Thursday, June 2, 2011

Are We Misinterpreting China’s Decline in Growth?

The press is filled with accounts of the “planned” decline in Chinese economic growth. The standard interpretation appears to be the following:

To confront rising raw material prices, China’s bankers have applied the brakes. There will be less lending for large state enterprises and infrastructure investment will be cut back. In the mean time, China’s growth with fall slightly, but it can resume after tight money has done its job. The decline in growth is a cyclical response by wise Chinese monetary authorities. When the emergency passes, rapid growth can resume.

I would like to offer an alternative explanation which has much longer term consequences.

The press is also filled with accounts of rising pressure on the Chinese labor market. Wages appear to be soaring everywhere. Business is moving from the coast inward, and interior areas are playing catch up. Migrant labor is drying up. Residents from the interior say they no longer need to commute long distances. The jobs have come to them. In the press, this wage inflation is, almost comically, explained as a deliberate state move to grow the Chinese consumer market. It is not. Wage inflation is the result of deep economic forces.

In a word, China’s era of unlimited supplies of labor has ended as is evidenced by the incredibly rapid wage inflation.

W. Arthur Lewis earned a Nobel Prize for his 1954 analysis of economic development with unlimited supplies of labor. With labor supply unlimited, an economy can grow by redistributing labor to the “modern sector” without driving up wages. The economy grows rapidly but only until the unlimited labor is exhausted. The signal that labor has become limited is economy-wide wage inflation. At that point, the economy reaches an inflection point, and future per capita growth is determined by technological progress and more capital per worker. No country in history has grown at China’s per capita rates based on these two factors.

Over the next months or year, we will see that China’s growth has indeed declined, but we will not know whether this is the consequences of tight money or the exhaustion of unlimited supplies of labor. We will also see less infrastructure investment as the central bank reduces lending.

But real Chinese growth occurs elsewhere. Chinese banks lend only to large state (or state connected) companies. They do not constitute China’s real credit market, which lends informally at high rates to private companies that have so far earned huge rates of return. They are the true drivers of Chinese growth. If their profits drop and their growth declines, China’s era of easy growth is over.

1 comment:

  1. In a word, China’s era of unlimited supplies of labor has ended as is evidenced by the incredibly rapid wage inflation