through closure, restructuring and other capacity reduction measures can receive corresponding subsidies for capacity reduction, staff placement and re-employment. Regions with a large number of competitive enterprises can try using an auction technique, in which the company that bids the lowest [restructuring] cost will have preference in obtaining the subsidy. In short, the idea is to reduce the barriers and conflicts in the process by giving some compensation and some choice to companies that reduce their capacity.

Fifth, give local governments a relatively large amount of autonomy and scope for innovation in the use of the fund and the techniques for cutting capacity. [trimmed for space reasons] …

Sixth, there should be appropriate preventive and punitive measures to prevent a situation where companies think “other people are cutting capacity so I don’t have cut to cut capacity.” National statistics and auditing agencies can do checks in the affected regions, and we can also introduce mechanisms for public supervision. If they find that capacity reductions have been reduced or falsified, there can be a public report and criticism, and a corresponding reduction in the central government’s subsidy. There can also be a request for political discipline of those areas that have committed to reduce capacity. We can use administrative methods in combination with market mechanisms to ensure the desired effect.

China Economic Times: What do you think will happen if such an action plan is implemented?

Liu Shijin: If you implement this action plan for reducing capacity, restructuring industry and raising efficiency, it will send an important signal to society, which is that there will be important changes in the relationship of supply and demand in the affected industries. This signal may drive a rebound in prices. Coal and steel account for a large share of the industries with severe overcapacity. According to preliminary estimates, the funds required for these two sectors are 80-100 billion yuan and 200 billion yuan respectively. If the term of the bonds is over 10 years, and there is an interest subsidy from the central government, it will not create great pressure for local governments. In the short term, there may be some impact on the growth of local GDP and tax revenue from cutting capacity, but once prices rise, these losses will be more than made up for. This is a process of “trading quantity for price,” and is overall beneficial to the locality. Therefore this should be considered a supportive policy for areas with a high concentration of excess capacity, particularly the old industrial bases that have a high proportion of heavy and chemical industries.

 

by Andrew

In China of the 2010s, some echoes from the 1970s

Browsing at the Beijing Book Fair this past weekend, I stumbled across an old book (in English) called China’s Economy: A Basic Guide, by one Christopher Howe, mixed in among the usual mess of the collected works of Mao and art auction catalogs. Of course I snapped it up; not because it is some kind of lost classic, but because it presents a view of China circa 1976, before the reform era and big changes in the Chinese economy that ensued. In these days when China’s massive role in the global economy is a fact of life, it’s hard to look at its history without having your view colored by the knowledge of what happened after 1978. I think it’s quite informative to see what China looked like to people who did not already know that it was going to turn into a world-shaking economic power.

In fact there seem to be some interesting continuities between the China of the 1970s and the China of the 2010s, suggesting that the launch of “reform and opening” was not such a break with the past as it sometimes seems. I have only skipped around in the book so far, but a few interesting parallels have already jumped out. Take this passage, which appears to show that today’s obsession with the internationalization of the renminbi has deep historical roots:

The Chinese frequently refer to the fact that trading partners from sixty countries use the renminbi as the unit of settlement. In general, this reflects the wishes of the Chinese rather than of their trading partners; indeed, insistence that contracts are denominated in the renminbi has at times been a serious obstacle to trade.

On the domestic front, this passage describing urbanization policy also sounded spookily contemporary:

In 1958 a further policy was introduced, one that has persisted to this day. This is the policy of developing “small and medium” cities. In conversation, Chinese officials give varying definitions of these city types, but an authoritative article published in 1958 described the policy in the following terms. “Small cities” have populations of up to 300,000, and are to be “generally developed”; “medium cities” are those with populations of 400,000 to 700,000, and are to have “limited development.” Anything bigger is a “large city,” and is to be “generally restricted.” Special emphasis is put on control of cities with populations of a million or more.

With some updates to the numbers for the size of cities, this passage would serve nearly word-for-word as a summary of the current government’s urbanization policy. It is interesting that the focus on “small and medium” cities, which I think is misguided, has such a long history. It’s not clear why this policy has remained so attractive over time–Howe notes that the justifications for the policy kept changing–but perhaps inertia explains some of its persistence. I suspect further reading will reveal even more parallels.

ChrisHoweChinasEconomy_small

by Andrew

In the future, all economic debates will be conducted through rap battles

That happy future is getting closer, thanks to this excellent discussion of the changing policies of the Chinese government under Xi Jinping, delivered in the hip-hop idiom:

And let’s not forget previous instalments in this genre:

  • the rap battle on currencies on the codependent US-China economic relationship
  • the original Keynes vs. Hayek rap battle, though round two is even better
by Andrew

A warning on Chinese education

The Financial Times has a series of articles this week about China’s rural migrant workers; the general theme seems to be that the fact that a very large number of people have successfully transitioned from backbreaking low-paying farmwork to higher-paying industrial and service jobs is a big problem for China. To me that seems like a rather strange angle to take. Sure, once a lot of people have made this transition it means fewer will make it in the future, but that’s a sign of success not failure.

A more relevant question to ask is probably: once rural migrants have made the transition to the urban economy, how well-equipped are they to keep raising their incomes? Migrants get a big one-time gain in incomes just from going from the rural sector to the urban sector, but how do they do once they’re in the urban sector? A recent paper by the great development economist Scott Rozelle and a number of co-authors tackles this question by taking a close look at the educational level of Chinese workers. Scott has written more papers about Chinese agriculture than I can count, but over the last few years his focus has really been on rural education issues, and he has bent my ear about this every time I have seen him. The new paper documents more formally what Scott has been saying in talks and presentations for a while: China does not in fact have a very well-educated workforce, primarily because of problems in rural education.

Below are the data they calculate from the Chinese census, with comparative figures from the OECD:

Rozelle_Table2

The census data show much lower levels of educational attainment than the Ministry of Education’s figures, which claim very high enrollment rates. Some studies have shown far fewer rural students are completing secondary education than officially reported. The reasons why rural students are dropping out of school is not extensively discussed in this paper (there is more detail here). One factor that Scott has highlighted before is the very strong gains in migrant wages in recent years, which have made it more attractive for kids to start work early without completing school. It is also the case that the children of rural-to-urban migrants often fall into an administrative limbo between their home area and where their parents work, limiting their educational opportunities.

Why is the lagging education of rural kids a potential economic problem? Because they are the workforce of the future, and the future will need more highly-educated workers. To quote from the paper:

Wages are rising and low-wage manufacturing is moving out. China is already making plans to become an economy that will be based on higher value-added, high-wage industries. This will mean, of course, that there will be a high demand for skilled labor. International experience demonstrates that individuals will need to have to have acquired skills taught at the level of high school or above if they hope to be competitive in these higher value-added industries. If China fails to endow its labor force with such skills, not only will many individuals have a difficult time finding employment, the newly emerging industries may also falter from a short supply of skilled labor. The whole economy may experience slower development.