A significant shift is taking place that could see China lose its mitigating influence on global inflation, and even potentially make China a higher inflation driver worldwide. This change is the significant decline of the Chinese working age population. An important moment in this regard is whether China has crossed the Lewis return point (LTP). This marks the moment when a country that is industrializing has largely exhausted its cheap rural labor group and wage pressures begin to increase.
According to traditional metrics, China has already crossed this point. However, traditional measures are misleading: in our opinion, China has not yet passed the LTP with Chinese characteristics, to quote a beloved phrase of the Chinese leadership. Our reason for this view is the considerable pile of unused urban labor, which further weakens the already manpower of a modest bargaining power. As such, we do not expect China to be a major source of global inflationary pressure in the short to medium term, although it may be less of a deflationary impact than in the past.
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The working age population of Chinas is already declining and is expected to decline significantly over the coming decades. Falling labor supply would normally lead to a tightening in the labor market and wage increases. However, in recent decades China has experienced a massive migration of rural labor into urban areas that has helped increase urban wages.
On the one hand, with 64% the rate of urbanization in Chinas remains much lower than the average of advanced economies, and its agricultural share of employment is also high by about 24%. Taken separately, this would suggest that the turning point is far away. However, the industrialized eastern regions of China have higher rates of urbanization; and its overall levels of urbanization are very similar to the Japanese, which were 68% and 25% respectively when it hit its LTP in the mid-1960s sending rising production wages.
A key indicator that LTP is close is when migration from rural to urban areas has begun to slow. Over the past decade, this has indeed been the case in China. This probably reflects several factors, including the declining gap between disposable urban and rural incomes, the high and rising cost of housing and urban living, and the shrinking pool of young rural workers available to move to cities as they age. rural population. As rural redundancies are largely depleted and one country passes the traditionally measured LTP, we would expect a sharp jump in both urban and rural wages, and a narrowing of the gap between average wages in state-owned enterprises and those in private firms as the greater the power of negotiation increases wages. However, this did not happen. Instead, a fairly strong slowdown in wage growth began in the early part of the previous decade.
Slow wage pressure is difficult to reconcile regardless of other factors. A very important hidden factor is likely to be a dramatic increase in the number of underemployed in the Chinese workforce. We have long argued that the unemployment rate in China significantly underestimates the sluggish amount in the labor market, and our Urban Underemployment Index (CUUI) indicates a significant increase in underemployment over the past decade. Significant underemployment reduces the power of the already modest negotiations of the majority of workers, which the trade war with the US has further undermined. This is why we argue that traditional LTP may not be relevant when analyzing China, and argue instead for an LTP with Chinese characteristics. Fathom will soon publish a more detailed section on this topic, available to customers, which explains our reasons for this belief.
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In summary, the unemployed group should continue to maintain wage pressure in China. Once this working group is accounted for in LTP with Chinese characteristics, it is likely that current LTP will not pass for several years at current growth rates. Moreover, until the Chinese authorities manage to rebalance the economy, we think they will be inclined to use many of the tools at their disposal to prevent their exports from losing international competition. Therefore, we do not see China becoming a source of global inflationary pressures in the short to medium term, although deflation may have less of an impact than in the past.
To learn more about Fathoms’s unique approach to understanding China and its economy, please contact Joanna Davies at [email protected]
 Lewis, WA (1954), Economic Development with Unlimited Labor Supplies, Manchester School, Volume 22, Edition 2, p. 139-191.
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