China challenge not demographic

One of the biggest economic questions of the decade is undoubtedly whether China will succeed in changing its development model. Since the late 1970s the Asian giant has enjoyed spectacular success in transforming itself from a poor rural economy to a dynamic industrial power. The time has come to shift the balance even further towards improving the quality of its output rather than simply catching up with the West.

This should mean more innovation and better technology. It also means raising labour productivity by investing more productively rather than simply throwing huge resources into prioritised sectors.

To a large extent the Chinese leadership recognises these challenges. There are already significant signs that it is becoming more innovative and moving towards developing more advanced forms of technology.

The problem is that the challenges facing China are often misunderstood. For example, last week the Financial Times ran a series arguing that China has reached what is called the Lewis turning point. That is essentially the point at which it can no longer grow simply by shifting surplus rural labour to the cities. China will have to raise urban wages and raise industrial productivity to continue developing.

In putting this argument the FT is following research from the International Monetary Fund, World Bank and others. Although there is debate about whether China is still yet to reach the Lewis turning point – named after Nobel laureate Arthur Lewis – it is widely seen as a valuable concept.

Before examining why this conception of China’s economic challenges is flawed it is worth doing a back-of-an-envelope calculation on the country’s labour situation. It is hard to imagine how, at least on the face of it, a country with a population of more than 1.3 billion people can be facing a labour shortage.

According to the latest statistics from the World Bank just under half of China’s population is rural. That amounts to about 640m people. However, a disproportionate share of that population is either elderly or children since a large number of those of working age migrate to work in cities. The FT quotes an estimate from China’s National Bureau of Statistics that 278m people lived outside their home towns for at least six months last year.

It is also worth noting that some people classified as living in the countryside work in the service or industrial sector. The true share of agriculture in the workforce could be as low as 20 per cent.

The flaw in the notion of the Lewis turning point is that it conceives of the challenges facing China in primarily demographic terms. It sees the main constraint as one of the number of available workers.

But that is an upside-down way of viewing the problem. It would be more accurate to see the challenge as one of increasing productivity across China. That way the whole of China’s enormous labour pool, amounting to many hundreds of millions of workers, can be harnessed more efficiently. It should be possible for China to produce far more than it does at present with the existing number of workers. Indeed, with the right investment it could even produce multiple times what it does at present even with a substantially smaller labour force.

China should also move much faster to abolish hukou: the system of household registration that ties an individual’s access to education, healthcare and housing to their home town or village. This represents a formidable barrier to labour mobility and hence to raising productivity.

The economic and social challenges facing China are far more pressing than any demographic shifts.

 This blog post was first published today on Fundweb.