2  The outlook for China's economic growth

In this section we discuss the outlook for China's economic growth in the next decade, concentrating on structural developments and risks. The first two sub-sections are concerned with medium-term risks to China's growth (loss of competitiveness and high debt levels), while the final two are concerned with the long-term sustainability of China's growth (slowing population growth and slowing economic growth with rebalancing and income convergence).[2]

We conclude that there are risks to China's growth in the medium term, although we consider that these are manageable, but that China's growth rate is likely to slow in the longer term as a result of structural factors while remaining high by advanced economy standards. We do not discuss short-term risks and external threats to China's growth such as the recovery of the rest of the world economy from the global financial crisis and the European debt crisis.[3] These represent cyclical rather than structural factors.

2.1  Wage growth likely to erode competitiveness

Figure 1 – China's labour costs

Source: Haver Analytics, IMF (2013)

Annual nominal wage growth has averaged just below 15% for the past decade (Figure 1), much higher than inflation of 2.6%. Minimum wages increased by an average of 22% in 2010 and 2011, but smaller increases were recorded in 2012.[4] The Five Year Plan to 2015 calls for minimum wage increases of at least 13% per annum, to reach 40% of the average wage. This comes after an average annual increase of 12.5% between 2006 and 2010.[5] Wages in export-focused coastal regions were reported to have increased by 10% from a year ago in early 2012. Labour unrest in some coastal factories in 2010 pointed to increasing wage pressures and possibly a shift in the balance in the labour market from employers to employees, suggesting that labour supply was becoming more restricted.

Some commentators consider that China is approaching its Lewis Turning Point, when the supply of unskilled labour begins to run out and wage growth accelerates.[6] Incremental demand for unskilled labour is currently outstripping demand for skilled workers, evidenced by the large increases in minimum wages and reports of graduates having difficulty finding jobs, but with a rural/urban population split still close to 50/50, there appears to be ample supply of unskilled labour. This indicates that despite rising real wages, China is approaching but has not yet reached its Lewis Turning Point which would be marked by a more constrained supply of labour and even faster wage growth.[7]

However, rising real wages still pose a threat to competitiveness and so could retard China's export-led growth. That would occur only to the extent that the wage growth is not supported by productivity growth (ie, to the extent that unit labour costs are rising); China's labour productivity growth has averaged around 10% per annum in the past decade, as we saw in section 2 of the accompanying paper (Bowman and Conway, 2013), but nominal wage growth in that period exceeded that. As a result, unit labour costs have increased by around 5% per annum over the past decade, posing a threat to international competitiveness (Figure 1).[8]

The impact of any loss of cost advantage will depend on the extent of that margin. China may already be losing ground to lower-cost producers in some countries (eg, Vietnam) and higher wage inflation will hasten that process. So far, overseas investors and buyers have generally remained loyal to China because of the size and quality of the labour force (eg, skill levels), the agglomeration effects of having so many factories close together (giving more reliable supply chains), and the fact that there is already infrastructure in place (eg, ports), even if it needs to be extended in some areas. China is also able to shift production inland where labour is more abundant and cheaper. A shift to less price-sensitive products would also help offset rising labour costs.

Faster wage growth is not necessarily a threat to China's development as higher household incomes would boost private consumption and help with the rebalancing of the economy away from its dependence on exports and investment. In fact, this is part of the strategy of the current Five Year Plan, but it will take a long time for private consumption growth to replace exports and investment as the main driver of growth, even with a move towards a larger services component in the economy.

We consider that the high wage growth is likely to be positive for the rebalancing of the economy away from dependence on investment and exports and towards increased reliance on consumption; it will also support the demand for higher-value food products and materials for housing construction as people's real incomes rise, benefiting New Zealand. It may bring some loss of competitiveness and market share for China in its export markets, but this can be offset to some degree by productivity growth and utilising cheaper labour from the rural hinterland.

Higher wage growth may, however, bring an end to the deflationary pressure which developed economies have experienced over the past decade as prices of their imports from China stop falling and begin to increase, particularly if combined with an appreciation of China's currency. As we saw in section 3.3 of the accompanying paper (Bowman and Conway, 2013), this is one of the benefits New Zealand has derived from its closer trade links with China.