China’s war on inequality has to begin with wages

By Andy Mukherjee Bloomberg

Chinese Premier Wen Jiabao’s speech at this year’s meeting of the country’s largely symbolic legislature broke little new ground. Those who expected to hear more details of how China intends to ease its growing economic disparities and arrest its rapid environmental degradation must be disappointed. Much of what Wen stressed yesterday at the National People’s Congress in Beijing is already old hat. Achieving a balance between investments and consumption, reducing the trade surplus, curbing growth of polluting industries, spending more money in rural areas and boosting incomes of low- and middle-income citizens are all well-known elements of China’s policy wish list. It’s well-accepted by now that rapid economic expansion, which has pulled more than 200 million Chinese out of poverty in 30 years, isn’t the end game; the quality of growth — sustainable exploitation of natural resources and a fair distribution of income — also matters. In March 2006, a new five-year plan adopted a stiff target for reducing energy consumption by 20 percent — and water use by 30 percent — per unit of output. Then, in October 2006, the Communist Party endorsed President Hu Jintao’s vision of a “harmonious society” by vowing to address inequality. The ratio of urban to rural incomes, it was agreed, must narrow from the current level of more than 3-to-1; the 10-fold divide between per-capita gross domestic product in the richest coastal province and the poorest landlocked region must be bridged. How will China do it?

Lowering inequality in China will require planners to figure out a way to reverse a steep decline in the share of wages in the economy. This is a fundamental challenge, which is going to be tough to surmount. Much is being made of the drop in the share of wages in the developed world and how that could be linked to multinational companies’ moving work to cheaper locations in China and India. Economists are concerned that this marginalization of rich nations’ workforces may cause a political backlash against globalization. The threat to social stability from too much profit and too little remuneration is even more pronounced in China. The share of wages in the Chinese economy fell to 41 percent of GDP in 2005 from 53 percent in 1998, according to the World Bank. In the U.S., wages account for 57 percent of GDP. Profit and taxes have grown faster than wages in China in the past decade. China isn’t alone in this; among developing countries, Mexico’s share of wages in the economy fell by half from 1976 to 2000 — to less than 19 percent. Cambridge University economist Jose Gabriel Palma blames it on the emergence of the “scissors” effect between wages and productivity.

In China, the concentration of economic power in the hands of companies and the government has led to an economy-wide boom in savings and investments; household consumption, especially in rural areas, has struggled to keep up. “Most of the decline in the consumption-to-GDP ratio since the late 1990s can be explained by the decline in the share of wage income in the total economy,” Louis Kuijs, an economist at the World Bank’s Beijing office and the lead author of a quarterly update on the Chinese economy, said in the February edition of the bulletin. In the countryside, where four out of five farmers pay their entire medical expenses out of their own pockets, consumption is further constrained by the fear of falling sick. In October last year, the government implemented some health-insurance changes that will at least cover the basic requirements in rural areas.

To boost consumption, as well as to narrow income disparities in the economy, China needs to create jobs in areas where production, for a fixed amount of capital, uses more labor. Service industries fit the bill. The income divide between urban workers, who have better- paying factory jobs, and farmers, a large number of whom are stuck with an occupation that’s only a sixth as productive as the rest of the economy, can’t be bridged without redeploying surplus labor from agriculture to service businesses. At present, the economy is biased toward absorbing migrant rural labor in capital-intensive, export-oriented manufacturing industries. This bias is evident in tax rebates, systematic under-pricing of energy resources — such as coal — and the undervalued exchange rate.

The strategy, very successful in the past, has now run its course. The export push must now be moderated in order to unwind massive industrial overcapacity, control nightmarish pollution in cities, reduce large trade imbalances with the U.S. and curb further accumulation of potentially inflationary foreign-exchange reserves, which already exceed US$1 trillion. Too much concern with inequality in poor nations leads to policies that stifle growth. Approaching US$2,000 a year, China’s per-capita GDP is now that of a middle-income economy, which has no choice except to address disparities before they affect social cohesion. Wages hold the key. Wen’s remarks yesterday fell short of providing a blueprint for correcting the wage-to-GDP ratio by rotating the economy toward more services-led growth. The Chinese leadership will have to come up with a plan for leaving more money in the hands of a larger number of people. The rest of the desired rebalancing in the economy would then be simpler to achieve.