Xi Jinping Is Not Stalin
How a Lazy Historical Analogy Derailed Washington’s China Strategy
It became fashionable after the Soviet Union’s collapse to say that breakneck economic growth was the only thing postponing the Chinese Communist Party’s (CCP) day of reckoning. Communist ideology was discredited, went the argument, but as long as the economic pie kept growing, citizens would set aside broader concerns and take their piece. But what if growth were interrupted by, say, a global financial crisis, collapse of world trade, and mass layoffs on the Chinese factory floor? The music would stop, the masquerade party would end, and Jennifer Connelly would smash her way through David Bowie’s bubble prison, so to speak.
Except that it didn’t. The Chinese economy faced exactly this cataclysmic scenario in the final months of 2008. Collapsing confidence and worldwide financial dysfunction forced businesses to cancel orders en masse. It was a huge blow to the Chinese manufacturing industry, compounding the weaknesses of a domestic economy already fragile after months of government efforts to cool a real estate bubble and overheating inflation. Tens of millions of Chinese migrant workers were laid off in the lead up to the Lunar New Year holiday in late January 2009. They returned to the countryside, passed the holiday with relatives, and waited for the crisis to abate.
Meanwhile, Zhongnanhai’s poobahs began to sweat. The global economy was plunging into the worst recession since the 1930s. China responded hastily with an outsized stimulus package that boosted confidence, but was insufficient to create jobs for both the laid-off workers and the millions of college graduates and young migrant workers who had flocked to urban job markets every year for decades. Early in 2009, Chinese officials were openly worrying about maintaining social stability in the Chinese countryside.
The economy in 2009 was indeed shaky by Chinese standards, if not in comparison to the rest of the world. China’s real GDP growth slowed to single digits -- the lowest it had been in nearly a decade. Accordingly, the China bears rose from hibernation to swarm op-ed pages and talk show panels, predicting the collapse of the Chinese labor market, an economic crisis, and a political crisis.
Instead, the labor market overheated.
Over the next two years, China’s economic policymakers flooded the economy with bank credit, funding countless new housing projects, amazing feats of infrastructure modernization, and some fantastical white elephants along the way. Migrant workers gravitated toward the millions of jobs created on construction sites, or back to the factories whose order books were filled by investment-led demand. By early 2010, job postings began to outnumber jobseekers for the first time since the start of China’s resource-intensive economic boom at the beginning of the twenty-first century, a period we call the Panda Boom (after that cuddly creature’s voracious habit of eating 10–15 percent of its body weight in bamboo each day). Suddenly, in 2010, it was a lack of workers rather than a lack of orders keeping factories from running at full tilt.
In the heat of the moment, it was unclear exactly what had saved the country from disaster. Did the massive stimulus program pull the economy from the brink of recession? Or did the crisis fundamentally transform the labor market in some unanticipated way? With the benefit of several years’ hindsight, it seems clear that the labor market had been transforming even before the crisis hit.
SOCIALIST EMPLOYERS PARADISE LOST
The structure of the Chinese labor force changed -- and is still changing -- much faster than Beijing had anticipated.
During the Panda Boom, all the major factors guiding Chinese labor relations had swung in employers’ favor, the foremost being supply and demand. First came demographics: the country was enjoying a mini–baby boom that boosted the number of annual workforce entrants around the end of the twentieth century, an echo of the baby boom amid the relative peace and social stability of the decade following China’s 1949 reunification. Second came urbanization: a massive movement of workers gravitated toward factory work on the coasts in the 1990s and 2000s after the earliest market-oriented reforms of the 1980s, which freed up farm laborers by dramatically increasing agricultural productivity per worker. And third came tens of millions of layoffs in state-owned enterprises in the late 1990s, which helped keep true unemployment in urban China (as opposed to what meaningless official unemployment statistics said) elevated for most of the 2000s. Add to this the millions of teenagers aging into the workforce each year, and you have an employer’s paradise: workers needed jobs much more urgently than employers needed labor.
During China’s demographic explosion, maintaining job growth was the government’s paramount priority. Occupational safety, collective bargaining rights, and other costly labor protections were vastly less important, and summarily ignored. That started to change a little with the Chinese Labor Contract Law of 2008, the centerpiece of a stronger labor regulatory package that increased worker protections against layoffs, obliged employers to negotiate with the party-controlled unions over pay rates and benefits, and provided workers with new avenues to defend their rights against employers in courts. Fully enforced, the regulation’s provisions were estimated to increase the cost of employing Chinese workers by some 10–20 percent. But at the time the law was enacted, no one gave that much thought. After all, there were still nearly 200 million migrants in the cities and millions more waiting to move off farms. As long as the supply remained abundant, the employer’s paradise would endure.
By 2010, however, cracks were starting to show. They became most visible in a string of highly publicized wildcat strikes at foreign-owned factories that year. Multinational and Chinese manufacturers had cut wages during the downturn of 2008–2009 and had been slow to raise them as production began normalizing over the following year -- even as inflation had taken off in a hurry.
