Should China Raise Wages?

There is a very interesting graph on page 14 of the World Bank’s December 2008 Quarterly Update on China. I am not smart enough to figure out how to reproduce the graph but I will describe it. It shows private consumption and wage share in China as a function of China’s GDP, from 1993 to 2007. From 1993 to 1996, wages rose from 50% of GDP to 54%. During that same period private consumption rose from 47% to 49% of GDP.

Both remained more or less stable for the next three years, but then beginning in 1999 and over the next eight years wages declined from 52% to 40% of GDP. During that time private consumption declined from 47% to 37% of GDP. In almost every year except two both figures move in the same direction.

Over the last fifteen year, in other words, private consumption as a share of GDP has been very highly correlated with the level of wages. China has very weak labor unions and worker representation, so in the fight between workers and capitalists for a share of the economic pie, workers have been on the losing end, and it is hard to see how they will do much better in the future, but it is probably in China’s best long-term interest that they do. As wages have risen and fallen as a share of GDP, so has private consumption. This isn’t a surprise, but the relationship is pretty dramatic.

Unfortunately the World Bank report also says:

Direct government spending, in the form of government direct consumption or investment, typically creates more economic activity than an increase in transfers or tax cuts. This is because higher transfers or tax cuts that increase income may not necessarily induce spending, especially by higher income people or when times are especially uncertain. Stimulus targeted at increasing demand for products of sectors with excess capacity will have a larger activity and employment effect. In the short term, however, there is no difference in the growth impact between government investment and government consumption.

That means, as I see it, that in the long run it is very important for China to raise wages as it tries to develop an internal market, but it will be hard to exploit the crisis to force through wage increases since in the short term they are less effective than government spending. There have been rumors about wage increases that have then been denied, so I have no idea where this idea stands in the hierarchy of policies, but I suspect that companies will use the crisis as a way of arguing that the last thing China needs is wage increases.

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About Michael Pettis 166 Articles

Affiliation: Peking University

Michael Pettis is a professor at Peking University's Guanghua School of Management, where he specializes in Chinese financial markets. He has also taught, from 2002 to 2004, at Tsinghua University’s School of Economics and Management and, from 1992 to 2001, at Columbia University’s Graduate School of Business.

Pettis has worked on Wall Street in trading, capital markets, and corporate finance since 1987, when he joined the Sovereign Debt trading team at Manufacturers Hanover (now JP Morgan). Most recently, from 1996 to 2001, Pettis worked at Bear Stearns, where he was Managing Director-Principal heading the Latin American Capital Markets and the Liability Management groups.

Visit: China Financial Markets

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