Labour Market Transition, Income Inequality and Economic Growth in China

By Lu, Ming; Gao, Hong | International Labour Review, June 2011 | Go to article overview

Labour Market Transition, Income Inequality and Economic Growth in China


Lu, Ming, Gao, Hong, International Labour Review


Abstract.

After "opening up" in 1978, China followed a development strategy that has led to internal and external economic imbalances, especially since its labour market reform of the mid-1990s and the resulting surge in rural-to-urban migration. Low labour costs emerged as its main comparative advantage, but its over-reliance on exports for growth was starkly exposed by the global economic crisis of 2008. This, coupled with widening income disparities, could jeopardize the sustainability of China's growth unless it adjusts its reform and development strategies to promote income equality and domestic consumption. The Employment Contract Law in force since 2008 could signal institutional change in the right direction.

Open economies, including China, are still grappling with the lessons and after-effects of the subprime crisis which began in August 2007. This crisis was primarily triggered by individuals' consumption and savings behaviour and the resulting trade imbalances, mainly between China and the United States. Compared with GDP growth, domestic consumption in China has indeed increased only modestly over the past 30 years, partly as a result of widening income inequality, producing a secular decline in the consumptionGDP ratio. China's low domestic consumption together with its huge production capacity have led to over-dependence on increased exports for growth, a situation further entrenched by the low labour costs underpinning the comparative advantage of Chinese products.

Since the mid-1990s, China has maintained its low labour costs through large-scale rural-to-urban migration and urban labour market reform in response to the global relocation of labour-intensive manufacturing industries to China. By comparison with other large economies, China's trade dependency ratio is excessively high. Through international trade, however, a balance was struck between China's high savings ratio and "excessive" consumption in the United States. But what accounts for China's comparatively low labour costs? What are the consequences of this unbalanced development path, and in what sense has the recent economic crisis provided China with an opportunity to redress the balance? Answers to these questions are critical to gain greater understanding of the linkages between labour market reform, China's growth pattern and the economic crisis, and to develop better ways of sustaining China's long-run growth.

This article relates the recent economic crisis partly to the labour market reform that has been taking place in China since the mid-1990s; and it also discusses why and how China should adjust its development strategy. The next section examines China's internal and external imbalances and the effects of the subprime crisis on the Chinese economy. The third section presents a brief review of developments during the labour market reform of the mid-1990s. The fourth section then looks at how the labour market reform weakened labour's market position and widened income disparities; it also outlines the potential threats to economic growth posed by income inequality. In the final section, an explanation is offered of why China must adjust its labour market reform strategies in order to narrow its income inequality and sustain its economic growth, especially in the wake of the recent economic crisis.

China's development path and the global economic crisis

The recent economic crisis was both a short-term shock to the Chinese economy and a longer-term challenge to its growth model. China has indeed grown rapidly since the initiation of its open-door policy in 1978, greatly benefiting from the low labour costs which largely account for the comparatively low prices of its products. Low labour costs - the main driver of China's export-oriented development strategy - have been primarily sustained by labour market reform. However, the unbalanced growth path China has been following for the past 30 years raises several potential problems. …

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