It was a double shock for foreign employers. First, they were flummoxed that workers were emboldened to shut down production so soon after many manufacturers had been driven to the brink of bankruptcy. Managers were still twitching at the memories of 2008, when the economy was so bad that many owners in Shenzhen had snuck over the factory wall in the cover of night, leaving their unpaid workers behind. Second, that the strikes happened at all turned preconceived notions on their heads: China was not supposed to have strikes.
Double-digit wage increases eventually ended the strikes, but they didn’t bring back the old labor market. Factory employers who were slow to keep wage increases in line with market rates quickly saw their workers walking away. Annual workforce turnover of half or more were not uncommon at some factories. After lagging behind GDP growth for the previous decade, average Chinese wages grew faster than GDP in 2011 and 2012, right alongside a major slowdown of the economy as a whole.
MIGRANTS CAME, SAW, AND LEFT
The recent labor drought revealed that the usual explanation of how the Chinese blue-collar labor market works is insufficient. It significantly overestimated the amount of excess labor. In particular, it misunderstood the dynamics of a large rural labor force that could have potentially entered the workforce as migrant workers. It was widely believed that Chinese would leave the farms, come to the cities where they would be vastly more productive, GDP would boom, and the countless underemployed laborers still idling on the farm would keep wages from rising.
But that story ignores an ugly truth of how the Chinese workforce functions, or at least how it functioned historically.
Many westerners have failed to recognize, for example, that the size of the Chinese labor market is significantly limited by Chinese prejudices. By Western standards, China would be considered a racist, ageist place. Nondiscrimination is a foreign legal concept to Chinese employers. During the previous decade of unrelenting growth, many factories would only hire female Han Chinese workers under the age of 25, because they were believed to be more easily managed than men and more energetic than older workers. For migrant workers over the age of 40, finding work was exponentially more difficult than it was for younger migrants (and sometimes impossible). Based on employers’ preferences, if one wanted to understand the real supply of potential laborers for Chinese factories, it would have been unrealistic to include many potential workers in their 40s and 50s.
Analysts overestimated the blue-collar labor force in another important way, as well. It is true that, in the last decade, high schools graduated millions of students who might have gone straight to work. But many of them opted to go to college rather than to factories and construction sites. From 2000 to 2010, the number of young people enrolling in higher education programs rather than entering the workforce after high school tripled, growing from 2.2 million to 6.6 million. With so many young people hitting the books, the usual squeeze through the factory gates became less tight.
Chinese factory managers have more or less adapted, willingly or otherwise, to the new reality. Employers are, of course, increasing wages as necessary to keep their workers from walking off the line. Manufacturers are also shifting factories further inland, away from the largest Chinese cities where costs of doing business (and wages) are highest, and where they might find more willing migrants -- those who would rather work six hours from their home village instead of 26 hours away in Guangdong.
A job close to home appeals not only to older migrant workers as a practical way to balance work and family obligations, but also to migrants of the post-1980s and 1990s generations, though for different reasons. The younger migrants tend to weigh lifestyle considerations heavily and approach the workforce with radically different expectations and attitudes than previous generations.
Early on in the post-1978 reform and opening period, migrant workers often left their parents and siblings (the one-child policy was not as strictly enforced in the countryside as in cities) for life in the factory town or the city. To be sure, the work they found in Chinese factories was tough and mind numbing, but still compared favorably to the exhausting rigors of farm life.
The new generation of migrant workers, by contrast, hardly worked on the farm, if ever at all, and often never saw their parents doing field labor either. Recent studies from Chinese think tanks have shown that these new migrants are less motivated by simple financial opportunities than by their own career advancement and individual interests. Moreover, they tend to put a premium on social justice and fair treatment. These lifestyle considerations make living closer to home, family, friends, and a familiar dialect and culture (which range as much in China as do the modern-day variations of Latin spoken in different corners of Europe) as important as their salary, if not more so in some cases.
SCHOOL OF HARD KNOCKS
The flip side of the dearth of blue-collar labor has been the glut of recent college graduates that scarcely qualify for work in China’s competitive job market. During the beginning of the market economy era in the 1980s, less than three percent of Chinese young people received a four-year university education. This exclusive cabal of credentialed elites was placed into high flying careers and lived lifestyles befitting their social status.
That was then. College graduates now face a life that would be totally unrecognizable to those a generation earlier, who had the fortune of first-mover advantage. Tripling the size of the higher education system in only a decade has meant a rapid proliferation of new institutions, most of which provide educations -- and professional prospects -- that can’t compare with those of the graduates of the top tier institutions. A massive riot in 2006 illustrated how different the prospects are for graduates of elite universities and those of newer ones: Some graduates of the satellite campus of a university in central China apparently went berserk when they discovered that their diplomas designated them graduates of the satellite, not of the parent university as they were originally promised.
