China’s Economic Downturn: Employment is The Critical Issue

The economic slowdown in China started in the second half of 2007: well before the effects of the subprime crisis in the United States began to be felt internationally. The initial downturn was orchestrated by the Chinese government, which aimed at cooling an overheating economy (GDP growth in 2007 was recently adjusted upward to 13 percent!) and at controlling a property market bubble that was considered potentially dangerous (Xinhua News Agency, January 15).  The government was also concerned about the stock market bubble, although less inclined to intervene. Japan’s prolonged economic stagnation following the simultaneous bursting of property and stock market bubbles in 1990-1991 was clearly on the minds of Chinese policy makers when they intervened in the property market by tightening credit (especially for mortgage and construction loans) and making it harder to get land for construction. 

The government succeeded, perhaps more quickly and more dramatically than it had expected, in achieving these objectives. Housing prices leveled off or began to fall in some major cities in the second half of 2007. Property markets slumped, causing a sharp contraction in new construction and an associated drop in demand for building materials such as steel, copper, cement, glass and aluminum. To make things worse, the stock markets of Shanghai, Shenzhen and Hong Kong collapsed simultaneously at the end of October, around the same time that housing prices in some major cities such as Shenzhen started a steep decline. This further reduced business and consumer confidence. The demand for cars and other consumer durables, already subdued because of the slowdown in new housing sales, further contracted.  Exports, which continued to grow briskly in 2007 and at a slightly slower rate during the first half of 2008, suddenly slumped in October—the month after the collapse of Lehman Brothers in the United States—and turned negative in November, for the first time since 2001.

In the first half of 2008 China’s earlier inflation worries were removed from the front burner by fears that the domestically engineered slowdown might intensify and consequently generate high levels of unemployment, especially in construction.  Export industries were also beginning to lay-off workers, but at a moderate rate. This was before policy makers knew that the subprime crisis in the United States would trigger a global recession that would affect China through a sharp contraction in demand for its exports.  The post-Olympic economic slowdown that many had predicted did in fact occur—but for reasons that had not been anticipated.

Since banks in China had little exposure to derivatives based on American mortgage loans, the direct financial effects on China of the subprime crisis in the United States were minimal. The indirect effects, however, are serious.  Export growth collapsed and lay-offs in export industries intensified in the fourth quarter of 2008 when the whole world came under the spell of the financial crisis. Thus, China’s economic slowdown, which had started in the second half of 2007 as a result of domestic policy action, was unexpectedly compounded by a severe export slump that kicked in during the fourth quarter of 2008. It is now clear that banks in China are negatively affected by the recession, but since they were generally in good shape before the crisis, there is no threat of a banking crisis. In fact, with government encouragement, bank lending in China expanded sharply in December 2008 and January 2009, which may suggest that China’s recession will bottom out sooner than later.

Effects of the Downturn on Employment in China

Hard (un)employment data are scarce in China, but the little that has been officially reported, combined with abundant anecdotal evidence presents a rather grim picture (China Brief, December 19, 2008). Most international attention has been focused on lay-offs in China’s export-oriented industries in the coastal zones, but that is probably not the most important problem category for understanding the employment challenge that Beijing faces. There have been significant lay-offs in small and medium scale enterprises (SME) that supply large state-owned enterprises (SOE) producing construction materials.  Many of these SMEs are privately owned and started their operations as spin-offs from state enterprises that used to be vertically integrated before the aggressive SOE reforms of the late 1990s. Due to the slump in new construction, demand for building materials dropped precipitously. The first victims of this slump were not the SOEs—they enjoyed fat profits in earlier years and are encouraged by the government to avoid lay-offs as much as possible and accept lower earnings instead—but the thousands of SMEs that supply them or serve as sub-contractors. However, if the recession lasts much longer or intensifies, even SOEs may begin to lay off workers as profits disappear.

