Inflation is always and everywhere the topic of conversation, at least among macroeconomists. It is running at almost 8% in the US and will exceed that number in the UK in the months to come if the Bank of England is correct. Those numbers have not been seen for more than thirty years, and they resonate ominously with the experience of the 1970s: the Great Inflation.
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Most of it is attributable to the enormous global convulsion that was (and is) the pandemic. Global supply chains were just not capable of responding to the exceptionally rapid bounceback in demand for goods after the initial massive recession. Layered on top of that is the impact of rapid increases in commodity prices. And the last, most worrying, aspect is a small but significant increase in the degree of persistence of inflation: a sign that inflation expectations might be slipping the anchor that has held fast since the introduction of inflation-targeting in the early 1990s.
However, in our central forecast, Fathom remains sanguine about the medium- to long-term outlook for inflation. The anchor will hold — lodged among the rocks of new technology, the growth of flat or zero marginal cost companies, high levels of global trade, and a continued flow of cheap goods out of China, once the COVID convulsion has washed through the global economy.
Rapidly industrialising countries like China typically hit a point of inflection when the supply of cheap rural labour has been exhausted. After that point, known as the ‘Lewis turning point’ (LTP) after the economist Arthur Lewis who first identified it back in the late 1960s, both rural and urban wages must increase rapidly, and that will pass through to the prices charged by companies for the goods and services they produce.
China’s demographic trends are terrible, by its own standards and by international standards too, pointing to a possible decline in available labour.
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Moreover, rural employment excluding migrants has roughly halved since 2010. And those that remain in rural areas tend to be older. More than 60% of the population 15 years of age and above are older than 45, which makes them relatively unlikely candidates for migration to urban centres. On the face of it, the pool of available rural labour appears to be much smaller and perhaps almost exhausted.
Yet there is no evidence to date that the gap between rural and urban wages has narrowed — something that we would expect to see if the supply of cheap labour had been exhausted.
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In Fathom’s view, this is due to an additional pool of labour that is potentially available for productive employment, should the demand for such productive labour exist. These are the underemployed. Fathom has long maintained that official Chinese GDP data are overstated, and that in truth GDP growth was substantially slower than the official data suggest in the period between 2013 and 2017. We maintain our own alternative measure, called the China Momentum Indicator (CMI). Its growth compared to that of official GDP is shown in the chart below.
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The undershoot in our measure of growth compared to official statistics has implications for the labour market too. Assuming that the official statistics are correct in respect of the productivity that a typical employee will normally produce, and assuming that Fathom is correct about growth, that must imply an overhang of underemployed people — who are notionally employed, but producing very little or nothing. That overhang, broken down by sector, is pictured in the chart below.
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Taking into account the numbers underemployed (not just in construction but across all sectors), the overall amount of slack in the Chinese labour market is not dissimilar now to how it stood in 2010 — there is no shortage of cheap labour in China. However, it does not have markets deep enough to absorb the goods and services its plentiful labour could in principle supply.
In many rapidly industrialising economies, the demand for manufactured goods is so strong, either from domestic or foreign markets, that it drags more and more employees into manufacturing industry until the pool of available labour is exhausted, with the effect of closing the gap between the real wage and labour productivity in manufacturing industry thereafter. Not so in China. There, manufacturing employment has passed its peak without manufacturing wages ever closing that gap.
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Should the demand for manufacturing goods and therefore employment increase, there is still a large pool of unexploited or underexploited cheap labour available in China. Hence, In Fathom’s view, China has not yet passed the LTP ‘with Chinese characteristics’, i.e., taking into account the pool of underemployed. So, for now, the Chinese labour market does not threaten to drive up global inflation
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