Red Flags on Growth

A stultified innovation environment and increasingly stale labor market present some of the biggest challenges to China’s economy in the coming decade.

China’s workers have made their country the workshop of the world over the past three decades. Low wages and high productivity growth in China have kept prices down throughout the world. It is China’s workers who have fueled exports and, with it, economic growth.

Low wages and waves of young new workers filling factories are becoming a picture from the past. Three powerful trends will put new pressure on the low-wage, low-skill recipe in the coming years. How successfully China navigates these challenges will go a long way toward determining whether or not it gets stuck in an economic dead-end or if it’s able to grow its way out of trouble.

First, wages are rising. The low-wage export model is dying quickly. Second, fewer workers are coming into the labor force, a fact that is hitting export-oriented factories especially hard. Third, Chinese workers’ skills are lagging behind the demands of an increasingly sophisticated economy.

We can see these challenges in skyrocketing wages in the Pearl River Delta, reportedly up almost 20 percent since March 1 and expected to rise 20 percent annually for the next five years.  That means, in rough terms, a four-fold increase in nominal wages from 2010-16. Wages are being forced up for many reasons. There are higher minimum wages and greater enforcement of a range of expanded labor protections. There is more emphasis on a “harmonious society” and a desire to build a “moderately well-off society.”

China is entering a new age of scarcity, a scarcity of people. There’s debate about whether or not the number of new entrants into the workforce has already peaked and when exactly the total workforce will peak (probably in about five years), but there’s no question that China is nearing a major inflection point. The long-term trend is extremely challenging: renowned demographer Nicholas Eberstadt notes that there will be fewer Chinese under the age of 50 in 2030 than there are today. Meanwhile the number of Chinese over 60 will double from 115 million in 2010 to around 240 million in 2030.

Higher wages and fewer workers are a given for China in the next two decades. Twenty years sounds like a long time to people in an economy that is hurtling along a turbo-charged rate. But it’s just the blink of an eye when we’re talking about guiding a nation with the size and complexity of China. The only way out of the dead-end is for China to ensure that its workers have the skills to work in a more modern economy.

The third challenge: China’s economy needs better-trained, more-skilled workers if it’s going to continue its high-growth trajectory. Put another way, China thrived on cheap inputs – labor, capital and resources arguably have been underpriced. Capital may remain cheaper but labor and, almost certainly resources (food, energy, minerals) are going to go up in price.

China’s extraordinary economic growth is unmatched in world history.  The United Kingdom barely eked out 2 percent growth during the heyday of its industrial revolution, the golden years of 1820-1870. Late industrializers, like Japan, South Korea and Taiwan, had sustained growth in the 8 percent range. Much of this is because latecomers can learn from others – especially by importing technology.

That allows much more rapid productivity growth, which is the way out of China’s demographic dead-end. The 20 million or so rural residents who flood into cities every year have fuelled productivity growth. Eberstadt notes that “underutilized technical know-how,” as well as a more efficient financial system and other institutional and policy reforms can help China keep growing. “Such untapped potential can fuel growth, but nevertheless, China’s serious demographic challenges could slow economic growth more than is currently accepted.”

China has a number of programs underway to improve the skills of its workers. University places have expanded dramatically. Today about 30 million students attend Chinese universities and the country spends more than US$ 100 billion a year on higher education. Both the Hundred Talents Program and the Thousand Talents Program hope to reverse China’s brain drain by bringing back expatriates. David Zweig, a professor at the Hong Kong University of Science and Technology, notes that many more students are now returning – returnees are about one-third of the number who go abroad each year, up from about one-quarter in the early 2000s.

China is turning out more and more university graduates and the number is expected to keep rising. The China Economic Quarterly points to high unemployment figures. About 15 percent of vocational-technical college graduates are unemployed. The figure is only marginally better for graduates of lower-tier universities – and, worryingly, unemployment among this group is trending up. Even graduates of top-tier universities have an unemployment rate approaching 10 percent.

So where does China go from here? It will have fewer but nominally better-educated workers. But it has far too many college graduates from mediocre institutions that aren’t really trained for the modern economy. There aren’t any easy answers but here are two suggestions:

  • Re-orient education. Chinese education is still too focused on rote memorization. Most of the developed world has moved away from the idea that there is a body of knowledge that can be memorized and will prepare people for life. Programs such as the International Baccalaureate (IB) are based on the notion of active, life-long learners. The IB program (for high school students) is designed to instill a spirit of critical inquiry in students. Yes, facts are necessary, and students need to learn a body of subject-specific knowledge. But few people in a modern economy will work their entire lives at a single job, and many will switch professions over the course of their working careers. Schools need to prepare students for jobs that don’t even exist today. This is a tough challenge but as the emerging problems of China’s university expansion grow more apparent, it is a necessary one.
  • Loosen ideological controls. If China wants to be a knowledge economy, and if it wants to lure back returnees, it needs to have a more relaxed attitude toward ideas that seem crazy. It also needs to tolerate failure. Lots of good ideas only emerge after a period of trial and failure. Even geniuses are wrong sometimes. David Zweig quotes Politburo member Li Yuanchao, who heads the Chinese Communist Party’s Organization Department, as saying that the success of the government’s new Thousand Talents program depends on creating a “relaxed, tolerant and lenient” research environment. Frankly speaking, it would be impossible for China overall to claim progress.

Can China move from an input-driven economy, one that depends on more inputs of cheap labor, capital, and resources to a knowledge- and innovation-driven economy, one where thousands of good ideas scattered throughout many companies drive the economy? If so, can this happen in an environment where a hard state continues to keep a tight grip over expression? If the answer is yes, China will have shown the world a new economic model. Call me a skeptic, but for all of China’s success in creating “socialism with Chinese characteristics,” I don’t believe that even China can repeal a fundamental law of economics: economic innovation needs freedom.  China’s catch-up period is over. Now comes the hard part. I am a long-term optimist on China, but the twin pressures of demographics and a political hardening mean that this is likely to be a bumpy decade.

Originally published in Caixin. Can be accessed at