The End of Cheap Labor

• Author: Mitali Das and Papa N’Diaye
• Position: a Senior Economist in the IMF's Research Department, and is a Deputy Division Chief in the IMF's Asia and Pacific Department.­

Fast-rising wages, worker activism, and intermittent labor shortages suggest that China, whose economic rise has depended on a vast supply of low-cost labor, is about to enter a period of widespread labor shortages.Â

As China crosses the line from being an economy with plentiful low-cost labor to one with higher-cost workers, the implications for both China and the global economy could be far reaching.Â

For China, the transformation will likely mean that its extensive growth model—which relies heavily on increasing the number of workers involved in production (called factor input accumulation)—cannot be sustained. As a result, the world’s second largest economy will likely change to an intensive growth model that uses resources more efficiently and would rebalance growth away from investment and toward private consumption. Successful rebalancing in China would, in turn, have significant positive global effects—including increasing output in commodity exporters and in the regional economies that now are part of China’s supply chain. Even advanced economies would benefit (IMF, 2011). Importantly, rising labor costs—which would affect prices, incomes, and corporate profits in China—would have implications for trade, employment, and price developments in key trading partners. For instance, foreign manufacturers may find it increasingly less profitable to produce in China, raising their domestic employment; Chinese goods could become less competitive in global markets, potentially raising export shares elsewhere; and rising Chinese prices could pass through to trading partners that rely heavily on imports from China.Â

The future of cheap labor

Recent developments in the Chinese labor market seem somewhat contradictory. On the one hand, aggregate wage growth has remained about 15 percent during the past decade, and corporate profits have remained high. Wage growth lags productivity, resulting in rising profits, which suggests that China has not reached the so-called Lewis Turning Point (see box), at which an economy moves from one with abundant labor to one with labor shortages. At the same time, though, since the financial crisis began, industry has increasingly relocated from the coast to the interior, where the large reserve of rural labor resides. As a result, previously large gaps between the demand for and supply of registered city workers have progressively narrowed, and worker demand for higher wages and better working conditions has risen—suggesting the onset of a structural tightening in the Chinese labor market.Â

The Lewis Turning Point

In Sir Arthur Lewis’s seminal work (1954), developing economies are characterized by two sectors: a low-productivity

sector with excess labor (agriculture, in China’s case) and a high-productivity sector (manufacturing in China). The

high-productivity sector is profitable, in part, because of the surplus of labor it can employ cheaply because of the low

wages prevalent in the low-productivity sector. Because productivity increases faster than wages, the high-productivity

sector is more profitable than...