Real wages are canary in the coal mine

Chinese policymakers should be wary of changes that dramatically lower capital accumulation or savings rates

Rapid increases in wages are key to a beneficial cycle of continuous economic upgrading. Real wages (adjusted for inflation) in China went up on average by 11 percent a year from 1995 to 2015. This means the real living standard of the average Chinese worker multiplied more than eight times in 20 years - doubling about every six years - thus improving to an incredible extent the lifestyles and opportunities of workers.

Since the reforms implemented by former premier Zhu Rongji in the late 1990s, China's wages have been determined by market forces. Businesses could not pay higher wages without innovating into higher value-added products. In turn, the higher wages ensure there is rapidly growing domestic demand for more sophisticated Chinese products.

The development cycle works like this: Starting with a very poor economy, government financial policies create high savings and investment levels. This capital is used for initial industrial investments, which create opportunities for workers and other companies throughout the economy. Workers learn on the job, becoming more skilled and productive, and thus demand higher wages.

In order to pay these higher wages, companies must learn to make and sell more advanced products. Because the workers have higher incomes, they will be able to afford to buy the higher quality products. This generates company revenues and worker savings, which can be plowed back into another round of capital investment. So, the cycle begins again.

The other East Asian economies that achieved transformative growth out of dire poverty - Japan, South Korea and Taiwan - all went through this cycle during their high growth periods.

A competitive environment is essential. Companies that have to compete for workers and customers will both drive up wages and drive down prices. So, the benefits of a rising economy flow to workers, rather than to a few crony capitalists.

South Korea's president during its high growth period, Park Chung-hee, famously personally intervened to ensure that companies had to compete internationally if they wanted access to capital. Japan and, especially, China, are large enough to have lots of internal domestic competition.

The Chinese economy is highly competitive, compared with either other high-growth-stage East Asian countries or to developed economies. Japan had an average three-firm concentration ratio of 44.1 percent in 1962. South Korea's comparable ratio for all industries was 62.9 percent in the 1980s. The current Chinese four-firm concentration ratio is only 23 percent, according to research by Dylan Sutherland and Lutao Ning, of Nottingham University.

Similarly, the Organization for Economic Cooperation and Development concludes that the number of highly or moderately concentrated sectors in China declined from nearly 30 percent in the 1990s to only 14 percent in 2007, a lower level than in the supposedly highly competitive United States.

Rising wages are not an automatic result of economic growth. Brazil, for example, had high growth in the 1960s and '70s' and a commodity-driven boom from 2006 to 2011, but average wages stayed basically flat. Without a competitive market, the gains in the economy were captured by capital or land owners. Growth collapsed because there was no benevolent cycle of worker productivity and income increases.

The Chinese economic model is often criticized because consumption is a low percentage of GDP. But real consumption growth has averaged 9.6 percent a year over the past 20 years. Consumption seems low only because productivity and real wages have grown even faster.

Chinese policymakers should be wary of any changes that dramatically lower capital accumulation rates or savings rates. China's capital stocks per capita are still far below developed country standards, and abundant capital is needed for the ongoing industrial reform.

Both China and the US have had low interest rate regimes since around 2000. But their economies have taken very different paths. China has had high savings, high capital accumulation and high wage rate growth. The US has had low savings and very low wage rate growth. Why such a difference?

In China, low interest rates were caused by financial policies that led people to save and invest. This is "supply side" in that it actually creates more real capital.

Low interest rates in the US were caused by "aggregate demand side" monetary policy, which created liquidity but not savings and thus did not lead to capital accumulation.

The major effect of soft money in the US for the past 15 years has been asset appreciation. In the first half of the 2000s, we saw housing appreciation. Since 2009, the liquidity has gone into stock price appreciation. I fear that the lack of wage growth in the US economy is also caused by declining internal competition, so economic gains are going to a few capital owners, not to workers.

I'm optimistic that the Chinese government's industrial upgrading policies will allow industry to continue its transformation. But I am watching for a few warning signs. The huge flow of funds into housing speculation signals that people cannot find uses for their money in productive industry. Any increases in monopolization in the economy would also be a bad indicator.

Market-determined real wages are the canary in the coal mine. As long as they continue to grow, I'll be confident that the beneficial cycle is still going.

The author is a reporter with China Daily.

(China Daily European Weekly 06/09/2017 page9)