In a situation that would sound familiar to Americans, graduates of new and lower-ranked universities have struggled to find good entry-level jobs. They live in small, crowded, shared apartments at the edge of major cities, scraping by to make rent. The plum jobs for university graduates at state-owned enterprises, in government, or at glitzy multinationals are no more attainable for these young people than for migrant laborers of the same age. And the college graduates won’t take the manufacturing jobs, perhaps to their detriment: average starting wages for college graduates were actually lower than average migrant worker salaries in 2011. Without a good employer to secure their place in urban China, these young people do not simply struggle economically; in many ways, they can be as marginalized from the economic and social fabric of their urban life as are migrant workers.
The consequences of China’s transforming labor market are by no means all bad; in fact, they will make the task of managing the Chinese economy easier in several crucial ways. A simultaneous influx of college graduates and lack of blue collar workforce entrants will narrow the wage gap between more and less educated Chinese, and also between rural and urban households. It must be a relief for the government that a secular demographic change is narrowing inequality in a way that its own policies have not. However, the strains of a rapidly changing population also bring new and unfamiliar complexities. Growth is slowing as China’s economy runs short of underemployed laborers to power its export juggernaut and anchor the “China price” for which the country is so famously known.
These changes are quite visible in China’s recent economic statistics. In nominal terms, GDP rose 9.8 percent from 2011 to 2012, but in a change for China, more of the gains from growth accrued to workers, thanks to a tight labor market, than to the owners of capital. Median urban disposable incomes rose by 15 percent. The corporate profits of industrial firms, by contrast, rose by only five percent. Rapidly rising wages accelerated the country’s shift from an export-oriented to domestically focused economy. Economic underperformance in the United States, Europe, and Japan also did China no favors.
Yes, to a certain extent, China’s demographic hangover and the country’s transition to a consumption-based economy are actually good news. Overreliance on investment and exports is not exactly sustainable. But the process of transition will have winners and losers. Rebalancing means households living on their salaries get more of the economic pie. Entrepreneurs, “red capitalists,” multinationals, and tax collectors, commensurately, will likely be left with less.
Meanwhile, governing and encouraging economic development will become considerably more challenging. Economic management is much easier with an enormous demographic gust blowing at a government’s back, propelling its economy forward even if policies are less than optimal. As the wind dies, individual policies and economic decisions are starting to matter much more. Now, China will need to be a whole lot smarter and more creative in designing policy incentives.
Productivity growth (that is, growth in output per worker) is likely to slow markedly. This is partly because of a less productivity-friendly mix of economic activity. Expanding demand for services means that a larger share of Chinese GDP will be generated by the service sector. It is much harder to double GDP per person employed in these parts of the economy than it is in the manufacturing sector. Slower growth, in turn, will blunt some of the government’s most effective tools at managing its hybrid market economy. Beijing has been incredibly successful at growing out of economic problems. The bad loans crippling the banking sector at the dawn of the hyper-growth era, which began in the early 2000s, weren’t fully repaid, for example -- they just shrank relative to the rest of the financial industry and gradually stopped being a systemic risk to the economy. China still has to deal with the fallout from the credit boom of 2009–2010, which will inevitably generate hefty bad loans; its old strategy of growing out of the problem may not be as effective in a post double-digit growth era.
There are also several challenges to companies, foreign and domestic. They are already moving factories inland and raising wages to adapt to the new balance of power between migrant workers and employers. Inevitably, many companies will also start incorporating business practices for managing a mature workforce, analogous to those adopted in the United States or Europe.
More broadly, corporate strategy has to adapt to the end of cheap Chinese labor. The shift matters most for multinationals, which allocate investment, R&D, and managerial resources between China and other markets. Some U.S. companies have contemplated bringing operations back to the United States, Mexico, or Vietnam. But a lower growth and more expensive China won’t drive all the multinationals away. There is still value to being in proximity to the world’s largest high-growth market, which contributes the most to global aggregate demand each year. Those that do stay, though, will likely opt for increased mechanization. As labor becomes more expensive, machines become relatively cheaper and a more attractive option for maximizing efficiency.
Finally, China’s demographic hangover could coincide with a right-sizing of expectations about what China can do for a multinational business. Managers might become less willing to accommodate “Chinese characteristics” -- the combination of regulatory uncertainty, intellectual property violations, and the risk of becoming embroiled in corruption scandals that seem much harder to avoid there than in a developed market. In other words, these dynamics might serve as a catalyst for the government to renew economic and institutional reforms as new enticements to attract foreign investment.
China’s demographic hangover is here, and it is as unexpected and unpleasant as the morning after a 30th birthday. Given the facility with which the government has managed difficult economic transitions in the past 20 years -- forcing the military out of the market economy in the 1990s and initiating the Panda Boom later that decade -- the purely economic dimensions seem daunting, but no more so than the other feats the CCP has pulled off. Instead, it’s the social and political dimensions of the demographic hangover that seem most perplexing.
Most obviously, the prospect of an independent labor movement, albeit a small one, holds the potential to trigger revolutionary changes. Much more so than a decade ago, Chinese workers, historically poorly represented in the country’s politics, seem aware of their own interests and more vocal about their demands. If China’s leaders want to keep the music playing, the emergence of labor as an interest group could well require them to rethink the grand bargain -- growth in exchange for stability -- they strike with the public they govern.