Rising unemployment challenges Beijing’s policy agility

·       Income growth has held up relatively well despite China’s ongoing economic slowdown. Sure, wage growth may have slowed – from 14.5% y/y in 2012 to 9.5% y/y in December 2015 – but pay rises have been outpacing GDP growth.

·       However, though workers have gained spending power, higher wages have not triggered an equivalent increase in productivity. And so, unit labour costs have risen, rapidly eroding China’s global competitiveness.

·       Deflation and slowing GDP growth accompanied by rising wage demands has squeezed corporate revenue growth down to record lows. Currently, from general equipment and automobile manufacturing, to consumer discretionary and staples, and industrials and technology, corporate profits are in the red.

·       Something has got to give. Facing diminished demand, whilst having built up high inventory levels and indebtedness, the logical progression is that the pain will manifest in the labour market. The labour market is already sending distress signals. Wages for migrant labour, which account for the majority of the work force in the beleaguered export and construction sector, slipped from high teens in 2009-2013, to just 7.2% in 2015. And migrants have seen zero net new jobs over the past 12 months. Meanwhile, the secondary sector has seen output growth slump from 5.8% in 2014 to just 0.9% in 2015, shedding over 4 million jobs.

·       After years of a policy-led drive to elevate minimum wages, Beijing has changed course. Finance Minister Lou Jiwei criticized labour laws as being “overly protective of “workers”, and stressed that wage inflation is “discouraging employers from creating jobs”. Prior to this, Guangdong, a manufacturing hub, announced a two-year freeze on minimum wages in February. Indeed, realizing the difficulties ahead, China’s 13th Five Year Plan aims to create 50 million jobs through 2019, which is less than the 63 million jobs created in the past five years.

·       A critical challenge facing the Xi administration in coming years is to absorb surplus, unproductive and retrenched labour into quality jobs. Employment in the state sector, which employs around 35 million people, could fall by 20% within the next two years. The starting point will be sectors with overcapacity (and high levels of pollution) – such as coal, steel, paper. Worryingly, at an annual GDP growth rate of 5% over the next five years, coupled with stable employment elasticity, urban unemployment could reach 8% per cent within three years.

·       It is accepted that the growth in the service sector is helping; in fact, over the past three years, every one percentage point of growth in services has seemed to create two million new jobs. However, casting job mismatches aside, as factories shed more and more employees, wages in the services sector will face downward pressure, complicating ambitions to boost domestic consumption. In addition, it is worrying that PMI for non-manufacturing mangers fell from 53.5 in January to 52.7 in February — the lowest reading since December 2008.