The third and probably most important source of lay-offs in 2008 was the construction industry itself.  Including informal day workers (not included in China’s official employment numbers for the construction sector after 2002); the author estimates the total employment in construction at the end of 2007 to be at 55 million. In Table 1 below the author assumes that 10-20 percent of construction workers were laid off in 2008, because of the property slump.

No official information is available on lay-offs by SMEs or construction companies in 2008.  The following table pulls together government estimates of lay-offs in export-oriented industries and the author’s own provisional estimates of what may have happened in the other two categories of enterprises mentioned above.

Table 1.  Estimated number of lay-offs in 2008 in three categories of enterprises

The author’s estimate of 17-30 million unemployed migrants at the end 2008 is broadly consistent with an estimate of “about 20 million” included in an official statement by Chen Xiwen, director of the Office of the Central Leading Group on Rural Work, in Beijing on February 2 [1]. To get a picture of the total non-agricultural unemployment at the end of 2008, we have to add the officially reported 4 percent registered urban unemployment at the end of 2007 (8-9 million people), yielding an estimated total of 25-39 million, or roughly 5-8 percent of China’s total non-agricultural labor force of about 500 million. 

The unemployment situation may further deteriorate in 2009, even with fiscal stimulus and overall GDP growth of 7.5 percent.  The author places the estimate of the total number of non-agricultural job seekers in 2009 at 39-48 million, as shown in Table 2.

Table 2. Estimated (net) non-agricultural job seekers in 2009

Assuming that China’s GDP will grow 7.5 percent in 2009 and that the growth pattern will remain as capital intensive as it was in recent years [2], the total number of new jobs created in 2009 will be only about 6-7 million. Unless, (1) China’s growth pattern suddenly becomes much more employment intensive, (2) a much larger number than the assumed 50 percent of laid-off migrants start farming, or (3) the various stimulus programs succeed in creating many additional jobs, total estimated non-agricultural unemployment at the end of 2009 would be 33-42 million, or 7-8 percent of the non-agricultural labor force at that time (author’s estimate).  Total non-agricultural employment may shrink by 1-1.5 percent in 2009. The overall employment picture in 2009 presents even more serious challenges for Beijing  than the contraction of state sector employment by 45 million jobs over 5 years that followed the aggressive SOE reforms started by then Premier Zhu Rongji in 1998.

From a socio-political perspective, the two most sensitive categories of unemployed for the leadership in Beijing probably are migrants and university graduates.  Anecdotal evidence suggests that many of the workers who were laid-off in 2008 are second generation migrants who are disinclined to return to farming, even if they have the option to do so. Local governments will be faced with the difficult choice between: forcing unemployed migrants to return to their rural villages under China’s household registration (hukou) system; subsidizing local employment or unemployment benefits from scarce fiscal resources; or accepting open unemployment in their district.

The problem of unemployed university graduates is new in China, but politically and socially not less troublesome than the problem of unemployed migrants.  In this respect, China’s labor market is beginning to resemble India’s, where large numbers of university graduates have been unemployed or underemployed for many years. Of China’s 5.6 million university graduates in 2008, 1.7 million are reported to have been unable to find a job (Ming Pao [Hong Kong], December 15, 2008).  The main blame for this is thought to be a disconnect between some of China’s higher education programs and market needs, but the slowing economy must also have been a factor. The projected number of university graduates for 2009 is 6.1 million (Ming Pao, December 15, 2008).

There is no short-term solution for China’s unemployment problem other than to maintain a high overall growth rate and to generate as many jobs as possible through fiscal stimulus. In the medium-term the solution lies in changing the growth pattern such that labor/GDP elasticity increases, adjusting education programs to market needs, and demographic dynamics. China’s total labor force is projected to peak in the next 7-8 years and to start shrinking at a rate of 0.5-1.0 percent per annum for several decades thereafter [3].  While a shrinking total labor force will take some pressure off China’s chronic employment problem, it is important to realize that the urban part of the total labor force will continue to grow for decades. 

