Will China Have a Labor Shortage, Sending Inflation Out of Control?

Labour shortage could spell inflation and trade deficits for China

Informed researchers are asking what happens to China based on the recent demographic shift from rural labour surplus to rural labour deficit. The answer may be slower growth and higher inflation, according to a paper released last month by China's Center for Economic Research at Peking University. But other impacts may also be increased consumption and a deteriorating external balance.

The paper by Huang Yiping and Jiang Tingsong is a very technical and dense work based on macroeconomic modelling. But the results are clear: If China's rural labour surplus evaporates (as seems to already have occurred), we are going to see savings drop and productivity collapse.

The paper is based on the work of Sir Arthur Lewis, an economist from St. Lucia.

What Lewis found is that industrial wages rise very quickly when the supply of excess rural labour is exhausted. This is called the Lewis Turning Point and is where China is right now.

This will have major implications for the Chinese domestic economy and the world economy. The first implication is inflation. Without the endless stream of excess rural labour, wages are going to go way up in China and this means inflation will be a problem.

Shortage of Labor? Now?

The situation Harrison describes is based on the document What Does the Lewis Turning Point Mean for China?

The thesis is interesting, but how probable is a labor shortage in China, and in what timeframe? I certainly see no reason to be concerned over a "Lewis Turning Point " now or for that matter any time soon.

However, inflation can certainly happen for other reasons such as rampant credit growth and malinvestment in infrastructure. That said, the Chinese property bubble is likely to pop at any time, and with it China's credit bubble.

Certainly China is overheating now, struggling to find useful work for its citizens. Malinvestment abounds because of it.

Michael Pettis Chimes In

Wanting another opinion, I pinged Michael Pettis at China Financial Markets about the Labor Shortage theory and Pettis responded ...
I think there are many reasons to be concerned about the rapid decline in the Chinese working population over the next decade or two, but I wonder if the Lewisian turning point is one of them.

As I understand it, Lewis' work was based on countries with very different demographic structures -- much younger, rising population as well as rising work population, and "normal" age distributions (i.e. more younger people than older for nearly every age group).

None of this applies to china. This doesn't mean that china might not see soaring wages per worker, and with it inflation, but it does suggest that we should be very skeptical about applying the Lewisian concept to china.

I always worry when economists apply highly technical econometric models to cases that are structurally very different than the cases on which the model was built. It may make for some great research credits, but it also makes for pretty random predictions.

Michael