IGTW presentationLewis Model: China

Group 3

Chinese key indicators

GDP - composition, by sector of origin: (2014 est.)

Agriculture: 9.2%

Industry: 42.6%

Services: 48.2%

Labour force: (2014 est.)

801.6 million

Note: by the end of 2012, China's population at working age (15-64 years) was 1.004 billion Country comparison to the world: 1

Labour force - by occupation: (2012 est.)

Agriculture: 33.6%

Industry: 30.3%

Services: 36.1%

Lewis Theory of Development• Also known as the two-sector surplus labor model

• Features of the basic model:

• Economy consists of two sectors- traditional and modern• Traditional sector has surplus of labor (MPL=0)• Model focuses on the process of transfer of surplus labor and the

growth of output in the modern sector

• The process of self-sustaining growth and employment expansion continues in the modern sector until all of the surplus labor is absorbed

• Structural transformation of the economy has taken place with the growth of the modern industry

Lewis Theory of Development

China

• With a 1.3 billion population, China is known as a labour-abundant

country.

• Cheap and unlimited labour supply from the agricultural sector with low

productivity to the industrial sector with high productivity has

contributed to China’s rapid economic growth in the process of its

export-oriented industrialization.

• Waves of labour shortage that hit the country in 2002, 2004 and 2009

• For a time employers in south-eastern coastal areas experienced

difficulties in recruiting enough migrant workers.

China

• Labour costs (including benefits) for blue-collar workers in Guangdong

rose by 12% a year, in dollar terms, from 2002 to 2009; in Shanghai,

14% a year.

• Roland Berger, a consultancy, reckons the comparable figure was only

8% in the Philippines and 1% in Mexico.

• China’s wage curves appear to conform to the Lewis model’s Turning

Point prediction.

China is gradually moving toward the Lewis Turning Point. IMF predicts that China

will reach the Lewis Turning Point between 2020 and 2025.

Indicators

Key Observations

• The agricultural wage has increased over time

• the marginal product of labor in the traditional sector has been increasing

at a faster rate than wages.

• Although the gap between the marginal product and wage is narrowing,

the average wage-curve as a whole still remains above the curve.

The Anomaly

• China faces the challenge of finding more productive

employment for a huge pool of underutilized rural labor.

• Also there is a tightening of the labor market in southern coastal

cities, and the consequent rise in wage rates in those areas.

• Reasons :

• China’s huge size which restricts migration

• administrative restrictions (such as Hukou) on internal

migration that still exist.

The arrival of the LTP also means China needs to make serious policy efforts

to realize the transformation of its economic development pattern, and to

avoid the so-called “middle-income trap”.

• Together, these results indicate that China is steadily progressing

toward the Lewis Turning Point, although it has not crossed that

point yet.

Lewis Turning point

• China’s labour-intensive and export-driven growth model will

gradually lose its competitive advantage.

• China will have to reorient its development strategy toward labour

practices that are more capital intensive and based on labourers’

skills .

Policy scenarios - i/ii

ONE-CHILD POLICY

• If China relaxed its one child policy

and people assume a very high

fertility rate the Lewis Turning

point might be delayed by a few

years

• higher fertility results in larger

working age population and larger

potential labor force.

• Changes occur with a delay as it

takes time for new larger cohorts

join the workforce.

HIGHER LABOR FORCE

PARTICIPATION RATES, HUKOU

reform

Growing share of older workers in the

labor force

higher disposition toward hiring

younger workers and a relatively low

retirement age

stability of the pension system

Higher participation rates

greater interprovince labor mobility,

e.g. accelerated progress in hukou

reform

Policy scenarios - ii/ii

FINANCIAL DEREGULATION

• If there’s financial sector reform, interest

rates will be deregulated

• higher deposit rates raise the return on

the stock of wealth

• households meet saving targets more

easily which reduces the supply of

labour.

• Whereas in the baseline the excess

supply of labour in 2020 was in the

range of 30 million, interest rate

liberalization would reduce this excess

to around 10 million, and the LTP would

arise shortly after 2020.

PRODUCT MARKET REFORM

Raising TFP is consistent with a

wide variety of policies

announced in 12th Five-Year Plan

Rise in TFP leads to a faster

decline of excess labour supply,

and a faster emergence of the

LTP

Conclusion

• Policy scenario analysis reveals that

• relaxation of the one-child policy, hukou reform will delay

LTP

• Financial reform and higher TFP accelerate the transition

to LTP

• through wealth effects and greater profitability of

firms, respectively.

• Market and policy responses to LTP transition will be

largely peripheral

• demographics forces play a dominant role in the

imminent transition to a labour shortage economy.

Bibliography

• Lewis Growth Model and China’s Industrialization Nazrul Islam

and Kazuhiko Yokota, May 2008

• IMF Working paper: Chronicle of a Decline Foretold: Has China

Reached the Lewis Turning Point?