A significant change is taking place that could see China lose its dampening influence on global inflation, and even potentially make China a driver of higher inflation worldwide. That change is the sharp decline in the Chinese working-age population. A key milestone in this regard is whether China has passed the Lewis turning point (LTP). This marks the moment when an industrialising country has largely exhausted its pool of cheap rural labour and wage pressures start to rise.
By traditional metrics, China has already passed this point. However, traditional measures are misleading: in our view, China has not yet passed the LTP with Chinese characteristics, to quote a phrase beloved of the Chinese leadership. Our reason for this view is the significant pool of underutilised urban labour, which further weakens the workforce’s already modest bargaining power. As such, we do not expect China to be a major source of global inflationary pressure in the short-to-medium term, although it may be less of a deflationary influence than in the past.
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China’s working-age population is already in decline and is expected to fall sharply over coming decades. The dwindling supply of labour would normally lead to a tightening in the labour market and rising wages. However, over recent decades China has experienced a massive migration of surplus rural labour to urban areas which has helped contain urban wage growth.
On the one hand, at 64% China’s urbanisation rate remains much lower than the average of advanced economies, and its agricultural share of employment is also high at around 24%. Taken on its own, this would suggest the turning point is some way off. However, China’s industrialised eastern regions have higher urbanisation rates; and its overall rates of urbanisation are very similar to Japan’s — which were 68% and 25% respectively — when it hit its LTP in the mid-1960s sending manufacturing wages soaring.
A key indicator that the LTP is close is when migration from rural areas into the cities has begun to slow. Over the last decade, that has indeed been the case in China. This probably reflects several factors, including the declining gap between urban and rural disposable incomes, the high and increasing cost of housing and living in cities and the dwindling pool of young rural workers available to move to the cities as the rural population ages. As excess rural labour is largely exhausted and a country passes the traditionally measured LTP, we would expect a sharp jump in both urban and rural wages, and a shrinking of the gap between average wages at State-Owned Enterprises and those at private firms as greater bargaining power drives up wages. This has not occurred, however. Instead, quite a sharp deceleration in wage growth began in the early part of the previous decade.
The slackening pressure on wages is hard to reconcile without the consideration of further factors. One highly significant hidden factor is likely to be a dramatic rise in the number of under-employed in the Chinese workforce. We have long argued that the headline unemployment rate in China significantly understates the amount of slack in the labour market, and our China Urban Under-employment Indicator (CUUI) points to a significant rise in underemployment over the previous decade. Significant underemployment lessens the already modest bargaining power of most workers, which the trade war with the US has further undermined. This is why we argue that the traditional LTP may not be relevant when analysing China, and argue instead for an LTP with Chinese characteristics. Fathom will shortly be publishing a more detailed piece on this subject, available to clients, which explains our reasons for this belief.
In summary, the pool of underemployed should continue to hold down wage pressure in China. Once this pool of labour is accounted for in the LTP with Chinese characteristics, it is likely that the actual LTP will not be passed for several years on current growth rates. Moreover, until the Chinese authorities succeed in rebalancing the economy, we think they will be inclined to use many of the tools at their disposal to prevent their exports from losing international competitiveness. Hence, we do not see China becoming a source of global inflationary pressures over the short-to-medium term, although it may be less of a deflationary influence than in the past.
To learn more about Fathom’s unique approach to understanding China and its economy, please contact Joanna Davies at email@example.com.
 Lewis, W.A. (1954), ‘Economic Development with Unlimited Supplies of Labour’, The Manchester School, Volume 22, Issue 2, pp. 139-191.
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