Government Measures to Counter the Downturn

It did not take the government long to realize that the economy had been hit by a double whammy: the residual effects of its own efforts to cool the property bubble in 2007 and the international financial crisis that broke in 2008.  Already in November 2008 the government announced plans for a major fiscal stimulus plan and began preparing other measures to counter the socio-economic effects of the sharp downturn.  A comprehensive plan, including all measures to stimulate growth, protect employment and minimum incomes, is not yet available, but the following initiatives have been announced:

• Reduced lending rates and eliminated lending quotas.
• Softer terms for mortgage loans.
• Easier access to finance for SMEs.
• Programs to help university graduates start their own business.
• Restored export tax rebates to pre-crisis levels.
• Stop further nominal RMB/US$ appreciation, from around July 2008.
• A RMB 4 trillion ($586 billion) fiscal stimulus investment program for 2009 and 2010.
• Increased recurrent central budget expenditures for a wide range of social programs, including education, rural health insurance, income support for rural and urban poor, and pensions.
• Temporary reductions in employer contributions to medical insurance, unemployment insurance and other pay-roll deductions for urban workers.
• Allow unemployment insurance funds to be used for job-retraining and subsidies to employers for up to 70 percent of local minimum wage.
• SOEs are encouraged to avoid lay-offs as much as possible by accepting lower profits.
• A conversion of the Value Added Tax (VAT) system from production-based to consumption-based.
• Extended rural land use rights and made them tradable (to boost agricultural productivity).

Several of these measures are already under implementation. The big question is whether the government will be able to avoid large scale civil unrest. Since the cause of the crisis is widely perceived to be external, while the government is seen to be making unprecedented efforts to create and extend social safety nets, the odds appear to be in Beijing’s favor.

In light of the government’s aggressive and apparently well-organized efforts to fight the recession, its experience with running fiscal stimulus programs (1998-2003), the new flexibility of China’s economy and the relatively strong position of its banks, the recession may bottom out in the first half of 2009. The author believes that serious deflation can be avoided. Yet, because of the substantial residential property overhang in major cities, it is unlikely that high growth (by Chinese standards) will be resumed anytime soon. It is more important, however, for China to restructure its economy than to resume double digit, but unsustainable growth. If China succeeds in rebalancing its economy, it may, after some years, be in a stronger position that it was when it entered the crisis.

Conclusions and Implications for the United States

The present crisis has underlined the growing importance of China’s role in the global economy and global governance. The Unites States, European Union and other rich countries should make more serious efforts to capitalize on China’s willingness to be a stake holder in the nascent global order. None of the existing “G” groups (e.g. G-8, G-20) is well suited to effectively integrate China into global governance systems. Moreover, China—and major developing countries—have to be given much greater voice in multilateral agencies such as the IMF and the World Bank.

In the present situation, the greatest risk is that the international crisis will trigger cascading protectionism around the world, undermining both letter and spirit of the WTO and associated agreements. This would be catastrophic for many poor countries and make it harder to avoid depression in rich ones.

Notes

1. Chen Xiwen’s statement was based on a survey of rural migrants in 15 provinces conducted by his office in January 2009. The survey showed that 15.3 percent of respondents reported to have lost their job in 2008 or were unable to find employment. The government’s estimate of the total number of rural migrants in China is 130 million.

2. The estimated average labor/GDP elasticity from 2000-2007 was about 0.11. That means that every 1 percent of GDP growth generates employment growth of 0.11 percent. Total employment in China at the end of 2007 is officially estimated at about 770 million (about 5 times the U.S. labor force), including 276 million farm workers and 494 million non-agricultural workers. Official employment numbers for 2008 are not yet available. If GDP growth in 2009 is 7.5 percent, the associated increase in total employment would be 6-7 million jobs.

3. See for example: Richard Jackson & Neil Howe, The Graying of the Middle Kingdom. The Demographics and Economics of Retirement Policy in China. Center for Strategic & International Studies (CSIS) and Prudential Foundation, April 2004.